It was a quick transaction and while investors were momentarily stunned, it appears that Credit Suisse (CS) pulled it off without a hitch! Last week, Chimera Investment Corp (CIM) announced that it would sell 85 million shares of stock to the public and named Credit Suisse as the sole underwriter for the transaction. Initially the stock traded sharply lower as investors feared dilution to their ownership of the REIT. After all, CIM sold the shares at a price of $3.61 which was roughly 7% below the closing price Wednesday afternoon when the announcement was made.
But the current market is quite resilient and CIM managed to rally throughout the day and actually close higher – a strong sign of demand for the stock. Investors obviously believe that CIM will be able to put the capital to work effectively and generate a profit on this new capital. While management certainly could have borrowed the money and used its available leverage to purchase these securities, I am pleased that management opted for permanent capital rather than leverage which can wreak havoc when economic periods are difficult.
Investors in CIM are currently counting on the high dividend rate as their primary return for owning the stock. Dividend payments are largely variable as they are linked directly to the operating earnings for each particular quarter. But with a very low cost of capital, and meaningful cash flow from mortgage securities, CIM has been able to pay a dividend yield north of 15%.
While management states that their primary goal is to produce attractive dividends with capital gains as a secondary objective, I am much more interested in the potential for the stock to trade significantly higher. As investors realize that the dividend payment is safe (which will likely happen as a function of the company continuing stable payouts), investors will be willing to pay more for this stable cash-flow security.
As demand rises, the price of the stock should trade significantly higher. In this market, a yield of 6% or 8% is still very attractive, and if CIM traded up to a place where the yield was 8%, the price would be roughly $7.50 per share – good for a 92% increase (all the while, investors are still receiving the dividend payments)
I should note that the ZachStocks Newsletter has a pending position in CIM to buy once the stock breaks out of its current range.
The attractive dividend yield also functions to implement a floor under the shares because as the stock trades lower, the dividend yield only becomes more attractive. Fund managers looking for attractive value will quickly zero in on the strong dividend yield and likely begin to place large buy orders.
Playing the devil’s advocate, Chimera could potentially come under pressure if mortgage securities take a nose dive. According to this Financial Times article, BlackRock Recently warned that banks would have to take losses on distressed mortgages. There is speculation that now that the Fed has wrapped up its monumental program to buy mortgage securities, that the market for these assets could dry up. And then there is the danger of write-downs as homeowners either cannot or will not (see the weekend piece on strategic defaults) pay mortgages on houses where they owe more than the home is worth.
But even with these risks in play, CIM has already taken significant write downs on its existing non-agency mortgages and is carrying them at nearly 50 cents on the dollar. It would take a very nasty economic reversal for these securities to be re-priced lower, and the potential for actual appreciation in the mortgage portfolio is good. Now that CIM has additional capital to put to work buying attractive opportunities, the returns on existing and new mortgage holdings has the potential to even increase the dividend payment which makes the buying argument even stronger.
With such positive trading after what could have been perceived as a dilutive transaction, I have more confidence in this position. Continue to look for opportunities to accumulate shares as management effectively invests and generates strong operating earnings.
FD: Author has a long position in Sound Counsel portfolios
Enjoy this article? Sign up for the ZachStocks Newsletter,
Your source for Sound Market Commentary, Growth Stock Analysis and Successful Investment Strategies
April 7th, 2010 at 1:28 pm
You have to love those over-the-wall overnight offerings. The ire of dilution lasted oh, maybe, an hour. In the prospectus, Chimera claims that it may use the proceeds to temporarily pay down its Annaly repo line until it finds suitable investments. Interesting. Why do a capital raise without a specific acquisition in mind?
April 7th, 2010 at 1:29 pm
It could be that they were expecting the RMBS to decline sharply after the Fed purchase program was over. In this case it might make sense for management to have the capital handy early in the game so they could jump on an opportunity immediately without needing to take the time to finance the deal.
If they are just using equity capital to pay down a line, I agree – that doesn’t make sense. Right now CIM’s cost of funds is approaching zero. But if that line remains open and they can draw it down for opportunistic purchases along the way – then the dilution effect might actually disappear.
Thanks for the comment
zachstocks.com
April 7th, 2010 at 1:30 pm
It just seems to me that Chimera could utilize its third-party and Annaly-related repo lines as a warehouse line of credit to initially fund any acquisitions – then arrange for permanent financing through a secondary to pay down the draw on the credit lines. When you’re paying a 17% dividend on your common stock, that’s a pretty expensive form of capital to immediately jump on.
April 7th, 2010 at 1:30 pm
But isn’t this transaction exactly what you’re talking about? with a slight adjustment in timing?
