Non-agency mortgage REIT Chimera (CIM): Collect 15% in dividends while you wait for the stock to double or triple?
Financial HippieIt's hard to find value these days in the market. However, I believe the whole agency REIT space is still attractively valued. I think CIM is a special case where it will provide the same yield as agencies but with an optionality on returning leverage.
IPOed at the worst possible time. When Chimera first IPOed on 11/15/07, the vehicle was supposed to achieve ROE in the low teens by investing in non-agency RMBS and other loans, while funding purchases with repos and lines of credit, resulting in a ROE model that looks something like:
Asset yield 6.5%
Cost of funds 5.0%
Spread 1.5%
Leverage 7x
Levered yield 10.5%
Equity yield 6.5%
Mgmt Fees,G&A 3%
ROE 14%
CIM raised 500mm in IPO. They were supposed to build the portfolio over a period of six months.
Then, the world fell apart... CIM's leverage got as high as 4x by 08Q1, but they had to sell some securities to mitigate funding risk and ended the quarter with 3.4x leverage. As the credit markets blew up in the next few quarters, non-agency paper continued to lose value, while funding them with repos became harder and harder as institutions tightened their quality of acceptable collateral (non-agencies weren't making the cut). Furthermore, banks were also reluctant to lend as many uncommitted lines of credit became useless. It was the perfect storm to coerce Chimera to sell assets at a huge loss. Book value declined by about 80% as they realized close to $150mm in losses from investments sold from Q1-Q3 and received low marks on the rest of the portfolio... stock went from $20 to $2.
The bottom? No leverage = no margin calls. For most of 09Q1 and 09Q2, according to several publicly traded mortgage REITs, non-agency paper could be bought on an UNLEVERED basis for yield-to-maturity of mid-to-high teens after adjusting for loss provisions. This means if these RMBS PMs have done their modeling correctly (and that's a big if, which I will address later), shareholders would be able to "clip" 15%+ percentage coupons. I put "clip" in quotes because a good portion of the return will be from amortization of discount, which will complicate cash flow around dividend payments. CIM said on their 09Q1 call that it wasn't an issue yet, but the non-agency book has tripled since then. CIM will probably need to further tap the Annaly repo line.
The stock went from $20 to $2. How can you trust management? Look, they got caught in a vice because of macro conditions; many people did during 2008. T-bills were trading at negative yields for crying out loud; I don't think anybody expected that. CIM's paper, of course, is on the polar opposite side of the risk spectrum. So if chances are that I will never see in my life time appreciation of t-bills like that again, then chances are that I will never see destruction in structured products like that again either. For that reason, I'm willing to give them a pass.
Mike Farrell's (CEO of Annaly) conservatism and recent macro data makes me sleep better at night. Although low, delinquencies are rising in the portfolio. Since Mike Farrell is staunchly in the "no greenshoots" camp, you would think PMs at Chimera model loss assumptions very conservatively. Against his bearish outlook, the stabilization of median home price and employment data in recent months might give CIM's portfolio more margin of safety and possible upside.
Barney Frank is the wild card. Cramdown, according to CIM, will not "increase the cumulative losses", but "alter the way losses are distributed throughout the capital structure" (08Q4 earnings call). To read about recent cramdown threats by Frank, click here. I hate politics. It gives me a headache. Please help me monitor this risk if you get involved.
How does the stock double or triple? This is the hard part. The company needs to leverage a teens ROA a few times; the problem is funding. Borrowing a poker term, your outs for possible funding sources are 1) repo 2) re-REMIC 3) TALF II. None of them looks that good for now. For that reason, until the company can show it can increase leverage, it's probably not worth more than $4 (slight under 15% yield on 2010 dividends). Their best chance for re-leverage currently is to do a re-REMIC, which is hard to sell right now. However, I do believe people's appetite for structured products will return if the yields are attractive enough, which will result in a higher funding cost to CIM. But if CIM can continue to purchase assets with such attractive yields, there will be plenty of spread left for CIM despite the higher cost. And if they can't buy assets at attractive yields, then that means their owns assets have appreciated. Book value will jump and you will make money either way.
August 31st, 2009 - 20:04
why not own NLY, arent they the best in class. i’d worry we get another major risk aversion trade in which CIM gets spanked. where on earth they gonna get the needed leverage? seems like a pipe dream, but i hear ya, if it happens its a homerun.
August 31st, 2009 - 21:15
I own NLY too… CIM is more of a late cycle play, in that… later in the cycle as the fed tightens, NLY’s spread will narrow, they will have to increase leverage also to maintain ROE. But CIM has no or very little repo funding and if the fed is tightening that means things are getting better, CIM should be able to maintain spread and even increase leverage through non recourse methods.
I would say today is a risk aversion trade, China being down 7%… but CIM held up pretty well against the tape… light volume sell off in the morning followed by buyers coming in the afternoon and buying all the way into the close…