2023-10-02 04:42:02 ET
Summary
- Chimera Investment Corporation has lowered its dividend twice in the past year due to lower distributable earnings in a higher-rate environment.
- The rise in short-term interest rates has made the leveraged mortgage trust model less sustainable, leading to a large contraction in the company's distributable earnings.
- CIM stock is currently trading at a 52% discount to book value, indicating that passive income investors are pricing in another dividend decrease in the short term.
Chimera Investment Corporation (CIM) lowered its dividend twice within the last year amid lower distributable earnings in a higher-rate environment.
The rise in short-term interest rates has made the leveraged mortgage trust model less sustainable, and it has led to a large contraction in the company’s distributable earnings.
The discount presently sits at 52%, and I think that the large discount already implies that passive income investors are pricing yet another dividend decrease in the short term.
Though the mortgage trust might soon see relief in terms of lower interest rates and interest rate costs, I think that the payout metrics really don’t look good at all.
As a consequence, I would expect Chimera Investment to continue to sell for a large discount to book value moving forward.
My Rating History
In Chimera: Avoid This 12.9% Yielding Mortgage Trust , I rang the alarm bells related to the steepening interest rate curve that posed a formidable headwind to the mortgage trust’s distributable earnings.
While inflation has eased considerably in 2023, indicating that the central bank will soon follow suit and lower interest rates, the payout metrics are looking bad and indicate yet another dividend cut in the short term.
Chimera Investment’s Investment Portfolio
Chimera Investment acquires residential mortgage loans from banks and other financial institutions, including government-sponsored agencies, and uses debt to finance such purchases.
At its core, Chimera Investment makes, like all the other mortgage real estate investment trusts, money on the spread between the yield on the asset and its funding costs. This business model works typically well in an environment of low interest rates, but results in dividend sustainability and earnings challenges during periods of rising interest rates and funding costs.
The current residential mortgage loan portfolio has an unpaid principal balance of $12.6 billion and included approximately 119K loans with an average loan size of $106K with the majority of loans (81%) being originated prior to 2008.
The central bank’s aggressive rate-hiking policy starting in 2022, which was meant to counteract four decade-high inflation rates, resulted in a significant increase in borrowing costs for mortgage-related investment trusts, including Chimera.
The immediate result of this rate-hiking trajectory was that the company’s distributable earnings contracted and forced two dividend cuts between the fourth quarter of 2022 and the third quarter of 2023.
High interest rates and borrowing costs have made the leveraged mortgage trust business model less attractive for shareholders, particularly passive income investors. Chimera Investment cut its dividend payout from $0.33 per quarter to $0.23 per quarter in the fourth quarter of 2022 and again slashed its dividend to $0.18 per share in the third quarter of 2023.
Inflation has started to ease, which could lead to relief in terms of funding costs and new capital flowing to the mortgage real estate investment trust sector in the medium term, but I think Chimera Investment is still headed for yet another dividend cut in the near term.
Dividend Coverage Substantially Deteriorated In The Last Year, Another Dividend Cut Probable
Chimera Investment’s dividend payout metrics substantially worsened in 2022 and 2023, resulting in two dividend cuts, and another one might be necessary to align the company’s earnings power with its dividend.
In the second quarter, the mortgage real estate investment trust produced only $0.12 per share in distributable earnings, a cent less than in the previous quarter, but paid out $0.18 per share in dividends, resulting in a payout ratio of 150%, which is not sustainable and points to yet another dividend decrease in the short term.
The dividend payout ratio in the last year was 138% of its distributable earnings. The mortgage trust could either cut its dividend, in my view, or risk for its stock to trade at an even larger discount to book value.
Large Discount To Book Value
Chimera Investment’s stock is selling at a 52% discount to book value, which strongly implies that the market expects yet another dividend adjustment to take place in the near term.
Larger mortgage real estate investment trusts such as Annaly Capital Management ( NLY ) and AGNC Investment ( AGNC ) are trading closer to book value, have better dividend coverage, and thus, offer passive income investors less (dividend) risk.
Why Chimera Might See A Lower/Higher Valuation Multiple
If Chimera Investment were to once again slash its dividend payout to shareholders, the mortgage real estate investment trust could be set for a higher valuation multiple, as the present valuation, in my view, already reflects concerns about dividend sustainability.
If Chimera Investment does not announce a dividend cut, I would expect the mortgage trust to continue to trade at a higher-than-average book value multiple, given its payout metrics.
My Conclusion
I would not recommend buying Chimera Investment stock for a passive income investor portfolio as the mortgage trust is, in my view, set for yet another dividend cut, which would then be the third since 2022.
Chimera Investment also trades at a very large discount of 52% to book value, suggesting that the market does not have a lot of confidence in its 16% dividend yield.
With so much uncertainty surrounding the future dividend payout, passive income investors may want to continue to avoid this 16%-yielding mortgage trust.
For further details see:
Chimera: This 16% Yielding Mortgage Trust May Cut Its Dividend Again