Chimera Investment Corporation — 2015 Form 10-K
Reporting period: Fiscal year ended December 31, 2015. The filing also reports results for the fourth quarter. Chimera is a mortgage REIT investing on a leveraged basis in Agency and Non-Agency mortgage-backed securities (MBS) and securitized residential mortgage loans.
Financial performance and position
- FY 2015: Interest income was $872.7 million, interest expense $259.4 million, and net interest income $613.4 million. Net income was $250.3 million, or $1.25 per basic share, down from $589.2 million, or $2.87 per share, in 2014.
- Fourth quarter: Net income was $115.4 million, or $0.61 per share, versus a $48.3 million net loss in Q3 2015 and $6.5 million net income in Q4 2014. Q4 net interest income was $137.0 million.
- Margins: Management reported a 3.5% annual net interest rate spread and 3.9% net interest margin, compared with 4.4% and 4.9%, respectively, in 2014. The average yield on interest-earning assets declined to 6.0% from 6.9%; average cost of funds was 2.5% in both years.
- Core earnings: The filing’s reconciliation reports FY 2015 core earnings of $472.4 million, or $2.37 per basic share, versus $440.6 million, or $2.14, in 2014. Core earnings are non-GAAP. The selected financial data elsewhere gives 2014 core earnings per share as $1.95, an inconsistency to verify.
- Cash flow: Operating activities provided $396.3 million, investing activities provided $2.0 billion, and financing activities used $2.5 billion. Cash and cash equivalents ended the year at $114.1 million, down from $164.6 million.
- Balance sheet and leverage: Total assets were $15.3 billion, total liabilities $12.4 billion, and stockholders’ equity $2.95 billion. GAAP book value was $15.70 per share; management’s estimated economic book value was $14.65 per share. Debt-to-equity was 4.0:1, up from 3.8:1; recourse leverage was 2.7:1.
- Dividends and repurchases: Chimera declared $1.92 per share in 2015, up from $1.80 in 2014. It repurchased approximately 18 million shares for $250 million. The first-quarter 2016 dividend was declared at $0.48 per share, and management expected to maintain that quarterly rate for the rest of 2016.
Material changes versus 2014
- Net income fell sharply, primarily because fair-value financial instruments shifted from a $193.5 million unrealized gain in 2014 to a $158.4 million unrealized loss in 2015. Net losses on derivatives improved to $114.6 million from $186.3 million.
- Net interest income increased, but interest expense rose substantially as the company expanded securitized subprime loan holdings and increased financing. Seasoned subprime securitized loans generated $287.7 million of 2015 interest income, versus $103.5 million in 2014.
- The portfolio mix shifted: Agency MBS declined to 46% of interest-earning assets at amortized cost from 52%; Non-Agency RMBS rose to 20% from 16%; securitized residential loans were 34%, versus 32%. Chimera reduced Agency MBS exposure by more than $2.5 billion and increased Agency CMBS to $952 million.
- Chimera internalized management in August 2015, ending its management agreement with FIDAC without a termination fee. It hired employees, assumed operating costs, and completed the transition by year-end, although certain transition services continued through February 2016. Management expected lower ongoing expenses than under the external model; 2015 included $9 million of internalization transition costs.
- Adoption of new accounting guidance for certain consolidated financing entities led to fair-value accounting for related loans and debt and a $12.1 million reduction in opening equity.
Outlook, risks, and unusual items
- Management described interest-rate markets as volatile and said it would adjust asset allocation as market conditions change. No quantified earnings or portfolio guidance is provided. The $0.48 quarterly dividend expectation for 2016 is not a guarantee.
- In the first quarter of 2016, a resolution of claims related to the prior Non-Agency RMBS accounting review was reached; Chimera expected to recover $95 million, characterize it as 2016 taxable income, and declare a special dividend after receipt.
- Key risks include leverage and short-term repo funding, collateral margin calls, higher borrowing costs, interest-rate and yield-curve movements, prepayment and extension risk, credit losses on Non-Agency and subprime assets, concentrated geographic exposure, illiquid and model-valued holdings, counterparty risk, and the effectiveness of hedges.
- Approximately 55% of recurring fair-value assets were Level 3 at year-end, requiring significant unobservable inputs. Non-Agency RMBS exposure was concentrated in California, Florida, New York, and New Jersey, which together represented 48.9% of that portfolio.
- The company reported that a previously identified material weakness in controls over complex spreadsheets was remediated in 2015. Management and the auditor concluded internal control over financial reporting was effective at year-end; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Reconcile the filing’s inconsistent 2014 core-earnings-per-share figures ($2.14 in the reconciliation versus $1.95 in selected financial data).
- Review the $95 million expected recovery, its receipt and tax treatment, and whether and when the special dividend is declared.
- Assess whether the $0.48 quarterly dividend is supported by taxable income, recurring cash generation, and funding availability.
- Examine repo maturities, collateral haircuts, margin-call capacity, counterparty exposures, and leverage as rates and asset values change.
- Evaluate Level 3 valuation assumptions, subprime loan delinquency and loss trends, geographic concentrations, and the gap between GAAP and estimated economic book value.