Business context and reporting period
Chimera Investment Corporation is an externally managed mortgage REIT investing primarily in residential mortgage-backed securities (RMBS) and mortgage loans. This Form 10-Q covers the quarter and six months ended June 30, 2013; it was signed March 20, 2014. The company reported that it was not current with required SEC filings.
Financial performance and position
Amounts below are in millions of dollars unless stated otherwise.
| Metric | Q2 2013 / June 30, 2013 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $127.6 | $161.5 in Q2 2012 |
| Net interest income | $101.0 | $139.6 in Q2 2012 |
| Net income | $143.2; $0.14 per diluted share | $40.8; $0.04 per diluted share in Q2 2012 |
| Comprehensive income | $66.5 | $102.4 in Q2 2012 |
| Economic net interest income and spread | $95.6; 5.16% | $134.4 and 6.44% in Q2 2012 |
| Cash and cash equivalents | $168.2 | $621.2 at December 31, 2012 |
| Total assets / stockholders’ equity | $7,183.6 / $3,627.8 | $7,742.5 / $3,542.5 at December 31, 2012 |
| Debt and leverage | $3,412.1 interest-bearing liabilities; 0.9:1 debt-to-equity | $4,034.0 and 1.1:1 at December 31, 2012 |
For the six months, net income was $223.0 million ($0.22 per diluted share), versus $121.0 million ($0.12) in 2012. Operating cash flow was $136.1 million versus $189.4 million; investing activities provided $222.4 million versus using $467.8 million; financing activities used $811.5 million versus providing $188.4 million. Cash declined by $453.0 million in the first half.
At June 30, the portfolio was 77.2% Non-Agency RMBS, 16.1% Agency RMBS and 6.7% securitized loans, measured by principal value. Non-Agency RMBS included substantial credit exposure: 96.81% was rated below B or unrated. GAAP book value was $3.53 per share; management’s non-GAAP estimated economic book value was $3.01 per share.
Material changes versus comparable periods
- Q2 net income rose by $102.4 million year over year, although net interest income fell $38.6 million. The six-month net interest income decline was $54.9 million.
- Higher earnings benefited from $54.1 million of realized gains on RMBS sales, versus no Q2 2012 sales, and improved swap results: a $7.8 million net gain versus a $16.2 million net loss.
- No Q2 2013 OTTI charge was recorded, compared with $65.7 million of net credit impairment losses in Q2 2012. First-half 2013 OTTI was $6.2 million versus $114.1 million in 2012.
- Economic net interest spread narrowed to 5.16% from 6.44% year over year. Management attributed weaker net interest income mainly to a smaller earning-asset base, including principal paydowns in consolidated VIEs.
- Cash and total debt declined from year-end, and reported leverage fell from 1.1:1 to 0.9:1. Securitized loans fell to $924.6 million from $1.30 billion, primarily due to principal repayments.
- Common dividends declared were $0.09 per share for Q2, unchanged year over year; first-half dividends were $0.18 per share versus $0.20.
Outlook, commentary, risks and unusual items
- Management’s stated objective was long-term risk-adjusted returns primarily through dividends and secondarily through capital appreciation. It expected the portfolio to remain weighted toward Non-Agency RMBS near term; no earnings or spread guidance was provided.
- The board declared $0.09-per-share regular dividends for Q3 and Q4 2013 and indicated $0.09 per share for each of Q1 and Q2 2014. A $0.20-per-share special dividend was paid in January 2014; it may be treated as return of capital for tax purposes.
- Interest-rate, prepayment, credit, liquidity and valuation risks are material. Management’s Agency RMBS sensitivity analysis projected annual economic net interest income increases of 4.73% to 11.49% for rate increases of 25–75 basis points, but portfolio value declines of 0.61% to 2.09%. These are model estimates, not forecasts.
- Repurchase agreements were $1.48 billion, generally short-term and collateralized by Agency RMBS; the weighted-average haircut was 4.85%. Market-value declines or margin calls could create liquidity pressure. Management believed available assets and financing were sufficient for anticipated short-term needs, while warning that forced sales could occur if cash proved inadequate.
- Late SEC filings restricted the company’s ability to issue shares under its equity distribution agreement or dividend reinvestment plan and to use Form S-3 until it had timely filed for a full year, limiting access to public capital.
- Material weaknesses in internal controls were not fully remediated, and disclosure controls were deemed ineffective at June 30, 2013. An Audit Committee investigation related to accounting and prior restatements remained ongoing; the board had received three derivative demand letters. The manager agreed to cover specified evaluation, restatement and investigation expenses not paid by insurance, including $5.2 million in the first half of 2013.
- The filing reported no contingency requiring accrual or disclosure at June 30, 2013. It identified potential repurchase obligations for specified representation-and-warranty breaches, but management was unaware of a triggering contingency.
Important facts for investors to verify
- Whether subsequent filings resolved the reporting delinquency and whether internal-control weaknesses and the Audit Committee investigation were remediated.
- Whether recurring earnings and dividends are supported by net interest income, given the spread contraction and Q2’s significant realized sale gains and lower impairment charges.
- Liquidity, repo renewal terms, collateral haircuts and margin-call exposure, particularly if RMBS values decline or counterparties reduce financing.
- The valuation assumptions and credit performance underlying the predominantly below-B-or-unrated Non-Agency RMBS portfolio and the gap between GAAP and economic book value.
- The status and potential costs of the derivative demands, related investigations and any representation-and-warranty claims.