Executive Summary / Key Takeaways

• Chimera is strategically transforming into a diversified hybrid mortgage REIT, combining its core mortgage asset investment portfolio with a growing third-party investment management and advisory business acquired via Palisades, aiming for enhanced resilience and diversified income streams.
• The company demonstrated strong financial performance in Q1 2025, reporting net income available to common shareholders of $146 million ($1.79 per share) and an economic return on GAAP book value of 9.2%, driven by unrealized gains on financial instruments and initial contributions from the new fee business.
• Significant capital management actions in Q1 2025, including re-securitizing non-Remic deals and refinancing facilities, unlocked over $287 million in investable cash, providing liquidity and flexibility for opportunistic deployment into target assets like Agency MBS and potentially MSRs.
• Management is focused on increasing allocations to Agency MBS and exploring MSRs to balance portfolio duration risk and enhance liquidity, while also growing the capital-light fee-based income from Palisades, which contributed $9 million in revenue in Q1 2025 and is expected to be accretive in 2025.
• While market uncertainty and interest rate volatility persist, Chimera's lower recourse leverage (1.0x) and use of non-mark-to-market financing facilities enhance funding stability and limit margin call risk, positioning the company to navigate potential headwinds and capitalize on opportunities.

A Strategic Evolution in Mortgage Credit

Chimera Investment Corporation, established in 2007 as a real estate investment trust, has a history rooted in investing across a broad spectrum of mortgage assets, including residential mortgage loans, Agency and Non-Agency mortgage-backed securities. Over time, the company has adapted its strategy to navigate dynamic market cycles, leveraging various financing sources and employing hedging techniques to manage risk and enhance returns. This journey has culminated in a significant strategic pivot, positioning Chimera as a hybrid mortgage REIT focused on both its traditional balance sheet investments and a burgeoning third-party asset management business.

The most recent chapter in this evolution is the acquisition of The Palisades Group in December 2024. This move was not merely an expansion but a fundamental reshaping of Chimera's operational footprint, adding a new, capital-light revenue stream through investment management and advisory services for unrelated third parties. This integration, described by management as fast and seamless, leverages Palisades' expertise in residential real estate credit, complementing Chimera's existing capabilities and creating a platform with nearly $37 billion in combined on-balance sheet and third-party assets under management and advisory as of Q1 2025.

In the competitive landscape of mortgage REITs, Chimera distinguishes itself through a more conservative leverage profile compared to peers like Annaly Capital Management (NLY) and PennyMac Mortgage Investment Trust (PMT). With a GAAP recourse leverage ratio of 1.0x as of March 31, 2025, significantly lower than the typical 5:1 to 8:1 ratios seen in some competitors, Chimera prioritizes financial stability. This lower leverage, while potentially limiting upside in rapidly expanding markets compared to PMT's high-volume mortgage banking or NLY's scale-driven efficiency, offers enhanced resilience during periods of market stress. Chimera also highlights its focus on ESG integration in investment decisions, aiming to attract a segment of the investor base interested in sustainable practices, a differentiator against competitors primarily focused on yield optimization or operational speed.

A key element supporting Chimera's strategic direction, particularly the integration of Palisades, is the enhancement of its technological capabilities. Palisades brings a suite of proprietary technologies and advanced data management capabilities. While specific quantifiable metrics for the performance improvement of this technology are not detailed, management states that these tools are designed to improve strengths in portfolio and credit risk management and optimize key workflows. The strategic intent is clear: to enhance asset-level outcomes from due diligence through loss mitigation, drive operational efficiencies, and expand asset management capabilities. This technological focus is a competitive factor, aiming to improve the company's ability to analyze and manage its diverse portfolio and provide high-quality services to third-party clients, contrasting with the tech advantages seen in competitors like PMT's integrated servicing platform or AGNC (AGNC)'s streamlined systems.

Performance Reflecting Strategic Shifts

The first quarter of 2025 provided tangible evidence of the impact of Chimera's evolving strategy and the initial benefits from the Palisades acquisition. Net income available to common shareholders saw a significant turnaround, reaching $146 million, or $1.79 per basic common share, a stark contrast to the $168 million net loss in the prior quarter. This improvement was largely fueled by $129 million in net unrealized gains on financial instruments at fair value, reflecting favorable market pricing dynamics influenced by declining Treasury yields and relatively stable residential credit spreads during the period.

Beyond market-driven gains, the core business demonstrated stability. Net interest income stood at $69.2 million for the quarter. On an economic basis, which adjusts for derivative interest, net interest income was $72.3 million, an increase from the prior quarter and the same period last year. The net interest spread remained steady at 1.50% quarter-over-quarter, widening by 20 basis points compared to Q1 2024, primarily benefiting from higher interest income in the Agency RMBS portfolio due to strategic purchases.

A notable new contributor to the bottom line was the investment management and advisory fees generated through Palisades, which added $9 million in revenue in Q1 2025, a substantial increase from the $3 million recognized in Q4 2024. This early contribution underscores the potential of the fee-based business to diversify revenue and enhance earnings on a capital-light basis, aligning with management's strategic objectives.

