The last I heard, the purpose of financial reporting was to provide information that investors, creditors, and others can use to make decisions.  Well, when a publicly traded company fails to file its required financial statements, and market regulators let it get away with it, that’s a real problem.  How are investors and creditors supposed to evaluate their investments?  And that’s the $3 billion question being asked of Chimera (CIM) by Aaron Elstein in “A mythical name and profits, too?

Here is a company that has neither filed a quarterly report since November 18, 2011 (for the quarter ended September 30, 2011), nor an annual report since February 28, 2011 (for the year ended December 31, 2010).  Yet, securities regulators permit Chimera to operate, and allow its stock to be listed and traded.  John Maxwell at the Motley Fool has described this situation as “inexcusable,” and that’s an understatement, for all the questions this situation raises.

Okay, why no financial statements? According to its Form 8-K filing with the Securities and Exchange Commission (SEC) on March 1, 2012, the Company needed additional time to “review the application of GAAP guidance to certain of its non-Agency assets.”  But then the story gets interesting when Chimera “fires” Deloitte as its auditor on March 11, 2012, replacing them with Ernst & Young.  What’s particularly curious is that the Company kept Deloitte to audit its 2011 10-K which has yet to filed. Then, in an August 1, 2012 Form 8-K filing, we learned of Chimera’s erroneous accounting for its non-agency residential mortgage-backed securities portfolio.  Basically, the Company accounted for this portfolio as if it were high credit quality, rather than reflecting its actual poor quality, necessitating a correction to reduce net income by almost $700 million during the affected reporting period (fiscal years ended 2008 through 2010).  And just recently, on March 1, 2013, Chimera notified the SEC in a Form NT 10-K filing that its annual financial statements for the fiscal year ended December 31, 2012 are not yet ready either.  However, there is a bit of good news…according to the filing, Chimera has finally completed its review of the accounting policies for its non-agency residential mortgage-backed securities portfolio, and that its 2011 annual report is forthcoming.  Better late than never, right?  Well, that’s just the first of my many questions.

Let’s start with the accounting error, or as today’s politically correct accountants call it, the restatement.  Given all of the expertise that Deloitte’s New York office presumably gained accounting for, auditing, and valuing financial instruments during the financial crisis of 2007 and 2008, it is unbelievable that it didn’t discover the “erroneous” accounting earlier.  My review of Chimera’s 2010 10-K uncovered plenty of clues that the Company’s non-agency residential mortgage-backed securities (RMBS) portfolio was “poor quality.”  Here are just a few:

  • Page F-14 reveals that non-agency RMBS with an estimated fair value of $2.5 billion had over $412 million in unrealized losses.  That’s unrealized losses of over 14 percent of their cost.
  • Page F-15 reports that 48.1 percent of all RMBS’s are rated below B or are not rated at all.
  • Page F-17 indicates that non-agency RMBS are collateralized by Alt-A mortgages of subprime fame, 56.1 percent of which were originated during the 2007 pre-bust mortgage boom, and 57.8 percent financed properties in the overheated California market.
So you tell me…does that sound like a high quality mortgage securities portfolio?  How could such an “error” have occurred?  Surely it wasn’t due to accounting ineptitude, after all, according to Aaron Elstein, Chimera's CEO received $35 million in compensation in 2011. That kind of money should buy some expertise, right?  And according to the Company’s proxy statement (Schedule 14A) Deloitte received a whopping $827,625 in audit and audit related fees for 2010 for its work on what should be a fairly straight-forward engagement.  The balance sheet is nothing more than securities funded by repurchase agreements and collateralized debt.  How could Deloitte not see the accounting problem for three years?  
Given the magnitude of this accounting “bust,” it’s pretty clear that Chimera’s internal controls over financial reporting don’t work, and Deloitte will no doubt confirm that in the near future (and after the fact).  However, given that the Company has only been operating since November 21, 2007, I would have thought that Deloitte would have carefully scrutinized accounting policies and procedures for this young entity, particularly with such rapid growth in the high risk RMBS portfolios.  Chimera’s total assets increased over 400 percent between fiscal year ends 2007 and 2010 (2010 10-K, 50).  And again, this is Deloitte New York…a Big Four firm center stage on Wall Street.  Is it any wonder they were fired?
But that raises yet another question?  You can’t fault Chimera for canning Deloitte, but why rely on the firm that couldn’t find the accounting problem to “fix” it? That’s right…E&Y doesn’t take over as auditor until the 2012 fiscal year engagement.  It just gets “curiouser and curiouser!”  Oh, you might argue that the Company will save money by having Deloitte clean up its (Chimera’s) mess, but let’s be realistic…E&Y is going to bill Chimera heavily anyway when it takes over given the material weaknesses, accounting errors, risky investments, and valuation issues.  E&Y is going to re-audit a lot of what Deloitte does anyway, so why not just have E&Y audit the delinquent years and restatements?
And then there’s the delay in fixing the accounting.  With all of Deloitte New York’s 2007 financial crisis expertise, as well as the Company’s own management experience, why is it taking so long to fix the books and issue an audit report?  Could the tardiness be signaling something else?  Is the situation worse than represented?  Are the books and records in shambles?  Or is it the RMBS portfolios that are causing the problems…after all these are Alt-A loans?  And then there’s always the possibility of an auditor-client conflict despite what is documented in the auditor termination letters.  It would not be surprising if the two parties disagreed over the magnitude of the RMBS valuation adjustments.  Or has the audit been completed, and Deloitte is “sitting” on the report at the client’s request for some reason?  See what kinds of questions surface when a company is not transparent?
And if you think these concerns are too farfetched, what about the creditors?  According to Chimera’s 2010 10-K (F-22 and F-23), the Company’s RMBS portfolios were funded significantly by short-term repurchase agreements (repos) and securitized debt.  How are these creditors functioning without some type of valuation information?  Normally, short-term repo borrowings are re-priced and renewed based on underlying collateral values.  Since the Company has not been forced into bankruptcy by these lenders, it seems reasonable to assume that these creditors have renewed Chimera’s short-term borrowings.  But what collateral valuation data did these creditors use to make their refinancing decisions?  Did they receive some “private” RMBS information that was not made available to investors and regulators?  If so, that might suggest that the delays in correcting the accounting error and issuing financial statements may be unjustified, right?  

And then there are the regulators…why do they “rubber stamp” extension request after extension request by the Company?  According to Chimera’s February 14, 2013 Form 8-K, the New York Stock Exchange has given the Company one final extension until March 15th to file its 2011 10-K.  So some very stale data may be forthcoming shortly.  But can’t the NYSE see the potential problems associated with the issues raised above?  And given the tardiness of the 2011 10-K, why is the NYSE cutting Chimera so much slack with the delinquent 2012 10-K?

See what chaos a lack of transparency in financial reporting can create?  Chimera is definitely living up to its name when it comes to its financial reports…for the past months, the Company’s reports have been nothing more than a “fanciful mental illusion” that create so many questions, and provide too few answers.  In a post 2007 financial crisis environment, one would not have expected that such a situation would be tolerated.

This essay reflects the opinion of the author and not necessarily that of The American College, or Villanova University.

AuthorAnthony Catanach