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Chimera Investment Corp.: A Game Changer


  • The Q2 earnings are out, and they were weak, but this was not overly unexpected.
  • I continue to like the stock at current levels, as the dividend has been covered once again.
  • A new move to shift the management structure and institute a buyback could make waves.

Chimera Investment Corporation (NYSE:CIM) has performed well in the last two years, after having a dismal performance from the Great Recession to 2011, which saw its dividend cut in half, along with its share price. It also recently underwent a reverse split to attract new investment. Well, CIM has just reported its second-quarter earnings, and they have shown that the company was not immune to the pain that was Q2 for mREITs. Many of them, as you are likely aware, succumbed to what was a very tough operating environment for mREITs, as interest rates were extremely volatile. That said, you may recall that I have predicted on numerous occasions that those companies that were the most diversified would likely be the most stable going forward. Further, you know that most of my best-of-breed list in the mREIT sector are almost all heavily diversified and held up fairly well, but did take hits in Q2. Chimera is not on this list, but is a bit diversified, investing in residential mortgage-backed securities, residential mortgage loans and commercial mortgage loans.

This diversification has led Chimera to have an industry-leading net interest rate spread and generally stable book value. These are the reasons I got behind this stock. But the share price continues to fall. I was pleased with the dividend not only being maintained but raised recently, and felt it would continue to be covered, given the company's earnings and cash flows. But just how did Chimera perform in this quarter?

Well, the company missed on revenues and earnings. First, Chimera once again increased its income quarter over quarter. Net income came in at $116 million, up from the $67 million in the fourth quarter. However, this is a GAAP measure, and so, we want to understand if the dividend was covered. Core earnings provide a much better indication of coverage. The company's core earnings for the quarter came in at $0.53 per share, down $0.06 from the $0.59 earned in Q1. Further, they missed estimates by $0.07. It hurts, but isn't exactly a shock, because most competitors saw their core earnings decline quarter over quarter. What is most important to note is that these earnings easily covered the quarterly dividend, as Chimera paid a common stock dividend of $0.48 per share for the quarter. The annualized dividend yield on stock is 14%.

What about the all-important book value? Well, this was an area where the company did take a bit of a hit. GAAP book value was $16.73 per share, down 2.5% from the $17.14 per share in Q1, and down significantly from the December 31, 2014 book value of $17.55. Despite it being a book value loss, it was not severe, and the book value is at the equivalent it was a year ago. But it was a loss nonetheless.

Now, as I alluded to above, Chimera is a leader in the sector for its net interest rate spread. Well, the net interest spread dipped again in Q2 2015, following a trend in the sector. On average, in 2014, the spread was 4.4%, and in this quarter, it came in at 3.6%. This is down from 4% a quarter ago. Further, it is down from 4.9% a year ago. Much of this has to do with the trending downward pressure on the yield the company earns, somewhat driven by prepayments in the sector, as well as the up and down volatility in rates experienced in the quarter. Despite the pressure, Chimera remains an industry leader in its spread.

Thus, the results were so-so, but the key is that the dividend is more than secure. But there is even bigger news out of this quarter, aside from the movement in fundamentals. The company has agreed, in conjunction with Annaly (NYSE:NLY), effective today, to internalize its management function. The independent directors on Chimera's Board agreed to the internalization with Annaly to "accelerate growth and realize cost efficiencies." As a shareholder, you care because the internalization should help maintain continuity of the leadership team, while lowering its cost base and having a simplified structure, as well as a more focused strategy. No termination fee was paid by Chimera in connection with internalization with Annaly to its external manager, Fixed Income Discount Advisory Company. As part of the agreement, Chimera will purchase Annaly's 4.4% stake in Chimera, for a purchase price of $126.4 million ($14.05 per share), as part of a new $250 million share repurchase program authorized by the Chimera Board. Purchases made pursuant to the program will be made either in the open market or in privately negotiated transactions.

So what is the take-home here? It was a weak quarter, but I stand behind Chimera. The stock trades at a significant discount to book. The new internalization should be positive for shareholders, but that remains to be seen. The company authorized a buyback, which, at this discount-to-book, I like. The dividend has been covered, and although the key metrics dipped again, I suspect that Q3 will look better. Thus far, interest rates have not moved with severe volatility. The buyback should help keep the price somewhat supported, in addition to the now 14% yield.