Avoid This REIT's Financial Restatement Mess

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Chimera Investment (NYSE: CIM) announced that as of Sept. 30, 2012 that its GAAP book value was $3.31 per share, and its economic book value was $2.95 per share. This is compared to its estimated June 30, 2012 GAAP book value of $3.08 per share and economic book value of $2.87 per share. Estimated economic book value considers the fair value of the assets the company owns or is able to dispose of, pledge, or otherwise monetize. It specifically excludes assets consolidated for GAAP purposes which the company cannot dispose of. The estimate of economic book value has important limitations because, if these assets are sold, the company may realize materially different proceeds from the sale than estimated as of the reporting date.

Delay in the publication of financials

Chimera Investment had previously announced that it would delay the filing of its 10-K for the year ended Dec. 31, 2011, and its 10-Q for the quarters ended March 31, 2012, June 30, 2012, and Sept. 30, 2012. The company also announced that its previously filed Annual Reports on its 10-K for the years ended Dec. 31, 2010, 2009, and 2008, and the quarterly reports on Form 10-Q beginning with the quarter ended Sept. 30, 2008, and for all subsequent quarters through the quarter ended Sept. 30, 2011, will be restated and can no longer be relied upon. The restatement is not expected to affect the company’s previously announced GAAP or economic book values, actual cash flows, dividends, and taxable income for any previous period. 

The Board of Directors of Chimera also declared a fourth quarter 2012 common stock cash dividend of $0.09 per common share. The company initiated a regular quarterly dividend of $0.09 per share for the third quarter and fourth quarter of 2012, portions of which may be ordinary income, capital gains, or a return of capital. The Board of Directors has reviewed this program and has decided to maintain a quarterly dividend of $0.09 per share for the first and second quarters of 2013. The Board of Directors will review this program after the conclusion of the second quarter of 2013. For the first three quarters of 2012, Chimera has paid cash dividends totaling $0.29 per common share. Of this amount, $0.06 is currently expected to be characterized as a return of capital for federal income tax purposes, although this estimate will not be finalized until the company files its 2012 tax return.

Implications of these announcements

For over a year, Chimera, a member of the Annaly family of companies, has filed a single financial statement and is now refiling effectively every financial statement it has issued since going public in 2007. In the meantime, the only scraps of information that Chimera has produced for shareholders are the periodical estimates of book value and the admission that it's returning capital to shareholders. In its announcement about the restatements, Chimera estimated that its net income would drop by two-thirds over the time period between the third quarter of 2008 and the third quarter of 2011 because of the deterioration in the value of its private-label mortgage-backed securities. The estimated net result is to decrease Chimera's net income over the period between 2008 and 2011 by an astounding 66%, from $1.06 billion down to $367 million. At the same time, however, according to Chimera, all of the changes will be balance-sheet neutral because it had already deducted the losses from its shareholders' equity account.

The issue has to do with how it accounted for the deterioration in the value of its non-agency mortgage-backed securities. Chimera previously recorded the unrealized losses in its shareholders equity account. However, it now says that it has come to the conclusion that it should have been recognizing the losses on its income statement.

Change in dividend policy

The company announcement on the fixed dividend to be paid up to the second quarter of 2013 provides some stability to the dividend payout.  The company was earlier declaring dividends on the basis of the estimate of current taxable earnings presumably in order to ensure that it met the 90% guideline on distribution of earnings to retain its tax exempt status.  This earlier method meant that dividends could vary depending on a number of variables including prepayment rates, net interest margin, and funding costs.  However, the absence of financial information for such a prolonged time frame means that it is extremely difficult to check on the GAAP value and the economic book value, as well as the sustainability of the promised dividend.

Chimera and the competition

Chimera is a hybrid REIT, which means that it invests both in agency backed and non-agency backed mortgage backed securities. Chimera currently pays a dividend yield of 13.8%. The mix of its portfolio means that it is inherently higher risk. On the other hand, agency-based mortgage REITs, which are lower risk, have provided satisfactory returns during the first half of this year. American Capital Agency (NASDAQ: AGNC), Annaly Capital Management (NYSE: NLY), ARMOUR Residential REIT, Hatteras Financial, and Capstead Mortgage (NYSE: CMO) returned an average of 8.17%. For some of the bigger REITs such as Annaly Capital, Hatteras, and American Capital Agency, acquisitions could well be a short-term possibility to provide diversification. It was announced that Annaly has plans to acquire the remaining shares of Crexus in an effort to diversify its holdings portfolio. American Capital and Hatteras are unlikely to be far behind. Armour Residential investors have already voted on and approved a strategy that allows the firm to diversify through the purchase of non-agency MBS. Capstead Mortgage recently announced plans to initiate a $100 million dollar share buyback plan, which could benefit investors.

Conclusion

There too many red flags surrounding Chimera at the moment. The lack of up-to-date financial information makes it extremely difficult to evaluate an investment in the company. Despite the attractive dividend yield, I recommend waiting until we are in a better position to analyze the company on the basis of up-to-date financial data.


jordobivona has no positions in the stocks mentioned above. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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