Business context and reporting period
Chimera Investment Corporation is an externally managed mortgage REIT investing primarily in Agency and Non-Agency residential mortgage-backed securities (RMBS) and securitized residential loans. This Form 10-Q covers the quarter and nine months ended September 30, 2012; it was signed and filed on November 27, 2013. Prior-period figures reflect a previously disclosed restatement.
Financial results and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Interest income | $144.7m | $185.6m | $455.9m | $537.5m |
| GAAP net interest income | $110.3m | $152.8m | $363.2m | $433.3m |
| Net income (loss) | $128.1m | ($60.0m) | $249.1m | $94.6m |
| Diluted earnings (loss) per share | $0.12 | ($0.06) | $0.24 | $0.09 |
| Dividends declared per common share | $0.09 | $0.13 | $0.29 | $0.40 |
- Margins: Economic net interest income, a company-defined non-GAAP measure including realized swap losses, was $105.0m for Q3 and $348.3m for nine months, down from $148.3m and $421.7m. Economic net interest spread was 1.07% and 2.52%, respectively, versus 3.96% and 3.63%.
- Cash flow: For nine months, operating activities provided $271.7m, investing activities provided $880.3m, and financing activities used $900.2m. Cash rose to $458.1m from $206.3m at year-end 2011.
- Balance sheet and leverage: At September 30, total assets were $7.54bn, total liabilities $4.12bn, and stockholders’ equity $3.42bn. Debt was approximately $3.9bn and debt-to-equity leverage was 1.2:1, compared with 1.5:1 at December 31, 2011. Repurchase agreements were $1.66bn; securitized debt was approximately $2.29bn and non-recourse to the Company.
- Portfolio: Interest-earning assets were $7.02bn at period-end. By principal value, the portfolio was 75.1% Non-Agency RMBS, 15.7% Agency RMBS, and 9.2% securitized loans. Non-Agency RMBS were predominantly below-B or unrated; the filing reports 97.71% in that category.
Material changes versus prior periods
- Net income improved substantially year over year, primarily because credit impairment charges were lower and realized gains on investment sales were higher. Q3 2012 included $69.2m of realized gains on RMBS sales, versus $58,000 in Q3 2011; nine-month gains were $85.2m versus $1.8m.
- Net interest income declined as interest income and portfolio yields fell. Management attributed the lower yield to a smaller share of higher-yielding RMBS and a greater share of lower-yielding securitized loans. Economic cost of funds rose to 3.61% in Q3 from 2.33% a year earlier.
- Agency RMBS fell to $2.0bn fair value from $3.1bn at year-end 2011; securitized loans held for investment grew to $1.14bn from $257m, following approximately $1.19bn of purchases. Cash and equity increased, while total assets and debt declined.
- Net credit impairment losses were $10.0m for Q3 and $124.1m for nine months, compared with $150.6m and $245.9m in 2011. The filing also reports $418.9m of nine-month other comprehensive income, largely reflecting unrealized securities gains.
Outlook, risks, contingencies and unusual items
- Management expected the portfolio to remain weighted toward Non-Agency RMBS, while adjusting asset allocation to market conditions. The filing provides no quantified earnings or margin guidance. The board declared a $0.09-per-share quarterly dividend for Q4 2012 and each of the first three quarters of 2013.
- Key exposures include Non-Agency credit losses, interest-rate and spread changes, prepayment and extension risk, collateral valuation, repo refinancing and margin calls, and counterparty performance. The Company reported a 5% weighted-average repo haircut and $1.66bn of repo borrowings, most maturing within 30 days. Its interest-rate sensitivity estimates apply to Agency RMBS and associated swaps only, not the full portfolio.
- Valuation and impairment depend on significant management estimates; Non-Agency RMBS are Level 3 fair-value assets. Management cautions actual results and realizable values may differ materially from estimates.
- Restatement and controls: The filing describes a material weakness involving technical accounting expertise and review of significant estimates; management concluded it was not remediated and disclosure controls were ineffective as of September 30, 2012 and the report date. The filing identifies additional presentation errors in prior-period OTTI disclosures, while stating the described corrections did not affect net income, EPS or cash flows.
- Legal and filing matters: An Audit Committee investigation into RMBS accounting was ongoing, and the board had received three shareholder derivative demand letters; outcomes were uncertain. Management reported no contingency requiring accrual. The late SEC filings restricted access to the Company’s equity distribution agreement and dividend reinvestment plan until it had filed timely for a full year.
- Related party: FIDAC, an Annaly subsidiary, manages the Company. Effective November 28, 2012, the management fee was reduced from 1.50% to 0.75% of gross stockholders’ equity until required filings were current. FIDAC also agreed to cover specified restatement and investigation costs, subject to insurance coverage.
- The Company reported that it believed it qualified as a REIT and met the applicable Investment Company Act exemption requirements. Loss of either status could adversely affect operations or financing.
Important facts for investors to verify
- Review the full restatement history, identified OTTI presentation errors, and whether the material weakness and ineffective controls were subsequently remediated.
- Assess the sustainability of earnings and dividends given declining net interest income and spread, the contribution of investment-sale gains, and the absence of quantified guidance.
- Verify Non-Agency RMBS valuation assumptions, credit performance, and the substantial Level 3 exposure, as well as the growth and credit quality of the loan portfolio.
- Monitor repo maturities, collateral haircuts and margin-call capacity, securitized-debt cash flows, and swap-counterparty exposures.
- Check the status and potential outcome of the Audit Committee investigation and shareholder demands, and confirm the effects of filing delays on capital-market access and management fees.