Chimera Investment Corporation — Q2 2014 Form 10-Q
Business context and period. Chimera is an externally managed mortgage REIT investing primarily in Agency and Non-Agency residential mortgage-backed securities (RMBS) and securitized residential loans. This report covers the quarter and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013. Dollar figures below are in millions unless stated otherwise.
Key financial results and position
- Q2 earnings: Net income was $104.8 million, or $0.10 per diluted share, versus $143.2 million, or $0.14, in Q2 2013. For the first six months, net income was $205.1 million, or $0.20 per share, compared with $223.0 million, or $0.22, a year earlier.
- Interest income and margin: Q2 net interest income was $113.6 million versus $101.0 million. Economic net interest income, a company-defined non-GAAP measure that includes realized swap interest costs, was $101.6 million versus $95.6 million. Q2 economic net interest margin fell to 5.93% from 6.59%, and the net interest rate spread declined to 4.92% from 5.16%. For the six months, economic net interest income was $194.2 million versus $187.0 million; net interest margin was 6.28% versus 6.34%.
- Cash flow: Operating activities provided $34.2 million in the first half, down from $136.1 million. Investing activities used $3.33 billion, while financing activities provided $3.30 billion. Cash ended at $73.9 million, compared with $77.6 million at year-end.
- Assets, equity and book value: Total assets were $12.57 billion and stockholders’ equity was $3.44 billion, versus $6.94 billion and $3.33 billion at year-end. GAAP book value was $3.35 per share. Management’s non-GAAP estimated economic book value was $3.09 per share; the $0.26-per-share difference from GAAP book value primarily reflects its treatment of consolidated securitization trusts.
- Debt and leverage: Repurchase agreements rose to $5.56 billion from $1.66 billion; total debt was approximately $7.0 billion, including securitized debt. Period-end debt-to-equity leverage increased to 2.6:1 from 1.0:1; recourse leverage was 2.4:1 (the filing also cites 0.5:1 at year-end in one table and 0.6:1 in MD&A). Repo financing carried a 0.44% weighted-average borrowing rate and a 75-day weighted-average remaining maturity at quarter-end.
- Dividend: Chimera declared $0.09 per common share for Q2, unchanged from Q2 2013; first-half declarations totaled $0.18 per share. Approximately $390 million of dividends were paid in the first half, including special dividends declared in 2013 and paid in Q1 2014.
Material changes versus prior periods
- Chimera substantially expanded Agency RMBS holdings, primarily during Q2. Agency RMBS rose to 70.1% of the portfolio at amortized cost from 36.1% at year-end, while Non-Agency RMBS declined to 23.5% from 49.8% and securitized loans to 6.4% from 14.1%. The company said it purchased approximately $4.5 billion of investments in the first half, primarily Agency RMBS.
- Higher portfolio size lifted Q2 net interest income, but the shift toward lower-yielding Agency RMBS reduced the overall asset yield and net interest margin. Management reported a Q2 average asset yield of 7.84%, down from 8.80% a year earlier.
- Derivative results reversed: Q2 derivatives generated a $42.3 million net loss versus a $7.8 million gain in Q2 2013; first-half results were a $50.2 million loss versus a $7.7 million gain. Management attributed the reversal to larger hedge positions as leverage increased and falling interest rates during Q2.
- Q2 results included a $47.8 million gain on deconsolidation of a securitization vehicle. First-half results also included a $2.2 million loss on extinguishment of securitized debt and $6.9 million of net other-than-temporary credit impairment losses.
Outlook, risks and unusual items
- The board declared that quarterly dividends would be $0.09 per share for each of Q3 and Q4 2014. The filing gives no earnings or portfolio-return guidance.
- Management expected to continue financing the portfolio largely through repurchase agreements and securitizations. It said current assets, leverage and borrowing arrangements were expected to cover anticipated short-term liquidity needs, while warning that falling collateral values could cause margin calls and force asset sales, potentially at a loss. About $2 billion of Agency RMBS purchases were due to settle in July 2014, financed with new repos.
- Key exposures include interest-rate and spread changes, mortgage prepayments and extension risk, credit losses on Non-Agency RMBS, repo refinancing and collateral requirements, derivative counterparty risk, and illiquid or model-valued securities. At June 30, 92.3% of the rated Non-Agency RMBS portfolio was below B or unrated. Management’s interest-rate sensitivity estimates are model-based and may differ materially from actual outcomes.
- Fair-value estimates for Non-Agency RMBS rely on significant unobservable assumptions, including prepayments, defaults, loss severities and discount rates. Management cautioned that actual conditions may differ from estimates.
- Controls and legal matters: Previously identified material weaknesses in internal controls were not fully remediated, and disclosure controls were deemed ineffective at June 30. The filing describes derivative demand letters related to prior accounting and restatements; the Audit Committee said it had reached an understanding with FIDAC while pursuing additional remedies against other parties. Management reported no contingencies requiring accrual or disclosure at quarter-end.
- Post-quarter management agreement: Effective August 8, 2014, the management fee increased to 1.20% of gross stockholders’ equity, and FIDAC agreed to a one-time payment of approximately $24 million. The amended agreement has a two-year term and provides for a termination fee in specified non-renewal or termination circumstances.
Important facts for investors to verify
- How the expanded Agency RMBS portfolio and higher repo leverage affect future net interest income, margins, and sensitivity to interest rates and collateral calls.
- Whether derivative losses persist, and how hedge gains and losses compare with changes in the underlying portfolio’s economics.
- The assumptions and valuation support for Non-Agency RMBS, related impairment estimates, and management’s non-GAAP economic book value.
- The July settlement and financing of the approximately $2 billion in Agency RMBS purchases, and the company’s ongoing liquidity and repo maturity profile.
- Progress in remediating material weaknesses, the status and potential cost of the accounting-related investigations and claims, and the implications of the amended FIDAC agreement and fee structure.
- The filing’s differing year-end recourse leverage figures (0.5:1 and 0.6:1) and the stated June 30 repo maturity figures across disclosures.