2023-12-19 03:34:37 ET
Summary
- Chimera Investment Corporation has cut its dividend by 39% and reset it to $0.11 per share, aligning it with the company's earnings trend.
- The dividend adjustment improves dividend coverage and suggests easing earnings pressure for highly leveraged mortgage trusts.
- With the central bank signaling a rate pivot in 2024 and a 27% discount to book value, Chimera Investment stock is a recommended buy for passive income investors.
According to the old adage that the dividend that has just been cut is the safest to buy, I have initiated a contrarian long position in mortgage real estate investment trust Chimera Investment Corporation ( CIM ) .
The mortgage trust slashed its dividend by a whopping 39% in the fourth quarter and reset its dividend to $0.11 per share which is much more in line with Chimera Investments’ distributable earnings trend.
The pay-out adjustment leads to improved dividend coverage moving forward and the central bank’s decision to finally conclude its rate-hiking cycle in 2024 points to easing earnings pressure for highly leverage mortgage trusts.
My Rating History
I rang the alarm bells about a potential dividend cut in my October piece This 16% Yielding Mortgage Trust May Cut Its Dividend Again as the lack of excess dividend coverage made a dividend adjustment very probable. Now that Chimera Investment indeed trimmed its dividend by a substantial amount, I think the risk and return situation has improved.
With the central bank also pointing to a rate pivot in 2024 and taking into account the 27% discount to book value, I am departing from my Sell stock classification. As Chimera Investment realigned its dividend with its earnings, CIM is a Buy for contrarian, passive income investors.
Portfolio Composition, Central Bank Rate Cuts
As a mortgage real estate investment trust, Chimera Investment primarily invests in residential mortgage loans as well as Agency and non-Agency mortgage-backed securities.
Residential mortgage loans are the core focus of Chimera Investment which accounted for 91% of the trust’s investments as of the end of the third quarter. Agency mortgage-backed securities and especially non-agency residential mortgage-backed securities made up the remaining 9% of the trust’s investment portfolio.
Net Asset Breakout (Chimera Investment Corp)
Chimera Investment primarily acquires residential mortgage loans primarily from banks, financial institutions and government sponsored agencies. The trust’s residential mortgage portfolio had a weighted average coupon of 5.96% as of the end of the third quarter and a total current unpaid principal balance of $12.2 billion. Most of Chimera Investment’s unpaid residential mortgage balance (80%) has been originated before the financial crisis in 2008.
Total Current UPB (Chimera Investment Corp)
Mortgage real estate investment trusts that buy high-yielding mortgage assets typically do so with debt, and this debt is set to become less expensive after the central bank laid out its plan to slash its key interest rates by 75 basis points next year. This means that short-term interest rates have peaked at the present range of 5.25-5.50% and are set, possibly, for a substantial fall in 2024 and 2025.
Lower interest rates have one major advantages for mortgage trusts like Chimera Investment which could lead to an improving earnings trend in 2024: MBS gain in value in falling-rate environments.
Dividend Pay-Out Has Been Realigned With Underlying Earnings Trend
The sudden rise in interest rates has been a major headwind for Chimera Investment’s distributable earnings and I warned of an impending dividend cut in my October piece, specifically citing the mortgage real estate investment trust’s excessive and unstable dividend pay-out ratio as a justification to proceed with caution.
Taking into account Chimera Investment’s third quarter distributable earnings of $0.13 per share and $0.18 per share in dividends, the pay-out ratio actually improved QoQ, but remained unsustainable at 139%.
Chimera Investment slashed its dividend in the fourth quarter by a whopping 39% and reset its dividend at $0.11 per share, thereby realigning its dividend with its underlying earnings trend that has manifested in a high-rate environment. This was, by the way, the second dividend cut within a year as the mortgage trust also reset its dividend lower by 22% in July. In total, the dividend has been slashed by 52% compared to the same period in 2022.
Based on Chimera Investments’ distributable earnings in the last four quarters, the mortgage trust earned an average income of $0.1225 per share. Chimera Investment’s earnings declined as the trust dealt with considerable headwinds in the market including higher funding costs and widening mortgage-backed security spreads. This has pressured Chimera Investment’s investment values and net interest spread, causing a steep drop in distributable earnings.
With the new dividend anchored at $0.11 per share, starting in January 2024, Chimera Investment’s indicative dividend pay-out ratio could be ~90% compared to 167% in the last twelve months.
I consider the dividend sustainable as long as the dividend is covered by distributable earnings, but an increase in the pay-out ratio above 100% should be seen as a flashing warning sign. The new dividend equates to a leading dividend yield of 9%.
Distributable Earnings (Author Created Table Using Company Supplements)
Contrarian Buy With A 27% Discount To Book Value
Chimera Investment is selling for a 27% discount to book value which is exceptionally large and probably reflects, since it slashed its dividend twice within a year, higher-than-average concerns about the mortgage trust’s dividend sustainability.
Annaly Capital Management ( NLY ) and AGNC Investment ( AGNC ) sell at BV premiums of around 8-9% again after the central bank announced its shift in interest rate policy for 2024.
Headwinds And Other Considerations
A slower-than-expected pace of rate cuts may influence the degree to which mortgage real estate investment trusts sell at premiums or discounts to book value in 2024. A resurgence of inflation, even if only temporary, could force the central bank to halt or slow down its pivot.
Obviously, should Chimera Investment’s run-rate distributable earnings fall short of the dividend again, the trust might be forced to slash its dividend a third time.
My Conclusion
The central bank is just about to pivot away from its interest rate policy which was announced at the December meeting. Thus, the expected decrease in short-term interest rates as well as the reset pay-out, which is now more aligned with Chimera Investment’s underlying earnings trend, make the trust’s stock a Buy.
Chimera Investment’s earnings declined drastically during the central bank’s rate-hiking cycle, but a normalization should be expected now that we seem to be on the brink of a major narrative change.
The new, lower dividend also looks to me to be more sustainable: The implied leading dividend pay-out ratio is ~90% which, together with the 27% discount to book value, makes Chimera Investment a promising rebound candidate in the mortgage trust market in 2024.
For further details see:
Chimera Investment: Contrarian Buy After 39% Dividend Cut