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 mortgage loans. This Form 10-Q covers the quarter ended March 31, 2015; comparisons are with the quarter ended March 31, 2014 unless stated otherwise. Annaly Capital Management owned approximately 4.4% of Chimera’s shares and its subsidiary FIDAC was the manager.
Financial performance and position
| Metric | Q1 2015 / March 31, 2015 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $243.1 million | $120.7 million |
| Net interest income | $182.7 million | $98.2 million |
| Net income; diluted EPS | $67.0 million; $0.33 | $100.4 million; $0.50 |
| Core earnings, non-GAAP; per basic share | $120.2 million; $0.59 | $82.9 million; $0.40 |
| Economic net interest income, non-GAAP | $167.2 million | $92.6 million |
| Economic net interest spread / margin | 4.0% / 4.4% | 5.1% / 6.6% |
| Cash and cash equivalents | $119.5 million | $164.6 million at December 31, 2014 |
| Total assets / stockholders’ equity | $17.34 billion / $3.52 billion | $19.16 billion / $3.61 billion at December 31, 2014 |
| Repurchase agreements / total debt-to-equity leverage | $8.30 billion / 3.7:1 | $8.46 billion / 3.8:1 at December 31, 2014 |
| Recourse leverage | 2.6:1 | 2.6:1 at December 31, 2014 |
| Operating / investing / financing cash flow | $34.0 million / $396.4 million / $(475.5) million | $64.0 million / $435.7 million / $(536.8) million |
| Dividend declared | $0.48 per share; $98.7 million | $0.45 per share; $92.5 million |
All dollar amounts are U.S. dollars. The filing reports financial statement amounts in thousands unless otherwise indicated. The company also disclosed estimated economic book value of $3.23 billion, or $15.70 per share, versus GAAP book value of $3.52 billion, or $17.14 per share; management cautions that economic book value is a non-GAAP estimate, not a substitute for GAAP book value.
Material changes versus prior comparable period
- Net income fell $33 million, while net interest income rose $84 million. The decline primarily reflected $68.6 million of realized losses on swap terminations and higher realized derivative losses overall.
- Interest income more than doubled as the portfolio and financing expanded, notably Agency RMBS and securitized loans. Interest expense also rose substantially with higher borrowing and securitized debt balances. Economic net interest income increased, but the economic spread narrowed to 4.0% from 5.1%, and the economic margin fell to 4.4% from 6.6%.
- Net derivative losses were $106.6 million, compared with $7.9 million in Q1 2014. Realized net losses included $68.6 million from swap terminations; unrealized derivative gains were $4.1 million.
- Other-than-temporary credit impairment losses were $7.8 million, versus $1.5 million. Other comprehensive income was a loss of $41.2 million, compared with income of $30.7 million, contributing to comprehensive income of $25.9 million versus $131.0 million.
- Portfolio allocation shifted: Agency RMBS were 47.5% of interest-earning assets at amortized cost, down from 52.1% at year-end; Non-Agency RMBS were 7.9%, up from 5.1%; and securitized loans at fair value were 33.7%, up from 28.5%. The company reported $1.7 billion of asset purchases, $2.2 billion of sales and $581 million of principal payments during the quarter.
- On January 1, 2015, Chimera adopted accounting guidance for qualifying consolidated collateralized financing entities and elected fair value treatment for related loans and debt. Adoption reduced equity by $12.1 million. A 1-for-5 reverse stock split became effective after quarter-end on April 6, 2015; reported historical per-share amounts reflect the split.
Outlook, risks, contingencies and unusual items
- No specific earnings or dividend guidance was provided. Management said it expects to continue financing investments largely through repurchase agreements and securitizations, and to meet liquidity needs principally from portfolio cash flows. It intends to pay regular quarterly dividends, subject to operating and debt-service requirements and REIT distribution requirements.
- Management said current cash, portfolio assets and borrowing arrangements were expected to cover anticipated short-term liquidity needs, but warned that falling collateral values could trigger margin calls and require asset sales, potentially at a loss. Repurchase agreements totaled $8.30 billion, had a 65-day weighted-average maturity, and $5.61 billion matured within 1–29 days. Agency and Non-Agency repo haircuts averaged 5.2% and 30.1%, respectively.
- Key exposures include interest-rate, prepayment, extension, basis, credit, real-estate-value, market-liquidity and counterparty risks. The portfolio is leveraged and depends substantially on short-term repo financing; hedges may not offset changes in funding costs or asset values. Non-Agency RMBS and seasoned subprime loans carry credit risk, and substantial portfolio valuations rely on Level 3 inputs and management assumptions. At March 31, 91.3% of the Non-Agency RMBS portfolio was rated below B or unrated.
- The company reported a material weakness in internal controls over financial reporting, arising from reliance on spreadsheets with manual inputs and complex calculations. It was not fully remediated as of March 31, 2015, and disclosure controls were not fully effective. Management said it was implementing and testing new systems, with completion targeted during 2015.
- Because of delayed SEC filings, Chimera said it was not then eligible to file a new Form S-3, potentially limiting its ability to access public capital quickly. The filing also describes historical shareholder derivative demands and ongoing Audit Committee remedies against other parties; management reported no contingency requiring accrual or disclosure at quarter-end.
- FIDAC’s management fee was increased to 1.20% of gross stockholders’ equity effective August 2014; Q1 management fee expense was $10.3 million versus $6.2 million. Terminating or not renewing the management agreement may trigger a termination fee, subject to stated exceptions.
- After quarter-end, Chimera exercised a call option to retire $230 million principal amount of securitized debt at par. It also disclosed a $300 million commitment to fund commercial MBS projects over three years.
Important facts for investors to verify
- Reconcile the stated swap-termination notional: the notes say $575 million, while MD&A describes seven terminated swaps totaling $525 million; confirm the amount and related $68.6 million loss.
- Assess the recurring earning power behind $120.2 million of core earnings versus $67.0 million of GAAP net income, including the company’s non-GAAP adjustments and derivative cash costs.
- Review the narrowing spread and margin alongside portfolio mix, borrowing costs, leverage and the large share of short-dated repo financing.
- Evaluate liquidity under margin-call and refinancing stress, including collateral haircuts, counterparty exposures and the concentration of repo maturities.
- Examine assumptions supporting Level 3 asset and debt valuations, Non-Agency credit estimates, loan delinquency trends and the $12.1 million accounting-adoption adjustment.
- Track remediation of the material weakness, SEC filing eligibility and access to capital markets, as well as the effect of management fees and potential termination costs.