Charming Chimera Learns Painful Lesson on Leverage

The initially successful Chimera Investment Corp. (CIM), which came public back in November, is having to admit they may have bitten off more than they can chew.

I originally posited in March that Chimera was quietly struggling to stay afloat after levering up at just the wrong time -- levering up four-fold just as competitor MFA Mortgage (MFA) was selling assets to de-lever its balance sheet.

After torching MFResidential's planned IPO, the poor conditions in the non-agency RMBS market chopped into Chimera, who slashed its quarterly dividend by 37.5%.

Matthew Lambiase, CEO and President of Chimera, commented on the dividend situation thusly: “Specifically, conditions compelled us to adjust our ramp-up pace and run our leverage at a more defensive level as we headed into the second quarter.”

In other words, maybe that $500 million repo facility with CSFB and a $350 million repo line with Deutsche Bank back in January wasn't such a good plan.

To be fair, Chimera did manage to complete a $619.7 million securitization, a long-term financing transaction whereby it securitized its then-current inventory of mortgage loans. Perhaps a lesson well learned.

Chimera Struggling Behind the Scenes

Chimera Investment Corporation (CIM) is quietly struggling to stay afloat after levering up at just the wrong time. Although the Company had reported leverage of just 0.5 to 1 at 12/31/07, the calculation excluded a $750 million payable for MBS, which was resolved at the end of January, when CIM entered into a $500 million repo facility with CSFB and a $350 million repo facility with Deutsche Bank -- levering up four-fold in the process just as competitor MFA Mortgage (MFA) was selling assets to de-lever its balance sheet.

Just a month later, the agency-backed and AAA markets dislocated again, and Chimera's repos have created a liquidity problem for the newly-formed company. Chimera held cash and cash equivalents of just $6.0 million at December 31, 2007, and warned in its 10-K that "an increase in prepayment rates substantially above our expectations could cause a temporary liquidity shortfall due to the timing of the necessary margin calls on the financing arrangements and the actual receipt of the cash related to principal paydowns." Not good news when the AP is reporting that mortgage volumes spiked on refinancing last week.

Chimera has had to amend its repurchase agreement with Deutsche Bank twice since initiating it in January to bring the liquidity covenant down to $40 million from $100 million. For this, it has had to agree to

-- Provide daily liquidity reports through April 15, 2008

-- Provide mark to market positions and advance rates with respect to all loans and securities

In addition, Chimera agreed to allow DB the right to act as the lead underwriter in connection with the next securitization or other similar public or private pass-through disposition of any Loan sponsored by Seller or an Affiliate thereof, for a market-rate fee.

Although markets may be stablizing, Chimera's first quarter dividend obligation of $9.6 million is looming overhead, and unless markets continue to improve quickly, the Company could be squeezed dry of cash at the end of April.

Earnings Roundup - Thursday Edition

Chimera Investment Corp (CIM) reported core earnings for the period commencing November 21 and ending December 31, 2007 of $1.3 million or $0.03 per average share. The Company reported a GAAP loss for the period commencing November 21 and ending December 31, 2007 of $2.9 million or $0.08 per average share. The difference between the Company’s Core Earnings and GAAP results is related to the Company’s unrealized losses on interest rate swaps at December 31, 2007 - meaning the Company is not designating its hedges under FAS 133.

Capstead Mortgage (CMO) reported net income of $15,860,000 for the quarter ended December 31, 2007 compared to net income of $2,350,000 for the fourth quarter of 2006. After considering preferred share dividends, the Company earned $0.31 per diluted common share for the fourth quarter of 2007 compared to a loss of $0.14 per diluted common share for the fourth quarter of 2006. Not surprisingly, Capstead's results benefitted from several accretive equity raises and aggressive Fed rate cuts.

