CHIMERA INVESTMENT CORP annual report, FY2013

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Chimera Investment Corporation — 2013 Form 10-K

Business and reporting period. Specialty finance REIT investing primarily in residential mortgage-backed securities (RMBS) and securitized residential loans; externally managed by FIDAC, an Annaly subsidiary. This annual report covers the year ended December 31, 2013, and was filed June 4, 2014. The filing was late and states the company had not yet filed its first-quarter 2014 Form 10-Q.

Financial performance and position

  • Income: 2013 interest income was $511.8 million and net interest income was $409.8 million, down from $589.4 million and $462.9 million, respectively, in 2012. Net income rose to $362.7 million ($0.35 per basic share) from $327.8 million ($0.32). The income increase mainly reflected lower other-than-temporary impairment (OTTI) losses, partly offset by lower net interest income.
  • Margins and returns: Annualized yield on average interest-earning assets was 8.81%; economic cost of funds, including realized hedge losses, was 3.51%; net interest spread was 5.30%, unchanged from 2012. Return on average equity was 10.55%, versus 9.95%.
  • Fourth quarter: Net interest income was $106.6 million and net income was $72.3 million ($0.06 per share). Q4 results included $22.5 million of net credit OTTI losses and $22.4 million of derivative gains.
  • Cash flow: Operating activities provided $304.8 million; investing activities provided $305.1 million; financing activities used $1.153 billion. Cash and cash equivalents fell to $77.6 million from $621.2 million. Management cited $260.2 million of unpledged, highly liquid Agency RMBS as an additional liquidity resource.
  • Balance sheet and debt: Total assets were $6.94 billion, total liabilities $3.60 billion, and shareholders’ equity $3.33 billion at year-end. Interest-bearing liabilities were $3.26 billion; reported debt-to-equity was 1.0:1 (1.1:1 in 2012). Debt comprised $1.66 billion of Agency RMBS repurchase agreements and $1.60 billion of non-recourse securitized debt.
  • Book value: GAAP book value was $3.24 per share, compared with $3.45 a year earlier. Management’s non-GAAP estimated economic book value was $2.82 per share, down from $3.05; management attributes the difference from GAAP primarily to consolidated securitization accounting.
  • Portfolio: At amortized cost, interest-earning assets were 49.8% Non-Agency RMBS, 36.1% Agency RMBS, and 14.1% securitized loans, versus 50.3%, 28.2%, and 21.5%, respectively, in 2012. The Non-Agency portfolio remained heavily exposed to lower-rated or unrated securities.

Material changes versus 2012

  • Net income increased 11%, while net interest income declined about 11%; average earning assets contracted and economic net interest income fell by $54.7 million.
  • Net credit OTTI losses declined to $45.2 million from $132.3 million. Management cited improved Non-Agency RMBS fair values and default expectations; it nevertheless expected some future OTTI.
  • Cash fell substantially as the company redeployed cash into investments, paid dividends, and repaid securitized debt. Total assets declined about $806 million and equity declined about $211 million.
  • Agency RMBS allocation increased and securitized loan allocation decreased. The company purchased $2.4 billion and sold $1.2 billion of Agency and Non-Agency RMBS during 2013, and received $1.5 billion in principal payments.
  • Management fees were reduced to 0.75% of defined gross stockholders’ equity until SEC filings become current. Net management fees were $19.2 million, compared with $44.8 million in 2012, after manager reimbursements for restatement-related costs.

Outlook, risks, and unusual matters

  • Outlook and dividends: Management expected to increase earning assets and leverage in 2014, primarily through repurchase financing, subject to investment opportunities and market conditions. The board declared $0.09 per share for each 2014 quarter; a $0.20 special dividend declared for 2013 was paid in January 2014. Future distributions remain discretionary and depend on taxable income, liquidity, financing terms, and REIT requirements.
  • Subsequent events: After March 31, 2014, the company sold its CSMC 2010-12R interests for approximately $580 million and subsequently increased its Agency portfolio by approximately $4 billion, financed primarily with repurchase agreements.
  • Reporting and controls: The company disclosed material weaknesses in internal control over financial reporting, including ineffective or insufficiently evidenced reviews, delayed validation of significant estimates, and overreliance on manually maintained spreadsheets. Management concluded controls were ineffective at December 31, 2013; Ernst & Young issued an adverse opinion on internal control. The auditor gave an unqualified opinion on the financial statements.
  • Late filings and capital access: The late 10-K and missing Q1 2014 filing limited access to public capital markets, including use of Form S-3 until the company had timely filed for a full year. The company had withdrawn licenses in some jurisdictions, constraining certain loan-purchase and securitization strategies.
  • Restatement-related matters: The filing describes prior restatements and immaterial corrections to certain prior-period presentations, shareholder derivative demand letters, and an ongoing investigation. FIDAC agreed to cover specified restatement and investigation expenses not covered by insurance; the company also noted potential additional costs and litigation. No contingency requiring accrual or disclosure was identified in the financial statement note.
  • Principal risks: Credit losses in subordinated Non-Agency RMBS; interest-rate, spread, prepayment and extension risk; margin calls and short-term refinancing dependence; illiquid and model-valued assets; counterparty exposure; geographic concentration; and maintaining REIT and Investment Company Act exemptions. About 65% of recurring fair-value assets were Level 3 at year-end.

Important facts for investors to verify

  • Whether the company became current with SEC filings, regained Form S-3 eligibility, and remediated the disclosed control weaknesses.
  • How the subsequent $4 billion Agency portfolio increase affected leverage, funding costs, liquidity, and exposure to margin calls.
  • Whether the $0.09 quarterly dividend was supported by REIT taxable income and recurring cash generation, rather than nonrecurring gains or accounting estimates.
  • The assumptions and sensitivity underlying Level 3 Non-Agency RMBS values, OTTI estimates, and the $2.82 estimated economic book value per share.
  • The status and financial consequences of shareholder demands, related investigations, and the manager’s reimbursement of restatement expenses.