Chimera Investment Corporation — 2011 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2011. This annual report, filed March 8, 2013, includes a material restatement of earlier financial statements and restated prior-period comparisons. The company is an externally managed mortgage REIT investing primarily in residential mortgage-backed securities (RMBS).
Business context and portfolio
- At year-end 2011, the portfolio by principal value was 75.4% Non-Agency RMBS, 21.1% Agency RMBS, and 3.5% securitized residential mortgage loans. In 2010, the respective proportions were 79.5%, 15.5%, and 5.0%.
- Non-Agency RMBS exposure is predominantly lower-rated or unrated: 96.91% of that portfolio was rated below B or not rated. The collateral was primarily Alt-A mortgages, with significant geographic concentration in California.
- The company uses leverage and is managed by Fixed Income Discount Advisory Company (FIDAC), an Annaly subsidiary. Annaly owned approximately 4.38% of Chimera’s common shares at year-end 2011.
Financial performance and position
| Metric | 2011 | 2010, restated |
|---|---|---|
| Interest income | $705.0 million | $576.1 million |
| Net interest income | $570.2 million | $429.7 million |
| Economic net interest income, including realized swap losses | $554.2 million | $423.8 million |
| Net interest spread | 3.64% | 2.78% |
| Net income | $137.3 million | $248.4 million |
| Basic earnings per share | $0.13 | $0.30 |
| Dividends declared per share | $0.51 | $0.69 |
| Cash from operating activities | $447.7 million | $322.0 million |
- Average earning assets rose to $11.4 billion from $8.5 billion. Average asset yield declined to 6.16% from 6.79%, while average cost of funds fell to 2.52% from 4.01%.
- Net income fell mainly because net credit impairment losses on Non-Agency RMBS rose to $357.1 million from $131.8 million. The company cited lower expected collections, higher expected loss severities, foreclosure delays, reduced credit enhancement, and slower prepayments.
- Fourth-quarter 2011 net income was $42.7 million, or $0.04 per share, compared with a third-quarter net loss of $60.0 million, or $0.06 per share. Fourth-quarter net interest income was $136.8 million and net credit impairment losses were $111.2 million.
- At year-end, total assets were $7.75 billion, total liabilities $4.70 billion, and stockholders’ equity $3.05 billion. Cash and cash equivalents were $206.3 million. Debt-to-equity was 1.5:1, up from 1.1:1; recourse leverage was 0.9:1, up from 0.5:1.
- Comprehensive loss was $109.3 million, including a $246.7 million decline in other comprehensive income, primarily reflecting unrealized investment losses.
- Cash used in investing activities was $114.1 million and cash used in financing activities was $134.5 million. Year-end repurchase agreements were $2.67 billion; securitized debt was non-recourse and totaled approximately $1.84 billion on the balance sheet.
Material changes and restatement
- The company corrected its accounting for certain Non-Agency RMBS, applying guidance it had previously omitted. The errors affected interest income and other-than-temporary impairment dating back to inception, and were deemed material. The filing restates 2010 financial position and 2010 and 2009 results, among other affected periods.
- The restatement had no material effect on previously reported book value per share, historical net changes in cash, or taxable income used to determine dividend distributions. Cumulatively from inception through September 30, 2011, the restatement reduced net income by $646.7 million, to $434.7 million.
- Non-Agency RMBS fair-value measurements were reclassified to Level 3 because significant valuation inputs, including default, prepayment, and loss-severity assumptions, were unobservable.
- Year-end estimated economic book value was $2.81 per share, versus GAAP book value of $2.97. The company cautioned that this non-GAAP estimate is judgmental and not a substitute for GAAP book value.
Outlook, risks, and unusual items
- No earnings or asset-growth guidance is provided. The board set quarterly dividends of $0.09 per share for each of the first two quarters of 2013, subject to review after the second quarter. The company reported 2012 dividends of $0.38 per share; $0.12 was characterized as return of capital.
- Management said it believed available assets, leverage, and borrowing arrangements could meet anticipated short-term liquidity needs, while warning that collateral declines could prompt margin calls and forced asset sales. Repurchase agreements were short-term, generally uncommitted, and subject to collateral and margin requirements.
- Late SEC filings restricted access to public capital markets and use of Form S-3. As of this filing, the company also had not filed its first three 2012 quarterly reports or its 2012 Form 10-K. It had reduced Agency RMBS repo borrowing in the fourth quarter of 2011 to preserve capacity to meet margin calls.
- The company withdrew licenses in some jurisdictions after the restatement and filing delays, limiting or changing certain mortgage-loan strategies. It also received three shareholder derivative demand letters; an Audit Committee investigation was ongoing and outcomes were uncertain.
- Management identified a material weakness in internal control over financial reporting, concluding that controls were ineffective at December 31, 2011. Deloitte issued an adverse opinion on internal control, while expressing an unqualified opinion on the financial statements. The company cited inadequate technical accounting expertise and insufficient independent review of accounting judgments and estimates.
- Additional material risks include Non-Agency mortgage credit losses, fair-value uncertainty, interest-rate and prepayment mismatches, refinancing and counterparty risk, collateral calls, geographic concentration, and dependence on FIDAC. Management and the Manager also had related-party and investment-allocation conflicts.
- Subsequent to year-end, FIDAC agreed to reduce its annual management fee from 1.50% to 0.75% until the company became current with required filings, and to cover specified restatement and investigation expenses not covered by insurance. A March 2013 amendment also allowed termination of the management agreement without a termination fee.
Important facts for investors to verify
- Review the restated financial statements and notes to understand the accounting corrections, especially impairment estimates, expected cash flows, and the cumulative impact on earnings and equity.
- Check whether internal-control remediation was implemented and independently validated, and whether subsequent filings were made on time.
- Verify current liquidity, repo counterparties and terms, margin-call exposure, leverage, and the ability to access capital markets.
- Assess the performance and valuation assumptions for the heavily concentrated, predominantly below-investment-grade Non-Agency RMBS portfolio.
- Confirm current dividend coverage using taxable income and cash flows, rather than GAAP earnings alone, and review subsequent dividend decisions.
- Follow the Audit Committee investigation and shareholder demands, as well as the fee reduction, expense reimbursement, and management-agreement amendment.