Chimera Investment Corporation — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; comparative periods ended June 30, 2016. Chimera is an internally managed mortgage REIT investing with leverage in Agency and Non-Agency mortgage-backed securities (MBS) and residential mortgage loans.
Financial results and position
| Metric | Q2 2017 / June 30, 2017 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $288.6 million | $221.1 million in Q2 2016 |
| Interest expense | $138.0 million | $83.2 million in Q2 2016 |
| Net interest income | $150.7 million | $137.9 million in Q2 2016 |
| Net income | $115.0 million; $0.56 per common share | $74.1 million; $0.39 per share in Q2 2016 |
| Six-month net income | $277.8 million; $1.40 per common share | $157.2 million; $0.84 per share in H1 2016 |
| Economic net interest spread and margin | 2.7% spread; 3.2% margin | 3.4% and 3.6%, respectively, in Q2 2016 |
| Assets / liabilities / equity | $20.82 billion / $17.24 billion / $3.58 billion | At June 30, 2017 |
| Debt and leverage | $16.03 billion total debt; 4.5:1 GAAP leverage and 1.7:1 recourse leverage | 4.1:1 and 1.8:1, respectively, at December 31, 2016 |
| Cash and cash equivalents | $168.7 million | $177.7 million at December 31, 2016 |
For the six months, operating activities provided $183.3 million of cash, investing activities used $3.34 billion, and financing activities provided $3.15 billion. Cash decreased by $9.0 million. Common dividends declared were $0.50 per share in Q2 and $1.00 per share for H1 2017; Q2 2016 included a special dividend, making its H1 total $1.46 per share.
Material changes versus prior periods
- Chimera continued shifting its portfolio toward residential credit loans: loans were 66.7% of interest-earning assets at amortized cost at June 30, versus 55.7% at year-end 2016; Agency MBS declined to 21.0% from 27.7%, and Non-Agency RMBS to 6.9% from 9.0%.
- Loans held for investment increased to $13.26 billion from $8.75 billion, including substantial purchases of seasoned residential mortgage loans and consolidation of loan securitization trusts.
- Interest income rose, largely with loan growth, but interest expense increased faster in percentage terms as debt balances and funding rates rose. The economic net interest spread and margin narrowed year over year.
- H1 GAAP earnings benefited from higher fair-value gains and lower swap termination losses than in 2016, while comparison was affected by a $95 million one-time receipt in H1 2016 that did not recur.
Outlook, risks, contingencies and unusual items
- Management described pursuing high-yielding residential credit investments while seeking durable dividends and protecting book value. No specific earnings, dividend or portfolio guidance was provided.
- Management reported book value per common share of $16.54 at June 30, up from $16.20 at March 31, attributing the increase to strength in residential credit markets, particularly loans.
- Rising rates and LIBOR, changing prepayments, credit deterioration, real estate values, financing availability, collateral haircuts and counterparty exposure may affect earnings, liquidity and asset values. Q2 average one-month and six-month LIBOR increased 66 and 52 basis points, respectively, year over year.
- Management’s modeled Agency MBS sensitivity estimated economic net interest income declines of 4.71% for a 50-basis-point rate increase and 11.76% for a 100-basis-point increase; estimated portfolio-value declines, including hedges, were 1.00% and 2.15%. These are model estimates, not forecasts, and actual outcomes may differ materially.
- A $48 million loss was recorded on extinguishment of loan-backed securitized debt acquired during Q2. The company issued Series B preferred stock, raising $314 million net, with an 8% initial dividend rate; preferred dividends are senior to common dividends.
- The filing disclosed a $605 million unsettled loan purchase commitment scheduled to settle in August 2017; MD&A also refers to approximately $620 million of additional loan commitments. Unfunded construction loan commitments were $442 million.
- Some repurchase-agreement counterparties can demand collateral, and derivative agreements include termination and collateral provisions. One counterparty exposure was $400 million, or 11% of equity. Significant loan and Non-Agency RMBS fair values rely on management models and unobservable inputs.
- The company reported no legal proceedings, no material change to the risk factors in its 2016 Form 10-K, and effective disclosure controls. It stated that it intends to maintain REIT status and generally distribute taxable income as required.
Investor verification priorities
- Assess whether loan-portfolio growth, borrower credit performance and servicing costs can sustain earnings as funding costs rise; residential loans included $1.29 billion of principal balances reported delinquent or in bankruptcy, foreclosure or REO at June 30.
- Review leverage, repo refinancing and collateral-call capacity, including the short remaining maturities of many repo borrowings and the disclosed counterparty concentration.
- Evaluate the quality and sensitivity of fair-value estimates: $13.26 billion of loans and $3.11 billion of Non-Agency RMBS were Level 3 assets; 93.6% of the Non-Agency RMBS portfolio was rated below B or not rated.
- Reconcile the $605 million unsettled purchase commitment with MD&A’s approximately $620 million commitment figure, and monitor the construction-loan commitments and planned funding.
- Separate recurring operating performance from fair-value movements, derivative results and the $48 million debt-extinguishment loss; also account for preferred dividends when evaluating common-share earnings and dividend capacity.