Business context and reporting period
Chimera Investment Corporation filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. It is an internally managed REIT investing with leverage in Agency and Non-Agency mortgage-backed securities (MBS) and residential mortgage loans. During 2016, the company shifted its portfolio toward residential credit assets, particularly seasoned subprime loans, and away from Agency MBS.
Financial results and condition
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Interest income | $251.0 million | $211.9 million | $673.2 million | $670.8 million |
| Interest expense | $94.9 million | $67.9 million | $241.1 million | $194.4 million |
| Net interest income | $156.0 million | $144.0 million | $432.1 million | $476.4 million |
| Net income (loss) | $172.8 million | ($48.3 million) | $330.0 million | $135.0 million |
| Diluted earnings per share | $0.92 | ($0.24) | $1.76 | $0.66 |
Q3 economic net interest income, a company-defined non-GAAP measure, was $151.3 million versus $134.7 million; the economic net interest rate spread was 3.6% versus 3.4%. For the nine-month period, economic net interest income was $407.2 million versus $442.1 million and the spread was 3.4% versus 3.6%. Q3 core earnings were $128.6 million, or $0.68 per basic share, versus $107.8 million, or $0.54.
For the nine months, operating cash flow was $263.9 million, investing cash flow was a use of $1.5 billion, and financing cash flow was a source of $1.3 billion. Cash and cash equivalents were $156.6 million at September 30, up from $114.1 million at December 31, 2015.
At September 30, total assets were $17.17 billion, liabilities $14.13 billion, and stockholders’ equity $3.04 billion. Repurchase agreements were $5.82 billion, down from $7.44 billion at year-end; loan-backed securitized debt at fair value was $7.19 billion, up from $3.72 billion. GAAP leverage was 4.4:1 versus 4.0:1; recourse economic leverage was 2.1:1 versus 2.7:1. Book value was $16.18 per common share; management’s non-GAAP estimated economic book value was $14.90 per share.
Material changes versus prior periods
- Q3 net income improved by $221 million year over year, principally because derivative results swung to a $13.4 million gain from a $92.7 million loss and fair-value instrument gains increased; net interest income also rose by $12.1 million.
- Nine-month net income rose by $195.1 million, reflecting fair-value gains and a one-time $95 million recovery from remedies related to prior Non-Agency RMBS accounting matters. These benefits were partly offset by derivative losses of $170.9 million.
- Interest-bearing asset mix shifted materially: securitized loans were 56% of interest-earning assets at amortized cost versus 34% at year-end 2015; Agency MBS fell to 27% from 46%. The company acquired approximately $5.0 billion of seasoned subprime loans in the second quarter and consolidated the related trusts.
- Common dividends declared for the first nine months were $1.94 per share, including a $0.50 special dividend, versus $1.44 in the prior-year period. Q3 dividends were $0.48 per share in both years.
Outlook, risks, contingencies and unusual items
Management said it expects to adjust asset allocation as interest-rate and credit conditions change and intends to pursue risk-adjusted returns and regular dividends; the filing provides no quantified earnings or dividend guidance. Management stated that available assets and borrowing arrangements should meet anticipated short-term liquidity needs, but falling collateral values could trigger margin calls and force asset sales or new financing.
Key risks include interest-rate and spread movements, mortgage prepayments and extensions, credit losses and delinquencies, reliance on short-term repurchase financing, collateral haircuts and margin calls, counterparty exposure, and subjective Level 3 fair-value estimates. The seasoned subprime loan portfolio had $1.01 billion of reported delinquent, bankruptcy, foreclosure and REO principal balances; the filing reports fair value of $400 million for loans 90 or more days past due. Non-Agency RMBS remained highly credit-risk exposed: 91.2% was rated below B or unrated. One repo counterparty represented 16% of equity at risk.
After quarter-end, Chimera called $563 million of loan-backed securitized debt at par and issued 5.8 million Series A preferred shares at an 8% dividend rate, receiving $140 million net. The preferred shares rank ahead of common stock for dividends and liquidation distributions. Management reported no material changes to previously disclosed risk factors, no legal proceedings, no contingencies requiring accrual or disclosure, and effective disclosure controls.
Most important facts for investors to verify
- Whether core earnings, distributable taxable income and future common dividends support the declared payout; these measures differ from GAAP net income.
- Performance, valuation assumptions and delinquency trends for the rapidly expanded seasoned subprime loan portfolio, including the impact of loan purchases and trust consolidation.
- Repo funding availability, haircuts, margin requirements, counterparty concentration and the company’s ability to manage leverage under adverse market conditions.
- The sustainability of reported earnings after excluding fair-value movements and the nonrecurring $95 million recovery, and the effect of derivative settlements and hedge performance.
- The costs and priority claims associated with the new preferred shares, and the timing and impact of the post-quarter debt call.