If you’ve followed me this far, then you likely see that the principal difference in accounting between agency and non-agency MBSes lies in the income statement and not the balance sheet. With respect to interest income, the difference is between contractual and expected cash flows. By their very nature, contractual cash flows related to agency MBSes are largely static; the credit risk has been eliminated, leaving only prepayment risks to worry about. Conversely, expected cash flows related to non-agency MBSes are much more volatile, as they change on an ongoing basis as a result of both credit risk and its proverbial little brother, prepayment risk. And the same is true when it comes to OTTI.
Thus, to get back to Chimera Investment Corporation (NYSE:CIM), its mistake was in treating its non-agency holdings as if they were impliedly backed by the full faith and credit of the United States, as agency MBSes are. The implications are threefold. First, it overstated its interest income since inception in 2007 by approximately $411 million from approximately $1.88 billion to $1.46 billion. Second, and over the same time period, it understated its OTTI by approximately $293 million from approximately $190 million to $484 million. And finally, it recorded $695 million in offsetting fair value adjustments in OCI as opposed to retained earnings/accumulated deficit. Thus, while the net impact on its balance sheet was effectively neutral, its restated net income declined by approximately $695 million, or 65.5%, from approximately $1.06 billion to $367 million.
To be fair, as is probably obvious at this point, accounting rules can seem complicated and esoteric. But this is not a legitimate excuse to be used by purported experts that are compensated — generously, I might add — to study and apply the rules at issue. There is no excuse for the type of egregious accounting error committed by Chimera Investment Corporation (NYSE:CIM)’s executive team here. And there should be consequences for the errors. At the same time, however, as best as I can tell, they were just that: errors and not lapses of integrity. That being said, the question of whether Chimera is a legitimate investment vehicle at this point remains open to debate, as it does for any other stock, for that matter.
The article Chimera Finally Breaks Its Silence originally appeared on Fool.com and is written by John Maxfield.
John Maxfield has no position in any stocks mentioned. The Motley Fool owns shares of Annaly Capital Management.
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