Chimera Investment Corporation: Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are to December 31, 2016. Chimera is an internally managed mortgage REIT that invests on a leveraged basis in mortgage-backed securities and residential mortgage loans.
Financial results and position
- Earnings: Interest income was $251.3 million and interest expense $110.2 million, producing GAAP net interest income of $141.1 million. Net income was $162.8 million; after $5.3 million of preferred dividends, income available to common shareholders was $157.5 million, or $0.84 per diluted share.
- Other earnings measures: Economic net interest income, a non-GAAP measure including periodic swap costs, was $136.5 million. Economic net interest rate spread was 3.0%, and net interest margin was 3.6%. Core earnings, also non-GAAP, were $96.0 million, or $0.51 per basic share. Annualized return on average equity was 19.63%.
- Cash flow: Operating activities provided $61.2 million; investing activities used $3.72 billion, primarily for loan purchases; financing activities provided $3.56 billion. Cash and cash equivalents fell $95.2 million to $82.6 million.
- Balance sheet and liquidity: Total assets were $20.43 billion and stockholders’ equity $3.51 billion. Repurchase agreements totaled $5.85 billion; securitized debt totaled about $10.41 billion. Period-end GAAP leverage was 4.6:1, while recourse leverage was 1.7:1. Management said it believed available assets and financing supported anticipated short-term liquidity needs, while warning that collateral declines could prompt margin calls.
- Portfolio: Securitized residential loans were 65.1% of interest-earning assets at amortized cost, versus 55.7% at year-end; Agency MBS were 22.0% and Non-Agency RMBS 7.1%. Book value per common share was $16.20, up from $15.87.
- Distributions and capital: The company declared a $0.50 common dividend per share. It issued 13 million Series B preferred shares at an 8.00% initial dividend rate, raising $314 million net of offering costs. Series B dividends rank ahead of common dividends.
Material changes versus Q1 2016
- Net income rose to $162.8 million from $83.1 million; diluted EPS increased to $0.84 from $0.44. Management attributed the increase mainly to improved unrealized results on derivatives and fair-value instruments and lower realized derivative losses.
- Results included $72.2 million of net unrealized gains on fair-value instruments and $4.9 million of net unrealized derivative gains. Q1 2016 included a one-time $95 million other-income receipt; Q1 2017 did not.
- Core earnings declined to $96.0 million from $109.5 million, primarily due to higher deal expenses and servicing fees. Deal expenses were $11.4 million, related to loan securitizations.
- Interest income increased 25% to $251.3 million, largely as the residential mortgage loan portfolio expanded. Interest expense rose 75% to $110.2 million, reflecting higher securitized debt balances and interest rates. Economic spread narrowed to 3.0% from 3.4%.
- The company acquired approximately $4.1 billion of seasoned residential subprime loans and expanded related securitizations. Loan assets grew to $12.7 billion from $8.8 billion.
- Common dividends declared were $0.50 per share, compared with $0.98 in Q1 2016, which included a $0.50 special dividend.
Outlook, risks and contingencies
- No quantitative earnings, spread, or portfolio guidance was provided. Management said it intended to continue investing selectively in residential credit assets and to adjust asset allocation as market conditions change. It stated an intention to pay regular quarterly dividends, subject to operating needs, debt service and REIT requirements.
- Management cited rising short-term rates and LIBOR, refinancing and prepayment changes, credit losses, property values, financing availability, and hedge effectiveness as key risks. A modeled parallel 100-basis-point rate increase was associated with a 13.77% decline in projected annual economic net interest income and a 3.01% decline in portfolio value; actual results could differ materially.
- Repurchase funding is short-term and subject to renewal, collateral haircuts and potential margin calls. Non-Agency RMBS and securitized loans rely significantly on Level 3 fair-value estimates and management assumptions. About 91.9% of Non-Agency RMBS was rated below B or unrated.
- Residential loan principal balances 30 days delinquent or worse, including bankruptcy, foreclosure and REO categories, totaled $1.17 billion; fair value of loans 90 days or more past due was $499 million.
- Q1 net other-than-temporary credit impairment losses were $18.7 million. The company also recorded a $2.0 million impairment on Agency commercial MBS positions it intended to sell.
- Management reported no material change to previously disclosed risk factors, no material legal proceedings, and no contingencies requiring accrual or disclosure. Certain securitization representations and warranties could require asset repurchases under specified circumstances. No subsequent events were reported.
Important facts for investors to verify
- Whether loan portfolio growth and securitization economics sustain core earnings and cash distributions, given core earnings fell despite higher GAAP net income.
- How much reported earnings and book value depend on Level 3 valuation assumptions, including the company’s valuation differences from third-party pricing for selected assets.
- The sensitivity of funding costs, margins and liquidity to LIBOR increases, repo renewals, collateral values and margin calls.
- Credit performance of the seasoned residential loan portfolio, including delinquency trends, defaults and loss severity.
- The impact of the 8.00% Series B preferred dividend obligation and future distributions on common shareholders.