BRT Realty Trust (BRT) announced its results of operations for the first quarter of its fiscal year. For the three months ended December 31, 2007, BRT reported total revenues of $7,508,000 and net income of $3,230,000, or $.28 per share on a diluted basis. For the three months ended December 31, 2006, total revenues, net income and net income per share on a diluted basis were $12,745,000, $8,289,000 and $.95 per share, respectively. BRT's results suffered as a result of a decrease in interest and fee income on outstanding loans. The decrease in interest on loans was due to (i) a decline in the average balance of loans outstanding, (ii) the increase in non-earning loans, and (iii) a decline in the rate earned on the portfolio. During the quarter ended December 31, 2007 two loans, aggregating $18,700,000, became non-earning.

Chimera Climbs on Cramer Pump

As if Cramer didn't do enough shilling for Annaly (NLY)...now he's recommending Annaly's new investment venture, Chimera Investment (CIM). The stock is up sharply on his recommendation. Here's the Mad Money recap regarding Chimera:

Right now, banks are busy unloading mortgage-backed paper off their balance sheets, Cramer said. While some of this paper is toxic, not all of it is bad, he noted. Because not all the banks have the time to go through all the paper, some are throwing out the babies with the bath water.

One stock that has the luxury to pick among the rubble and buy good paper and whose sole existence is to capitalize off this situation is Chimera Investment, Cramer said.

CIM, which went public on Nov. 16, was designed to feast off good paper because the banks have no choice but to unload it all, he said. It is one of the select few companies that have the money and knowledge to take advantage of the current situation, he added.

Since CIM became public, neither the company nor the stock has done anything, Cramer said. What they're waiting for is a bottom, and he said he wants investors in it before they start taking action.

Cramer said he expects CIM to buy only the good stuff that the banks cannot hold on to and profit from.

CIM, he said, is externally managed by a subsidiary of Annaly Capital Management and thus, Cramer believes Annaly CEO Michael Farrell, the so-called "king of mortgages," has what it takes to lead the stock higher.

Is this a rodeo? There's certainly a lot of bull being thrown about here. Chimera's own IPO prospectus says:

Our investment focus is different from those of other entities that are or have been managed by our Manager. In particular, entities managed by our Manager have not purchased whole mortgage loans or structured whole loan securitizations. In addition, our Manager has limited experience in managing CDOs and investing in CDOs, non-Agency RMBS, CMBS and other asset backed securities which we may pursue as part of our investment strategy.

So much for Mike Farrell's magical wisdom.

As for buying only so-called "good" paper, Chimera plans to invest in "real estate-related assets by investing directly in residential mortgage loans and indirectly by purchasing [non-agency] RMBS, CMBS and CDOs backed by real estate-related assets."

Not exactly the GSE-sponsored paper with which Annaly is used to dealing. Even "good" paper has suffered serious mark-to-market losses and has been difficult to finance -- just ask Thornburg (TMA).

In short, until Chimera becomes a little more seasoned, it's nothing but a blind pool. Do yourself a favor and wait for the Cramer hype to die down -- and consider investing in a mREIT with experience in non-agency securities.

Chimera Prepares to Come Public

Chimera Investment Corp. (CIM), a new mortgage REIT, filed another amendment to its registration statement this morning, pricing the offering at approximately $15/share, which would give the Company an initial market cap of around $500 million. Chimera will be managed by FIDAC, a wholly-owned subsidiary of Annaly Capital (NLY). Annaly will also own 9.8% of Chimera.

Chimera's investment portfolio is expected to be composed of purchased residential mortgage loans that have been originated by select high-quality originators, including the retail lending operations of leading commercial banks, and non-Agency RMBS. This is in contrast to Annaly’s strategy, which concentrates on Agency RMBS.

Chimera's IPO will be an interesting litmus test on a couple of different fronts:

1. Can Annaly's personnel manage investments in private-label RMBS, CMBS, and CDOs?
2. Will the market be receptive to a new mortgage REIT in this environment?

Chimera's investment strategy will be very similar to that of Luminent Mortgage Capital (LUM), which crashed back in August after defaulting on repurchase agreements. Although Annaly has been very successful in managing interest-rate risk, its management has not been tested with respect to credit risk.