Operational expenses saw an increase, with transaction expenses rising to $6 million in Q1 2025 due to increased securitization activity, and compensation and benefits increasing, partly attributable to the full quarter impact of the Palisades acquisition headcount and equity award acceleration for retirement-eligible employees. The provision for credit losses also increased to $3 million, reflecting a deterioration in cash flows on certain investments and higher unrealized losses on some Non-Agency RMBS positions.

Liquidity was significantly bolstered during the quarter. Cash and cash equivalents surged by $169 million to $253 million. This was driven by financing activities, including net proceeds from secured financing agreements ($164 million) and secured debt borrowings ($780 million), which offset cash used in investing activities, primarily purchases of Agency MBS ($150 million) and Loans held for investment ($403 million). Strategic capital management actions, such as exercising call rights on seven non-Remic securitizations and refinancing two structured financing facilities, were instrumental in unlocking over $287 million in investable cash. These actions not only provided immediate liquidity but also improved financing terms and extended maturities, enhancing funding stability. The company ended the quarter with $444 million in unencumbered assets and $1.9 billion in unused warehouse credit facilities, providing ample capacity for future investments.

Outlook and Strategic Priorities for 2025

Looking ahead, management anticipates continued market uncertainty and volatility but believes Chimera is well-positioned to capitalize on opportunities. The strategic focus for the remainder of 2025 centers on further diversifying the portfolio, growing recurring fee income, and adding liquidity.

A key investment priority is increasing the allocation to Agency RMBS. This is viewed as a means to enhance portfolio diversity, provide a more stable dividend stream, and serve as a source of liquidity for opportunistic acquisitions. Management also intends to actively evaluate opportunities in Mortgage Servicing Rights (MSRs), seeing them as a potential natural hedge for the loan portfolio that can help mitigate book value volatility associated with interest rate movements, while also generating attractive risk-adjusted returns. These asset classes are intended to complement the core credit-related loan investments and contribute to building a more durable portfolio.

The fee-based investment management and advisory business through Palisades is expected to continue its growth trajectory. Management is bullish on the potential to add new clients and expand service mandates, leveraging the integrated platform's capabilities and expertise in residential credit. This growth is seen as a crucial element in diversifying revenue streams and enhancing overall profitability on a capital-light basis, with the acquisition anticipated to be accretive to earnings in 2025.

Funding for these initiatives will come from a combination of organic capital generation, primarily through the re-levering of existing securitizations by exercising call rights, and potentially accessing the capital markets. The recent unlocking of over $287 million provides immediate capacity for deployment. Management is setting a relatively high bar for new credit investments in the near term, preferring to build liquidity and focus on Agency MBS and MSRs given the prevailing macro environment.

While the dividend decision is subject to various factors and market conditions, the strategic emphasis on generating stable income through a diversified portfolio and growing fee income, coupled with effective liability management, is aimed at enhancing the company's ability to support and potentially grow future distributions to shareholders.

Risks and Considerations

Despite the strategic progress and positive Q1 2025 results, investors should remain mindful of the risks inherent in Chimera's business. The company is exposed to credit risk on its Non-Agency RMBS and residential mortgage loans, which could be impacted by economic downturns or housing market deterioration, potentially leading to increased delinquencies, defaults, and credit losses. While management employs due diligence and portfolio monitoring, these risks are inherent in credit-sensitive assets.

Interest rate risk remains a significant factor. Fluctuations in interest rates can impact net interest income, borrowing costs, and the fair value of assets and liabilities. While Chimera utilizes derivatives like interest rate swaps and caps, and employs non-mark-to-market financing facilities to mitigate these risks, hedging strategies may not fully offset interest rate movements, and changes in the shape of the yield curve or basis risk can still negatively impact results and book value. The reliance on secured financing agreements also exposes the company to counterparty credit risk and the potential for margin calls, although the use of non-MTM and limited MTM facilities helps to reduce this exposure.

Prepayment and extension risks on mortgage assets can affect the yield and duration of the portfolio, potentially impacting the effectiveness of hedging strategies. Furthermore, the company's ability to execute its strategic initiatives, including acquiring target assets, re-levering securitizations, and growing the fee business, is subject to market conditions, competition, and regulatory factors. Covenants on financing facilities also pose a risk, as failure to comply could trigger accelerated repayment obligations.

Conclusion

Chimera Investment Corporation is actively executing a strategic transformation to become a more diversified and resilient hybrid mortgage REIT. By combining its established expertise in mortgage asset investments with the newly acquired third-party asset management and advisory capabilities of Palisades, the company is building a platform designed to generate income from both balance sheet assets and capital-light fee streams. The strong financial performance in Q1 2025, marked by a significant increase in net income and a solid economic return, provides early validation of this strategy, supported by effective capital management actions that enhanced liquidity.

Looking ahead, the focus on diversifying the portfolio with increased allocations to Agency MBS and potential investments in MSRs, alongside the expected growth in the fee business, positions Chimera to navigate anticipated market volatility and capitalize on opportunities. While risks related to credit, interest rates, and market execution persist, the company's conservative leverage and strategic use of financing facilities provide a degree of stability. The investment thesis hinges on Chimera's ability to successfully integrate and grow its new business segment, execute its portfolio diversification plans, and leverage its enhanced capabilities to generate sustainable, accretive returns for shareholders in a complex market environment.