2023-04-19 15:53:30 ET
Summary
- CIM experienced a serious compression in net interest margin over the last 12 months and the challenges are far from over.
- The start of the new year was fairly positive for CIM as they started to shift the focus to the securitization market and finalized four securitizations.
- The company has started to move in the right direction with major portfolio restructuring actions and the possibility to prepare for the potential 2024 interest rate cuts.
Investment thesis
Chimera Investment Corporation ( CIM ) is the 12 th largest publicly traded mortgage REIT among its peers. Due to the share price decline since the beginning of February, it is trading at a staggering 16.5% dividend yield. Chimera is feeling the heat of the current macroeconomic situation and it looks like the company took too long to adapt to the high-interest rate environment. As a result, its book value, net interest income, and NIM have experienced a dip, compared to last year's figures. Their situation seems stable at the moment but the dark clouds are far from over.
Investment portfolio
Q4 results met the anticipated expectations. Most mortgage real estate investment trusts took measures to safeguard their operations in 2023, such as engaging in financing, hedging, and securitizations. For the 4th quarter, the distributed earning per share was $0.11 which was in sync with the estimates. This has decreased from Q3's amount of $0.27 and Q4 2021's figure of $0.46. Economic NII of $76.9 million in the fourth quarter was lower than the prior quarter by 27% ($104.2 million) as well as from the same quarter a year ago by 50% ($154.6 million). The portfolio was seriously hurt by the extremely high-interest rates and the management took too long to hedge its positions and make changes to its portfolio. They halved the Agency RMBS and CMBS portfolio and decreased the non-agency MBS part of the portfolio by 3%. At the same time, the total portfolio value fell by 13.2%.
In addition, they experienced a serious compression in net interest margin. Investors saw a 26% drop from 3.1% to 2.3% Q-o-Q on CIM’s total portfolio. On a Y-o-Y basis, the margin compression is more dramatic, it fell from 4.5% to the current 2.3% while financing costs almost doubled and gross asset yield fell by almost 15%.
Portfolio updates for 2023
I expect that the Fed will keep rate increases for a longer period and maintain these increased rates until the fourth quarter of 2023. CIM’s management seems to be thinking similarly as they decided to lengthen their loan agreement until 2024 to ensure that they are secure if/when the Fed reverses its strategy and commences cutting rates. However, long-term financing is more expensive than short-term, but it could help the management to minimize the need for hedges, subsequently freeing up cash that can be used for other purposes. CIM also appointed a new CEO and his interpretation of the current situation is the following:
“Now, we do think 2023 presents challenges. We saw a lot of positives in January and believe there are still positive trends. Nevertheless, we also see some dark clouds… we believe the Fed when it says rates will go higher for longer. And we believe we have positioned ourselves to handle that outcome. We're also mindful of the second cloud, liquidity volatility arising from debt ceiling shenanigans.” Phillip Kardis - CEO since December 2022
In the last months of 2022, the management lowered their financial risk detail concerning mortgage loans by roughly $100 million through the sponsorship of CIM 2022-NR1 securitization. In addition, the book value per share grew to $7.49 at the end of the fourth quarter but this could only be a temporary uptick due to the portfolio restructuring. The start of the new year was fairly positive for CIM as they started to shift the focus to the securitization market and finalized four securitizations, while also registering two more. This enabled the management to reduce recourse borrowing by nearly $139 million and liberate approximately $90 million in equity.
In February 2023, the management estimated that they have committed to purchase close to $200 million of non-QM loans. It could be beneficial for shareholders when the rate environment stabilizes. On CIM’s balance sheet remains around $900 million worth of traditional non-Agency RMBS investments that are still providing strong returns in the double digits. In addition, the management is planning to rebuild the Agency RMBS and CMBS portfolios, which they cut significantly during 2022 to battle aggressive interest rate increases.
Valuation and Dividend
Since the more aggressive rate hikes started CIM underperformed the benchmark because the management adjusted too slowly to the new circumstances. Now, their portfolio is stable and the necessary risk adjustments have been made. However, they are still facing some challenges and I think there is no chance they can regain the pre-COVID share price in the next 3-4 years. On the other hand, the current valuation might be attractive for risk-takers because CIM’s price-to-book value is almost as low as during the first months of the pandemic panic. It is currently trading at 0.475x its book value and in March-April 2020 it was trading a bit below 0.4x.
CIM has been paying dividends for quite a while but its stability and consistency of it is questionable. During the second half of the 2010s because of the relatively stable macroeconomic environment, the dividend seemed secure but in turbulent times like the 2020s the management had to make some cuts. At the moment the new CEO appears confident in keeping the dividend at the $0.23 per share level but did not comment on maintaining it over the long term.
“Given where the portfolio is, they were comfortable with declaring the first quarter dividend at 2023 despite where EAD is at the present moment… But right now, we feel good about that $0.23 dividend.” Phillip Kardis - CEO
CIM is trading at an almost 17% dividend yield which is attractive even in the mREIT space. However, this dividend yield does not reflect the price stability and the portfolio stability of CIM so investors should be careful.
Final thoughts
The company has started to move in the right direction with major portfolio restructuring actions to prepare for the possible 2024 interest rate cuts by widening the RMBS and CMBS part of the portfolio. However, it is still far in the future and the short-term outlook for CIM is rather challenging. The valuation might seem attractive but I am not sure what the new CEO will be able to achieve. For risk-takers, CIM could be a cautious buy but for everyone else, I think it is a pass for now.
For further details see:
Chimera Investment: The Clouds Are Still Dark