It’s been a rough last 24 months for Chimera Investment Corp (CIM). The company is in the business of investing in Residential Mortgage Backed Securities (RMBS) – deemed “toxic assets” by many in the industry. After coming public at $15 in late 2007, the stock briefly rallied to give investors a temporary gain of 32%. But then the financial crisis hit and shareholders saw the value of home loans as well as the share price plummet.
In the darkest days of November 2008, the stock briefly traded below $2.00 per share and many believed that the company would not survive the credit crisis. Chimera had borrowed huge amounts of capital and used the funds to invest in risky Adjustable Rate Mortgages (ARMs) which had often been issued to borrowers without the means to repay the loans. The underwriters continued to write these admittedly irresponsible loans because they assumed that home values would rise and when the higher mortgage rates set in, borrowers could simply refinance based on the higher home value and net equity in the home.
As it turned out, trees don’t grow to the sky and home prices don’t rise forever. Chimera’s 4.6:1 leverage rate meant that for every dollar of company equity, an additional $4.60 had been borrowed to invest in these assets. As the value of the assets fell and the liabilities remained stable, Chimera was in hot water.
But rather than fold, management went to work improving their balance sheet and making wise strategic decisions. The strategy was to lower exposure to these risky ARM investments and reduce the amount of leverage the company utilized. Within four quarters, the company had paired down its leverage to a level of 0.9:1 – quite an impressive feat considering the environment. In April and again in late May, the company issued additional shares to the public raising capital and investing these funds at much more attractive prices.
Today, the company looks much more healthy and the stock price just shy of $4.00 appears to be an attractive value. The most recent quarter saw the company reporting adjusted earnings of $0.13 per share. This is down a bit from the 16 cents reported in the third quarter of 2008, but the prior three quarters had earnings of 7 cents, 9 cents and 10 cents in the June quarter. So it appears momentum has turned and is favoring this much more conservative approach.
After fully investing the proceeds of our capital raises earlier in the year, our team executed two re-securitizations that should enhance our return potential going forward. We continue to monitor evolving market conditions and prepare for a wide range of possible outcomes. ~Matthew J. Lambiase, CEO
Chimera briefly stopped paying a dividend at the height of the crisis, but the firm only missed one quarter and has been increasing its payout ever since. Looking at the last year, the company has paid out 44 cents per share in dividends and that includes the one quarter when the company did not make a payment. At this rate, the stock is offering investors a dividend yield of 11.3%. If you assume that the company will be able to continue to pay 17 cents per share each quarter (which it announced for the fourth quarter) then the yield increases to 17.5%
Currently Chimera is realizing an annualized yield on its assets at 7.71% and has been able to lower its borrowing costs to 1.67%. The interest rate spread of 6.04% is quite impressive and while that may narrow in a rising interest rate environment, the company should still be able to command a healthy margin. The current loan portfolio is now made up of 59% fixed rate mortgages which are more stable and likely much less risky than the ARM component.
As far as the Adjustable Rate Mortgages, the company has already written a large portion of these loans down to a fair market value of 52.4 cents on the dollar. So this means that if three quarters of these mortgages turn out to perform well, the company will recognize a large gain on this investment. Looking at the entire book, only 0.6% of the loans are delinquent 60 days or more, and 1.37% are in foreclosure. So the metrics are not particularly bad despite a difficult employment and economic picture.
I wouldn’t be surprised if Chimera were to sell additional stock in the near future to raise capital for more purchases. If another wave of ARM resets sends mortgage prices lower, Chimara will be in great shape to pick up assets at discounted prices. But for now, the company seems content to use low levels of leverage and enjoy its attractive interest spread.
FD: Author has long positions in Sound Counsel portfolios
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