2023-11-30 09:41:05 ET
Summary
- Chimera Investment Corporation's common stock has been negatively impacted by the Fed's aggressive policy, leading to a collapse in earnings.
- The preferred stock of Chimera Investment offers a fixed quarterly dividend of $0.50 per share, currently offering a 10.2% dividend yield.
- The preferred dividend of Chimera has a wide margin of safety, as the worse is probably behind the company with respect to rising interest rates.
Chimera Investment Corporation (CIM) has been severely hurt by the aggressive policy of the Fed, which has led interest rates to a 16-year high level. The borrowing costs of the company have greatly increased and thus its earnings have collapsed. It is thus natural that the common stock has plunged 65% since the beginning of 2022. It has also cut its quarterly common dividend by two-thirds, from $0.33 in 2022 to $0.11 in the most recent quarter. Therefore, the common shareholders of Chimera Investment have been going through fierce emotional pressure since early last year.
On the other hand, the preferred stock of Chimera Investment (CIM.PR.A) is offering a 10.2% dividend yield , which is much safer than the common dividend of the stock. While the preferred dividend is not 100% safe, it has a wide margin of safety and hence the preferred stock is suitable for income-oriented investors who can tolerate a minimum amount of risk.
Overview of the preferred stock of Chimera Investment
The preferred stock of Chimera Investment offers a fixed quarterly dividend of $0.50 per share. Due to the surge of interest rates to a 16-year high, the preferred stock of Chimera Investment is trading at $19.63, which corresponds to a 21% discount to the par value of $25 of the stock. As a result, the preferred stock is currently offering a 10.2% dividend yield.
The dividends are cumulative. This means that any suspended dividend payments will be effected as soon as the company resumes dividend payments. Moreover, the preferred shares of Chimera Investment comprise a significant portion of its capital stack . To be sure, the company has total equity capital of about $2.53 billion, which consists of $1.6 billion of common stock and $0.93 billion of preferred stock.
Source: Investor Presentation
This means that the preferred dividends represent significant amounts for Chimera Investment and hence investors should make sure that the preferred dividends have a wide margin of safety before purchasing the stock. On the bright side, preferred dividends have comprised just 26% of the total dividend payments of the REIT in the last 12 months. Therefore, they are much less burdensome To Chimera Investment than common dividends from a financial point of view.
Chimera Investment is a REIT that borrows funds at the prevailing short-term interest rates and invests these funds in a portfolio of mortgage assets, such as residential mortgage loans and non-agency residential mortgage-backed securities. As long as short-term interest rates remain low, the company usually enjoys a significant profit margin, which is positively related to the spread between long-term and short-term interest rates. This is clearly reflected in the performance record of the company, which remained highly profitable every single year between 2013 and 2019.
Unfortunately, Chimera Investment has faced strong business headwinds over the last three years. Due to the immense fiscal stimulus packages offered by the government in response to the pandemic and the Ukrainian crisis, inflation skyrocketed to a 40-year high last year. Consequently, the Fed began raising interest rates at an unprecedented pace and hence interest rates have surged to a 16-year high this year. The steep increase in short-term interest rates has caused an inverted yield curve, i.e., short-term interest rates have been higher than long-term interest rates for more than a year.
This is an extremely negative development for the business model of Chimera Investment, which profits from the spread between long-term and short-term interest rates. Even worse, the surge of interest rates was unforeseeable and hence the company did not have sufficient time to hedge its interest rates efficiently. As a result, its earnings per share plunged 39% , from $1.78 in 2021 to $1.08 in 2022. Even worse, the REIT is expected by analysts to post another 42% decrease in its earnings per share this year, from $1.08 to $0.63.
However, it is critical for investors to realize that the worse is probably behind Chimera Investment. Thanks to the aggressive stance of the Fed, inflation has cooled from a 40-year high of 9.2% in June 2022 to 3.2% now. Even better, according to the latest CPI report , inflation remained flat month-to-month in October, for the first time in two years. Thanks to the steady decrease of inflation since it peaked in the summer of 2022 and the latest CPI report, the Fed is not likely to raise interest rates anymore. Instead, it is expected to begin reducing interest rates at some point in 2024, after inflation decreases further, to the target range of 2.0%-2.5% of the central bank. Overall, the worse seems to be behind Chimera Investment with respect to interest rates. Analysts seem to agree with this view, as they expect the company to grow its earnings per share 16% next year, from $0.63 to $0.73.
Dividend
As mentioned above, Chimera Investment has reduced its common dividend by 67%, from $0.33 per quarter in early 2022 to $0.11 per quarter now. However, the preferred dividend is much safer than the common dividend. To be sure, the preferred dividend cannot be reduced unless the common dividend is eliminated first.
It is important to note that Chimera Investment has never suspended its common dividend since its foundation, in 2007. Even during the Great Recession, which was the worst crisis related to mortgage assets and the entire financial system, the company continued paying common dividends every single quarter. Therefore, Chimera Investment is not likely to eliminate its common dividend, particularly given that it is expected to remain profitable and begin to recover from next year.
Overall, the 10.2% preferred dividend of Chimera Investment has a wide margin of safety and hence income-oriented investors should lock in this yield before it falls further. During the last month, the preferred stock has rallied 12% and thus its yield has decreased from 11.4% to 10.2%, primarily thanks to the aforementioned positive CPI report. Whenever the Fed begins reducing interest rates, the preferred stock of Chimera Investment is likely to appreciate even further.
Risk
The primary risk of the preferred stock of Chimera Investment is the adverse scenario of persistent inflation for years. In such a case, the Fed is likely to maintain exceptionally high interest rates for much longer than currently expected and thus weigh on the profit margins of Chimera Investment. Fortunately, thanks to the above mentioned steady decrease of inflation, this metric is likely to revert to the comfort zone of the Fed at some point in 2024 or 2025 and hence the adverse scenario is highly unlikely. Nevertheless, investors should be aware of the possibility of such a scenario.
Final thoughts
Most income-oriented investors have suffered from above-average inflation in the last two years, as the real value of their portfolios and income streams have been eroded by high inflation. On the other hand, the surge of interest rates to a 16-year high provides a unique opportunity to lock in exceptionally high yields for the long run. Investors can lock in the 10.2% dividend yield of the preferred stock of Chimera Investment and rest assured that the dividend has a wide margin of safety. Whenever interest rates moderate, the preferred shareholders will also probably enjoy significant capital gains from this stock, which is now trading at a 21% discount to its par value. Overall, the preferred stock of Chimera is likely to highly reward the investors who can wait patiently for interest rates to moderate.
For further details see:
Lock In The 10.2% Yield Of The Preferred Stock Of Chimera Investment Corporation Before It Decreases Further