Summary
- Chimera slashed its dividend by 30% amid lower distributable earnings.
- The central bank is set to remain hawkish with respect to interest rates in 2023.
- Large book value discount is not a reason to buy.
Chimera Investment Corporation ( CIM ) reduced its dividend payout by 30% in the fourth quarter to align it with lower distributable earnings.
The mortgage trust's book value has plummeted in 2022 as a result of the central bank's aggressive interest rate hikes aimed at bringing inflation back under control.
The rise in interest rate volatility and the widening of MBS credit spreads have put a significant strain on the mortgage trust's portfolio, and the Fed is expected to continue steepening the yield curve in 2023.
I wouldn't buy Chimera Investment's 12.9% dividend yield right now because I believe the trust's book value per share will fall further.
Recent Dividend Actions
In my article Chimera Investment: A Dividend Cut May Be Coming , I highlighted the risk of Chimera's dividend policy, pointing to the trust's failure to earn its dividend with distributable earnings.
Chimera Investment's dividend coverage deteriorated in 2022 due to rising interest rate volatility and increasing pressure on the book values of MBS-linked investment portfolios, raising the risk of a dividend cut.
Chimera Investment finally reduced its quarterly dividend from $0.33 per share to $0.23 per share in the fourth quarter, aligning its new dividend with lower distributable earnings.
Portfolio/Book Value Likely To Remain Under Pressure In 2023
Chimera Investment, like the majority of mortgage trusts, has seen steep book value declines in 2022 as a result of the factors outlined in the introduction. Chimera Investment's falling book value in 2022 is primarily due to the central bank's aggressive approach to interest rate hikes.
Chimera Investment's GAAP book value as of September 30, 2022 was $7.44 per common share, down 37.2% from the end of 2021, when it was $11.84 per common share.
Since the central bank has begun its most aggressive rate hike cycle in decades, I believe that rate hikes in 2023 will continue to put pressure on Chimera Investment's book value. I believe the central bank will raise interest rates to a range of 5.00-5.50% by the end of the year, up from a current rate range of 4.25-4.50%.
Dividend Coverage May Improve
Chimera Investment's dividend policy change improved the trust's pay-out ratio in the third quarter, and the trust is likely to have better coverage in the fourth quarter. The pay-out ratio in 3Q-22 was 85.2%, down from 106.5% the previous quarter.
Chimera Investment's total dividend payout over the last twelve months (4Q-21 to 3Q-22) was 85.3%, so the lower quarterly dividend of $0.23 per share seems sustainable.
With that said, I believe passive income investors should avoid Chimera Investment due to the uncertainty surrounding its book value.
Price To Book Ratio
Chimera Investment is trading at a 39% discount to book value, with investors applying a large discount primarily due to yield curve uncertainty in 2023.
Furthermore, with higher interest rates on the horizon, leveraged business models such as Chimera Investment's may be forced to absorb even higher capital costs, putting pressure on the trust's net interest spread.
Why Chimera Investment Could See A Lower/Higher Valuation
What happens to Chimera Investment's portfolio/book value in 2023 will be determined primarily by the central bank's actions. If the central bank maintains its aggressive approach to reining in inflation by raising interest rates, Chimera Investment's portfolio will remain under pressure, and investors should expect lower dividend coverage and declining book value per share.
My Conclusion
The large discount to book value at Chimera Investment attests to the legitimate concerns that passive income investors have about the mortgage trust.
I believe the dividend cut was necessary, and the trust's dividend payout is now in line with its lower level of distributable earnings.
Having said that, the market environment is challenging, and the central bank is likely to maintain its hawkish stance on interest rates. This means that Chimera Investment will continue to face pressure on its portfolio and book values, while higher interest rates threaten the trust's net interest spread.
For the time being, I believe investors should avoid Chimera Investment's 12.9% dividend yield.
For further details see:
Chimera: Avoid This 12.9% Yielding Mortgage Trust