Chimera Investment Corporation (CIM) Finally Breaks Its Silence: Annaly Capital Management, Inc. (NLY)

Page 1 of 2

Chimera (CIM) Lives to Fight Another DayAt the end of last week, Chimera Investment Corporation (NYSE:CIM) finally broke its silence. For over a year, the high-yielding mortgage REIT had kept investors largely in the dark about its financial condition and performance, releasing only cursory updates about its GAAP and economic book values in lieu of its quarterly and annual financial filings. The reticence had gotten so bad that on three occasions, it had to request permission from the NYSE to allow its stock to continue trading on the exchange.

The issue, as we learned last August, was that Chimera Investment Corporation (NYSE:CIM) had incorrectly accounted for the deterioration in its non-agency residential mortgage-backed securities portfolio, which makes up roughly 75% of the company’s holdings. By doing so since its inception in 2007, it had overstated its net income by a factor of nearly three. But critically, the impact on its balance sheet and thus book value was neutral.

For a time, this led analysts, including me, to question the integrity of Chimera Investment Corporation (NYSE:CIM)’s executive team. Fueling my concerns was the fact that both its chief executive officer and chief financial officer are related, respectively, to a director and executive at Annaly Capital Management, Inc. (NYSE:NLY) , Chimera’s manager. The implication being that nepotism as opposed to merit was behind both their positions and seven-figure salaries.

But after combing through Chimera Investment Corporation (NYSE:CIM)’s 2011 10-K, which was filed belatedly last Friday, I’ve concluded that the issue appears rather to be one of competence and not integrity. And specifically, competence about the manner in which credit-impaired non-agency MBSes should be treated for accounting purposes. Bear with me for a bit, and you’ll see what I mean.

Painting with a very broad brush, there are two sets of rules that a financial company like Chimera Investment Corporation (NYSE:CIM) uses to account for MBSes. The first set governs agency MBSes — that is, MBSes that are either issued or otherwise backed by Fannie Mae and Freddie Mac. On the balance sheet, if these are characterized as available for sale, as they are on most REIT balance sheets, then they are held at fair value. Any deterioration in value, which is bound to be minimal assuming the security wasn’t egregiously overpaid for, is typically recorded as other comprehensive income (loss), or “OCI.” And on the income statement, the amount of interest recorded over the life of the security is equal to the contractual cash flows of the security and the accretion/amortization of any purchase discount or premium.

The operative word in the rule governing interest income on agency MBSes is “contractual.” Because the interest payments on agency MBSes are implied to be insured by the full faith and credit of the United States, outside of prepayment risk, it’s effectively safe to presume that all such payments will be made. The amount of interest accrued each month, in turn, is a function of the contractual — and not the actual or expected — cash flows of the security and thus the underlying mortgages. In addition, because the principal is similarly guaranteed, the magnitude of any other-than-temporary impairment to the security’s value, or “OTTI,” is narrowly constrained.

This is notably not the case with non-agency MBSes, which are governed by different rules for accounting purposes. On the balance sheet, like agency MBSes, if these are characterized as available for sale, then they are held at fair value. If the value of a security does deteriorate, however, and the deterioration is recognized on the income statement as an OTTI, then the corresponding amount is debited from equity via the retained earnings/accumulated deficit line item. On the income statement, meanwhile, the amount of interest recorded over the life of the security is equal to the amount and timing of cash flows expected to be collected. Additionally, if there is a negative change in expected cash flows, then an OTTI equal to the adverse change must also be recorded.

Page 1 of 2
Comments
Insider Monkey Small Cap Strategy
Insider Monkey Small Cap Strategy

Insider Monkey beat the market by 52 percentage points in 24 months. Our beta is only 1.2 (don't click this link if beating the market isn't important to you).

Lists

The Best B-Boy Movies

Most Awesome Hip Hop Documentaries

Foods That Stain Your Teeth

Richest Doctors in the World

The Best Movie Sountracks Ever

The Highest Grossing Musicals on Broadway

The Most Successful Reality TV Stars

Cheapest Cities to Visit in the US

Most Expensive Summer Camps

Most Expensive Animals in the World

Most Expensive Specialty Crops in the World

Movies That Took Ages to Make

The Longest Hollywood Films Ever Made

Most Expensive Concert Stages

The Richest Bands of all Time

10 Most Corrupt Countries 2013 List

10 Countries with the Highest Quality of Life Index

Most Expensive Mattresses in the World

5 Smallest Countries by Land Area

The Ultimate Heartbreak Songs

Richest Teenagers in the World

10 Most Haunted Places in America

10 Best Places to Retire in Florida East Coast

Top 10 Places to See Before You Die

Top 8 Countries in the World Where Justice Prevails

10 Richest States in America

15 Wealthiest Countries in the World

Richest Singers in the World

Most Expensive Tasting Menu in New York City

Most Expensive Baby Items in the World

Most Expensive Hotel Suites in Vegas

Most Expensive Brunch in New York City

Most Expensive Beef Cuts in the World

25 Best Colleges to Get a Job

Top 10 US Supermarkets

The 25 Most Dangerous Cities in the World to Visit

Most Expensive Xbox Games

Top 11 Cities Where Billionaires Live

Top 10 Most Charitable Companies in America

Most Expensive Seafood in the World

The 10 Wildest Conspiracy Theories

The 10 Best Job Markets in the US

Top 10 Accounting Scandals of All Time

The 25 Biggest Cities in the World

Top 10 Best Paying Virtual Jobs

Most Expensive Leather Shoes in the World

Top 6 Things to Buy in March

The 10 Most Stressful Jobs in America – 2014 List

Top 10 Jobs for Introverted People

Top 10 Honeymoon Destinations in the World

Subscribe

Enter your email:

Delivered by FeedBurner

X

Thanks! An email with instructions is sent to !

Your email already exists in our database. Click here to go to your subscriptions

Insider Monkey returned 47.6% in its first year! Wondering How?

Download a complete edition of our newsletter for free!