Chimera Investment Corp: A Mortgage REIT With a Sustainable and Growing Dividend
Chimera Investment Corp. (CIM) is a REIT that invests directly, or indirectly, in mortgage-backed securities (MBS), the majority of which are residential (RMBS). Chimera Investment Corp. first caught my eye because of its fat dividend yield that would most certainly scare anyone away barring the most ignorant or the most aggressive of investors. I decided to take a deeper look into their operations out of a desire to learn more about the Real Estate sector.
Chimera Investment Corp. has cash and cash equivalents of roughly $236 million. This represents about 6% of its current market cap, but what really drives Chimera's value is its portfolio of investment securities that drive its income. This is where we will really want to look. Chimera's investment portfolio is separated into the following:
Non-Agency MBS: $4.4 billion
Senior Notes: $817.7 million
Subordinated:$1.5 billion
Senior non-retained*:$2.1 billion
Agency MBS: $1.76 billion
Securities Held for Investment: $416 million
Total*:$4.462 billion
*For the purpose of this analysis the $2.1 billion of senior non-retained securities are excluded. It is my understanding that these notes are ones that have been re-securitized and sold to third parties. They are of no future benefit to the company and there is no further future recourse to Chimera from them. As such, there is no further value added from these assets.
In the quarter ending June 2010, these investments had an average yield of 8.49%, resulting in a spread of 5.56%. These yields have resulted in return on equity (ROE) readings that have fluctuated between 17.3% and 30.55% over the past year. In June 2010 ROE was 19.14%.
I believe that Chimera may be able to continue spreads of this magnitude and its high ROE because it has demonstrated its ability to do so over the past several quarters, even as long term rates have fallen. The Fed has also made it clear that interest rates will remain low for an extended period of time and there appears to be no current threat of inflation to drive them to do otherwise.
If Chimera is able to maintain its 5.56% spread on its $4.462 billion in assets, this would suggest earnings of $248.1 million dollars, or, what would equate to $0.28 before other expenses not directly relate to financing the purchase of securities. This figure does not include money that the company receives from re-securitizing loans and re-selling them. It seems to me that their current dividend of $0.18 may be sustainable and is supported by consistency and growth in the dividend over the past several quarters.
We will look into these securities in further detail below.
Non-Agency Mortgage Backed Securities
The majority of these securities are Alt-A, first lien mortgages. These are mortgage securities that are not guaranteed by Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB), thus, they are typically considered riskier than their agency backed counterparts. This $4.4 billion is divided into three categories as listed above: Senior Notes ($817.7 million), Subordinated Notes ($1.5 billion), and Senior non-retained ($2.1 billion).
As of June 2010, 99% of this portfolio consisted of Alt-A collateral. This collateral is ranked after prime but before subprime. Often, this ranking is assigned because of failure to qualify for Fannie or Freddie guarantee due to some criterion not being met. This could be something as simple as lack of documentation, or something as serious as a poor credit score, high debt to income ratios, or a high loan to value ratio.
The weighted maturity of the portfolio is 28.6 years but this does not tell us very much. A more useful measurement tool is the weighted average life (WAL) which takes into account prepayments speeds, interest rates, and other factors. With the agency backed securities included, the WAL for 79% of these securities falls between one and five years.
This basically means that about 79% of the principal value outstanding will be paid back within five years. This makes sense, given that prepayment typically increases during periods of low-interest rates as more borrowers refinance. It is interesting to note the similarity between WAL and duration. I imagine that it would be reasonable to expect values to act in a similar fashion in the event of rising interest rates.
It would seem that with such a short WAL the value of these investments would not fall very much with interest rate hikes and this is verified later by the management's expectations of value change in the event of rising interest rates.
The portfolio has an average weighted amortized loan to value ratio of 73.6%. It is my understanding that this is a measure of the discount that the securities were purchased at. This may suggest that a further drop in home prices (as may be expected with a wave of new foreclosures waiting to hit the market) may not detrimentally affect Chimera's holdings due to the margin of safety that they have built by purchasing assets at a discount.
Agency MBS
Chimera also has $1.76 billion of MBS that are guaranteed by Fannie Mae and Freddie Mac that will be adding to their earned income stream. These investments are considered relatively safe and are generally AAA rated.
Securitized Loans Held for Investment
These are securities that others have put together that Chimera has purchased. These have a value of $416 million, after an allowance for loan losses of $5.6 million. The underlying mortgages that characterize these securities have an average weighted FICO score of 756 and 90.7% are owner occupied. These seem like a relatively safe bet as well, given the high credit score and the high occupancy rate.
Overall Analysis
51% of Chimera’s holdings are AAA rated. 45% of them are either not rated, or below B. Looking at the results over the past several quarters I would be willing to bet that more of that last category fall into “not rated” as opposed to “below B”, but that is merely speculation and ultimately may not mean much either way.
What about changes in interest rates? If long term interest rates fall or short term interest rates increase, this could narrow the spread that Chimera is able to make. On the flip side, if interest rates rise, Chimera’s investment income may also rise. In their most recent 10Q, Chimera estimates that a 75 bps (.75%) increase in interest rates would result in an increase of interest income by 5.52% while decreasing the overall portfolio value by 3.79%.
This rise in income will offset some of the losses attributed to a decrease in the value of Chimera's future cash flows. With Chimera trading at such a low price in comparison to its dividend, it is possible that the stock price may still appreciate, even in an environment with increasing interest rates due to increased confidence within the real estate sector.
Ultimately, it appears that Chimera is investing in assets that typically expose investors to a considerable amount of risk; however, the underlying characteristics of the assets appears to make these securities more attractive. These characteristics include the discount the mortgages were purchased at as well as the occupancy rates and the average weighted credit scores. Chimera has done well navigating the current landscape after the burst of the real estate bubble and it appears to be consistent with dividend payments and dividend growth.
On top of all of this, the management has been buying a substantial number of shares in open market transactions which is a public display of their confidence in Chimera’s prospects. Since February 2009, insiders have purchased +485,000 shares and hold 5.17% of the company. Before their two most recent offerings, the inside ownership would have been substantially higher.
It appears that Chimera will continue to benefit as interest rates are low and may continue to benefit even in the event of rising interest rates due to its current discount. It is my opinion that its worth a second look and may add a large amount of value to a shareholder's portfolio.
Disclaimer: It should be noted that the prior analysis was done using the company's 10Q and the Google search engine to teach myself the meanings of terms and etc. It is possible, and very likely, that I have missed many of the nuances in the workings of the industry. This was undertaken as a learning project and should not be taken as recommendation for, or against, the stock until your own analysis has been done. Warren Buffett has attributed much of his success to staying away from investments he did not understand...I am simply trying to take that advice and understand as many investments as possible. Please feel free to make comments about important omissions, misrepresented facts, or misinterpretations of the presented data. It is my desire that these comments will help me better understand the Real Estate industry.
Disclosure: Author has been long CIM since July 2010. The author is not an expert in the Real Estate field and has no experience whatsoever with REITs. Readers should do their own due diligence by examining the companies quarterly and annual reports.
