2023-06-22 00:33:25 ET
Summary
- Fixed-to-floating rate mREIT preferreds offer potential value as their market share price has moved opposite to their contracted earnings power.
- Chimera Investment Corporation's preferred issues, CIM.PB, CIM.PC, and CIM.PD, can be purchased for going-in dividend yields above 10%.
- At conversion on 03/30/2024, CIM.PB and CIM.PD will offer yields above 14% as measured against today's share prices, with potential for 30% capital appreciation.
At the start of 2022, when the Federal Reserve got busy and started raising interest rates, fixed income investors got busy in the search for hedges to protect them in a higher rate environment. At Portfolio Income Solutions we catalogued the coupons and calendars of a large collection of Fixed-to-Floating Rate mREIT preferreds. From one company to another, and even within the various series of the same issuer, there has been no rhyme or reason as to how the market has priced these shares. This article will examine the trading of the three Fixed-to-Floating Rate preferred series issued by Chimera Investment Corporation (CIM).
The CIM Equity Capital Stack
Like its larger mREIT peers such as Annaly Capital Management ( NLY ) or AGNC Investment Corp. (AGNC), CIM has frequently gone to the capital markets to issue preferred equity to fund its ongoing operations. With $930MM liquidation preference of preferred shares issued against $1.28B common share market capitalization ($1.72B common book value capitalization), investors will perceive that CIM’s equity capital stack is more preferred heavy than either AGNC’s or NLY’s; many might say CIM’s is too preferred heavy. That is a different issue than we are addressing today, however. Today we are looking at market pricing of the CIM preferred shares and what might happen in a few short months when they convert from fixed rate to floating rate dividends. Specifically we are looking at the fixed-to-floating Chimera Investment Corporation 8% Series B (CIM.PB), Chimera Investment Corporation 7.75% Series C (CIM.PC), and Chimera Investment Corporation 8% Series D (CIM.PD).
Past is Prologue
To understand how Jay Powell’s actions have affected markets over the last year, we will look at an interest rate scoreboard. Longer term rates have edged up about 40 basis points with yields on 10y T-Notes rising from 3.33% to a current 3.72%. The real action has been at the short end of the curve and of particular note to the fix-to-floating crowd is the movement of 3 Month USD LIBOR. Over the past year, 3Mo LIBOR has more than doubled, shooting from 2.03% to 5.51% today. Since the fixed-to-floating schedules are linked to LIBOR, this is material to the CIM preferreds not just in consideration of rates, but also of the advancing calendar. LIBOR will be retired on 06/30/2023 and the shares will then be linked to a modification of SOFR, but the clock keeps ticking and the conversion to floating will still transpire.
The astounding aspect to consider when analyzing the potential value of the CIM preferred fixed-to-floating issues is that their market share price has moved in the opposite direction of their contracted earnings power.
On a share price only view, CIM fixed-to-floating preferreds have migrated as follows:
2MCAC 2MCAC 2MCAC
Until they convert to floating, the CIM preferred issues will pay their stated fixed coupon. With the last year’s approximately double digit share price declines, CIM.PB, CIM.PC, and CIM.PD can now be purchased for going-in dividend yields north of 10%. CIM.PB and CIM.PD are particularly interesting in that on 03/30/2024 each issue converts from a fixed coupon to the floating rate described in the table at the top of the article.
At conversion on 03/30/2024 CIM.PB and CIM.PD will offer yields north of 14% as measured against today’s share prices. That’s an excellent potential result, but wait, maybe there is more.
On conversion to floating, CIM.PB and CIM.PD become callable and redeemable by Chimera. At today’s LIBOR, CIM.PB will carry a coupon of 11.30% against its $25 liquidation preference. If Chimera can access capital at less than a cost of 11.30%, it would do well to redeem the CIM.PB issue. If that redemption happens, today’s CIM.PB shareholders would face a liquidity event at $25/share, a 29.53% premium to today’s $19.30 closing price.
Past being prologue, issues from NLY and AGNC were not redeemed when they converted from fixed coupons to floating rate yields; they did, however, trade near or above par, creating the same result.
Survival
We have long been wary of the mREIT, leveraged, carry-trade operating model. As such, we have not been long the common shares and have limited our exposure to what we considered opportunistic acquisition of the preferred equities. Chimera Investment survived the Great Financial Crisis and survived the even more extreme COVID liquidity crisis of March 2020. In anticipating CIM will survive until CIM.PB and CIM.PD convert to floating yield in March 2024, we can’t resist the prospect of higher yield and 30% capital appreciation. We are long CIM.PB, CIM.PC, and CIM.PD.
For further details see:
Chimera Investment Preferreds: Looking Back A Year To See Profit A Year Forward