Chimera Investment: Pullback Creates Massive Discount

Prepared by Chris, CEO Quad 7 Capital and lead analyst at team BAD BEAT Investing

Chimera Investment Corporation (NYSE:CIM) remains a holding in my long-term dividend reinvestment income portfolios, but it’s also a name that can be traded on the swings. We have been telling members that this name is a stock to buy on any meaningful pullback. Well, friends, with the stock nearing the $8 mark, that time has come. I have mentioned this before, but back in February, I detailed why I sold half the position and was letting the house’s money run, and our team highlighted it as a pick in March when mREITs were getting obliterated. We have been following this company and the portfolio very closely for quite some time. This year of course the stock and portfolio holdings were decimated.

The prior quarter which was rocked by COVID was a complete disaster, and huge margin calls were seen in the sector in the spring. Management teams scrambled, and CIM stock was extremely volatile. Right now, our firm thinks the stock is a solid buy, especially at the $7-$8 level. When it was at $9, we thought you should wait for a dip again. Well, the dip is here, we think you can add a leg here just over $8, and fingers crossed it falls into the $7 range so you can add.

Make no mistake, this stock was once the gold-standard play in the mREIT space for years, but it like so many others has fallen on some hard times, but I suspect the future is bright. You see, once the economy normalizes and the chaos in rates/bond yields stabilizes, this stock and others in the sector will thrive. It will not happen tomorrow or next month (aside from possible trading profits) but give it some time and this stock will be a massive winner. In the interim, collect that solid dividend. While the macro environment is always on the move let me once again just go over the key metrics you should be aware of following the recently-reported quarter and discuss what we are seeing.

A mixed quarter

To be clear, CIM put out a somewhat mixed quarter as far as key metrics, but there were some key strengths and weaknesses to be aware of. Quarter-to-quarter performance really depends on the company’s holdings and moves made within the portfolio.

During the second quarter, management worked to focus on liquidity and non-mark-to-market and longer-term financing arrangements to retain high-yielding assets, provide time for asset price recovery, while remaining positioned to take advantage of any opportunities that might arise. A few important moves were made.

These moves are important to be aware of. Management entered into three non-mark-to-market facilities to finance approximately $2 billion of its non-agency portfolio. Management also entered into a limited mark-to-market facility to finance roughly $611 million of non-agency securities. This was defensive, and now, over half of its non-agency borrowings are not subject to full mark-to-market risk.

You must understand that the increasing length of duration was key. In fact, management increased the weighted average day to maturity of its non-agency financing from 223 days in the first quarter to 698 days in the second quarter. Taken as a whole, as of the end of the second quarter, a bit less than half of its non-agency financings have terms longer than a year.

These moves were made to help bridge the company through this period of uncertain times. Let’s turn to performance.

You know it is all about dividend coverage

Folks, when investing in this name or similar companies, you need to care about income, and specifically how that income related to dividend coverage. With mREITs there are a few measures of income.

In Q2, net income swung to a loss, similar to most other mREITs. Net loss was $73 million, which translates to a loss of $0.37 per share. This was much better than what we saw in Q1. Of course, when we look at an mREIT, the GAAP net income/loss figure doesn’t inform dividend coverage. So what then?

Well for dividend coverage, we generally are more interested in net interest income and core income.

Net interest income was down from last year, coming in at $245.9 million vs. $339.9 million and was below our expectations of $250-$270 million. This was a bit of a surprise but was a direct result of the portfolio holdings and movements relative to motions in rates, etc.

Even with that said the income figure here doesn’t really tell us much about the ability to cover the dividend. Core earnings provide a much better indication of coverage. Core earnings for the quarter were down as well, but it was about we expected. The other key is that, based on this metric, the dividend was covered, and that’s critical. As a whole, despite being a strong player in this space, it’s vulnerable to fast changes in rates as well, both higher and lower. Core income came in at $76 million, or $0.32 per share and so the dividend of $0.30 was more than covered.

You should closely watch book value

Back in February, I sold off my huge position in CIM because CIM’s stock was way overvalued. It was too rich for my blood. Back then, some premium was expected and acceptable because you are paying for the consistency in performance, the dividend coverage, and management, in a highly risky sector. Operationally the company was doing well but it got expensive right before COVID-19 hit.

Again, some premium was appropriate for a quality performing management and portfolio. I tell our members at BAD BEAT all the time that premium names deserve premium pricing. Well, this crisis crushed the premium shine on this name, though, the market priced it accordingly. Now, I have to say that it is undervalued.

Valuation is a major reason why we see the stock as a great buy in the $7-$8 range. Still, you must time your entry points, and if you know how to pad your returns with well-timed sales and reentries, then this is one of those times. Get in there and do some buying. At the start of the current quarter book value was $10.63. Here, at $8.10 a share, we are at a $2.53 or 23.8% discount-to-book. Book value is likely to ramp up as things normalize in the next year or two. Since this is in my long-term portfolio, I have time, and I’m comfortable waiting. But I will add beyond house money if this thing falls more.

Playing with house money but the pullback is here

Things seem to be getting better. The dividend is covered. There is a nice discount. I am letting this run and will collect the dividend, but a 24% discount is tough to ignore. Book value may slip some but regardless this is a solid buy. The market outlook will be challenging in the near term. I think the current Q3 sees some volatility here, but I expect stabilization for the company and the sector to end 2020, with even better improvement in 2021.

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Disclosure: I am/we are long CIM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.