CIM really IS paying down its repo line with a secondary (as you suggest) – this repo line has been used to make acquisitions. And in the future, I expect the line to be used again.
So the transaction is exactly what you are suggesting, we’re just discussing it mid-way through the circle.
April 8th, 2010 at 11:01 pm
I think those shares were sold at $3.89 not $3.61.
April 8th, 2010 at 11:01 pm
The shares were definitely sold at $3.61 per share(bit.ly/cFXPd7). However, I would like to reiterate that I think Chimera could reasonably and safely operate with additional leverage. They were levered at just 1.1 to 1 at 12/31/09. I know they got burned on leverage a couple years ago, but that was in a very different market environment. What about issuing some preferred shares at 8 or 9 percent if they must go for permanent capital?
April 8th, 2010 at 11:02 pm
Why pay 8-9% when current borrowing rates are much lower? I think the capital raise was really just to give the company more flexibility to act quickly when they are ready to pursue opportunity.
With available capacity on the credit line, the company could immediately purchase mortgage assets up for sale at an attractive price. But if the credit line was fully used and the company had to wait to pursue a transaction until a capital raise was already completed, the opportunity could be missed.
Obviously we’re seeing this transaction differently, but I do agree with your point that the company could responsibly increase its leverage – not to the previous level of 4-1 or more, but maybe something in the 2-1 range considering the low cost of debt capital.
zachstocks.com
April 8th, 2010 at 11:03 pm
Well it’s somewhat difficult to ascertain the true borrowing capacity because of the nature of repurchase agreements versus standard revolving credit facilities, but Chimera had $2.0 billion of its RMBS portfolio (at fair value) pledged at 12/31/09 versus a total RMBS portfolio (at fair value) of $4.1 billion at 12/31/09. Obviously the haircut on the non-agency RMBS is pretty severe, but clearly Chimera had an additional $2.0 billion of RMBS to pledge as collateral for additional repurchase financing. Thus I submit that they had and continue to have plenty of available borrowing capacity.
However, my point is that if Chimera doesn’t want to add material additional leverage to the balance sheet (even though I’m arguing that they should), they should consider doing a preferred issuance over issuing more common. The cost of the preferred capital is much cheaper than the cost of the common.
July 15th, 2011 at 2:52 pm
I was very happy to search out this web-site.I wished to thanks for your time for this excellent read!! I definitely enjoying each little little bit of it and I have you bookmarked to check out new stuff you blog post.
July 15th, 2011 at 3:26 pm
There are definitely a variety of particulars like that to take into consideration. That could be a great point to convey up. I provide the thoughts above as normal inspiration but clearly there are questions like the one you convey up where crucial thing will be working in honest good faith. I don?t know if best practices have emerged round issues like that, however I’m sure that your job is clearly identified as a good game. Each girls and boys really feel the impression of only a moment’s pleasure, for the remainder of their lives.
July 19th, 2011 at 11:40 am
Oh my goodness! an incredible article dude. Thank you Nonetheless I’m experiencing issue with ur rss . Don’t know why Unable to subscribe to it. Is there anyone getting identical rss downside? Anybody who knows kindly respond. Thnkx
August 3rd, 2011 at 6:21 pm
I and also my buddies came examining the best solutions from your site and at once I had a terrible feeling I never thanked the site owner for them. All the ladies were definitely as a consequence passionate to read all of them and have now honestly been enjoying these things. Appreciate your truly being so helpful and for deciding upon this form of great resources most people are really wanting to be informed on. Our own sincere apologies for not expressing gratitude to sooner.
August 4th, 2011 at 2:13 am
I precisely needed to appreciate you once more. I’m not certain the things that I could possibly have made to happen without the entire concepts discussed by you directly on my industry. It previously was an absolute depressing matter in my opinion, nevertheless being able to view the very specialized form you treated it forced me to cry for gladness. I’m happier for the assistance and in addition expect you comprehend what an amazing job that you’re providing instructing other individuals through the use of your webpage. I know that you have never come across any of us.
August 27th, 2011 at 9:45 pm
Hiya! I just wish to give a huge thumbs up for the great info you’ve got right here on this post. I will probably be coming again to your weblog for extra soon.
August 29th, 2011 at 2:22 am
Hey! I simply wish to give a huge thumbs up for the nice data you’ve gotten here on this post. I will probably be coming back to your weblog for more soon.
September 23rd, 2011 at 8:02 pm
Hello! Someone in my Myspace group shared this site with us so I came to take a look. I’m definitely loving the information. I’m bookmarking and will be tweeting this to my followers! Fantastic blog and brilliant style and design. Kudos!