Business context and reporting period
Chimera Investment Corporation’s Form 10-K covers the fiscal year ended December 31, 2010; it is an annual report, not a standalone fourth-quarter filing. Chimera is an externally managed mortgage REIT investing primarily in residential mortgage-backed securities (RMBS). Its stated objective is long-term risk-adjusted returns, primarily through dividends. The financial statements were audited by Deloitte & Touche, which issued unqualified opinions on the statements and internal control over financial reporting.
Key financial metrics
| Metric | 2010 | 2009 |
|---|---|---|
| Net interest income | $603.2 million | $263.5 million |
| Net income | $532.9 million; $0.65 per diluted share | $324.0 million; $0.64 per diluted share |
| Comprehensive income | $907.3 million | $490.9 million |
| Dividends declared per share | $0.69 | $0.43 |
| Net cash from operating activities | $305.6 million | $168.7 million |
For the quarter ended December 31, 2010, net income was $156.2 million and net interest income was $154.1 million. The filing provides quarterly results but does not report quarterly earnings per share in the supplied text.
For 2010, average earning-asset yield was 8.91%, average cost of funds was 4.01%, and net interest spread was 4.90%. The reported 2010 interest income includes $192.6 million from consolidated securitization entities and related interest expense of $115.1 million; their net interest contribution was $77.5 million.
At year-end, total assets were $8.07 billion, total liabilities $4.39 billion, and stockholders’ equity $3.68 billion. GAAP book value was $3.59 per share; management’s non-GAAP estimated economic book value was $3.23 per share, a $374.5 million equity adjustment principally related to retained subordinated interests in re-securitizations. Debt-to-equity was 1.1:1; recourse leverage was 0.5:1. Repurchase agreements were $1.81 billion and securitized debt, including non-retained debt presented under consolidation accounting, was about $2.25 billion. Cash and cash equivalents were $7.2 million.
Investing activities used $1.58 billion of cash; financing activities provided $1.26 billion. Chimera raised approximately $1.31 billion net through 2010 common-stock offerings. It declared $577.5 million of common dividends for the year.
Material changes versus the prior comparable period
- Net income rose $208.9 million, while net interest income increased $339.7 million. Management attributed much of the increase to portfolio growth and the consolidation of re-securitization entities under ASC 810, adopted January 1, 2010.
- The accounting change added $2.33 billion of non-retained RMBS assets and $1.96 billion of associated non-recourse securitized debt to the year-end balance sheet. It also reduced opening retained earnings by $88.2 million, or $0.13 per share, and increased 2010 net interest income by approximately $0.09 per weighted-average share.
- Portfolio mix shifted further toward non-Agency RMBS: 83.4% of principal value at year-end versus 64.6% in 2009. Agency RMBS declined to 12.6% from 23.3%, and securitized loans to 4.0% from 12.1%.
- Annualized yield on average earning assets increased from 6.90% to 8.91%, while average cost of funds increased from 2.03% to 4.01%; net interest spread was broadly steady at 4.90% versus 4.87%.
- Realized gains on investment sales fell to $10.1 million from $103.6 million. Net other-than-temporary credit impairment losses were $12.7 million, compared with $10.0 million in 2009. Available-for-sale securities generated $374.4 million of other comprehensive income in 2010.
- Common shares outstanding increased from 670.4 million to 1.027 billion, reflecting equity issuance. Dividends declared per share rose from $0.43 to $0.69.
Outlook, commentary, risks and unusual items
Management expected the portfolio to remain weighted toward RMBS in the near term and said current assets, leverage and borrowing arrangements were expected to cover anticipated short-term liquidity needs. This assessment is conditional: market-value declines, margin calls, slower-than-expected prepayments, or difficulty renewing or replacing financing could create liquidity pressure. The filing gives no specific earnings, spread, or dividend forecast; dividends remain subject to board discretion and available cash.
- Credit and concentration: Non-Agency RMBS are not federally guaranteed and expose Chimera to borrower defaults and collateral losses. The filing says 99% of non-Agency RMBS collateral was categorized as Alt-A; California represented 57.8% of reported non-Agency geographic concentration. Nearly half of the RMBS rating mix was below B or not rated, a figure that includes non-retained securities consolidated for accounting purposes.
- Interest rates and prepayments: Rising short-term rates may raise funding costs faster than asset yields adjust; mortgage rate caps and asset-liability repricing mismatches may further compress earnings. Prepayment changes can alter premium amortization, discount accretion and asset duration. Management’s sensitivity analysis estimated that a parallel 75-basis-point increase would raise projected net interest income 13.12% but reduce portfolio value 5.04%; a 75-basis-point decrease would reduce projected net interest income 22.71% and increase portfolio value 5.21%. These are model estimates, not forecasts.
- Funding and valuation: Repurchase funding is short-term and generally uncommitted, with collateral margin-call exposure. Illiquid RMBS valuations rely on models and dealer/pricing-service inputs; sale proceeds may differ from reported fair values. Management cautions that economic book value is a non-GAAP estimate and not a substitute for GAAP book value.
- Accounting and impairment: Consolidation of re-securitization trusts materially changed reported assets, liabilities and income without corresponding recourse to Chimera for the non-retained debt. Some retained subordinated interests are illiquid and absorb losses before senior securities. 2010 included $12.7 million of credit impairment recognized in earnings and $41.7 million of non-credit impairment recognized in other comprehensive income.
- Management and regulation: Chimera depends on FIDAC, an Annaly subsidiary, and pays a 1.50%-per-year management fee based on defined stockholders’ equity, regardless of portfolio performance. The filing identifies potential conflicts involving Annaly, FIDAC and affiliated investment vehicles. REIT qualification and exemption from Investment Company Act registration are ongoing requirements; regulatory changes, including Dodd-Frank rulemaking and potential housing-finance reform, could affect operations.
- Subsequent event: On January 28, 2011, Chimera entered an equity distribution agreement permitting sales of up to 125 million common shares through UBS. The Treasury’s February 2011 housing-finance proposals to limit or wind down Fannie Mae and Freddie Mac were also identified as a potential risk, with impact not yet determinable.
Chimera reported no material litigation or known material contingencies at December 31, 2010. Management reported effective disclosure controls and internal control over financial reporting. The company recorded $752,000 of 2010 federal REIT excise tax related to a shortfall in 2009 distributions.
Most important facts for investors to verify
- Reconcile the impact of ASC 810 consolidation on reported assets, liabilities, earnings and cash flows, and distinguish retained economic exposures from non-retained trust interests.
- Review the basis and sensitivity of the $3.23 estimated economic book value per share versus $3.59 GAAP book value, including valuation assumptions for illiquid retained tranches.
- Assess credit performance and concentration in non-Agency/Alt-A RMBS, including California exposure, delinquencies, impairments and realized principal write-downs.
- Check current financing counterparties, repo maturities, collateral haircuts, margin-call capacity, recourse leverage and the cost and availability of replacement funding.
- Evaluate whether earnings and dividends are sustainable after separating recurring spread income from accounting changes, fair-value movements, asset-sale gains and equity issuance.
- Monitor potential dilution from the 125 million-share distribution agreement, as well as REIT qualification, regulatory developments and the management agreement’s renewal and related-party terms.