CHIMERA INVESTMENT CORP CIM
June 26, 2013 - 11:46am EST by
aquicap
2013 2014
Price: 2.95 EPS $0.00 $0.00
Shares Out. (in M): 1,027 P/E 0.0x 0.0x
Market Cap (in $M): 3,030 P/FCF 6.7x 6.1x
Net Debt (in $M): 2,467 EBIT 0 0
TEV ($): 5,497 TEV/EBIT 0.0x 0.0x

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  • Mortgage REIT
  • Accounting restatement
  • Activists involved
 

Description

Business:

Chimera Investment is a mortgage REIT that invests in agency and non-agency residential mortgage loans and residential mortgage-backed securities.

Summary:

Chimera presents an opportunity to purchase an unlevered portfolio of residential mortgage-backed securities at a steep discount to their probable realizable value. The primary driver of return will be the continued strength in the US residential housing market. At the 3/31/13 economic book value of $3.08/share, I estimate that the $7.7b principal/notional portfolio is being carried at a ‘fair value’ estimate of $2.7b or 35% and with an accreted yield reserve of $2.3b or 30% for an estimated recovery value of 65%. Furthermore, loss assumptions on the portfolio were established at purchase in 2009-2010 and are highly conservative and the credit performance of the underlying collateral has exceeded expectations to date. Consequently, I believe that actual recoveries may approach 70% - 85%.

Currently, the portfolio is trading at 0.96x economic book value. The portfolio consists primarily of private, non-rated mortgage-backed securities that are the subordinate and mezzanine tranches produced by 6 re-REMIC securitizations that CIM constructed in 2009-2010. If the portfolio realizes the recovery value estimated in the initial loss assumptions reflected in the accreted discount, an additional $2.22/share or 75% upside will be released over the next several years. If the ultimate recovery is to 70% - 85%, exceeding the initial loss assumptions, an additional $0.13 - $0.53 or 4% - 18% upside will be realized over the next several years.

Currently, I believe that the portfolio is being marked very conservatively and would command a price in the 40% - 45% range if sold to a private buyer today. I base this assumption on reviews of the underlying credit performance of the collateral for the 6 securitizations, as well as ABX index performance of other AAA and AA rated mortgage securities issued in 2006 and 2007. The underlying loans are primarily Alt-A jumbo whole loans issued to borrowers with FICO scores above 700. The portfolio is not subprime, not option-ARM collateral. Basically, simple jumbo loans issued to high credit borrowers that happened to be issued at a market top for the underlying home.

Consequently, I think there is a large margin of safety with the stock trading at book value which I believe understates current economic value. A permanent destruction of capital would require a change in underlying residential credit trends adverse to the portfolio. I believe the likelihood of this happening in the near term is nil, creating a highly asymmetric reward-to-risk profile for CIM.

In addition, since the cash flow on the securitizations waterfalls down from the senior to the subordinate tranches and the securitizations have now been performing for 3 – 4 years, cash flow should increasingly be directed towards the sub tranches that CIM owns.

The primary reason that CIM is mispriced is that it suspended publishing current financial statements after Q3 2011. Essentially, CIM was treating high credit quality and low credit quality loans identically and GAAP requires distinct treatment for each. Specifically, estimated and realized losses on high credit quality loans flows through the income statement, while such losses flow through both the income statement and the statement of comprehensive income for low credit quality loans. CIM filed its 10K for 2011 in March 2013, and is expected to file its 2012 10-Q’s and 10-K in 2013 following a change in auditor.

Notably, the accounting restatement impacts GAAP income, but does not impact book value, cash flow or taxable income. The company has been issuing quarterly press releases stating book value. In addition, CIM has committed to paying a $0.09 quarterly dividend through the end of 2013 representing a 12% yield.

CIM has sold off in recent weeks along with other mortgage REITS relating to interest rate fears. While CIM does have an estimated $3b agency portfolio that is primarily held to ensure compliance as a REIT and exemption from the ’40 Act, this portfolio is not the primary driver of CIM’s economics. The agency portfolio is levered 7x on $437MM in underlying equity, but these figures are estimated as the last portfolio data is for 12/31/12 and CIM may have well reduced the size of the agency portfolio since then as it was their only funding source available in the last 18 months since the lack of current financials has precluded them from raising equity.

I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Financial statements should become current in the next few months. 
 
Annaly who manages CIM will likely try and aquire the portfolio on the cheap (once financials are current) as they did with CreXus. Omega and Third Point are involved and I would expect a fight on price. Notably, given the accounting screw up, Annaly reduced their fee from 1.5% to 0.75% (no performance interest before or current) but also changed their contract to allow for them to be more readily fired as manager. I believe this gives great leverage in any merger negotiation.
 
Finally, the cash flow can't be ignored forever even if they continue to temper down the marks on the portfolio. Cash flow should accelerate sharply in the next few years as cash waterfalls down to the sub tranches held by CIM
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    Description

    Business:

    Chimera Investment is a mortgage REIT that invests in agency and non-agency residential mortgage loans and residential mortgage-backed securities.

    Summary:

    Chimera presents an opportunity to purchase an unlevered portfolio of residential mortgage-backed securities at a steep discount to their probable realizable value. The primary driver of return will be the continued strength in the US residential housing market. At the 3/31/13 economic book value of $3.08/share, I estimate that the $7.7b principal/notional portfolio is being carried at a ‘fair value’ estimate of $2.7b or 35% and with an accreted yield reserve of $2.3b or 30% for an estimated recovery value of 65%. Furthermore, loss assumptions on the portfolio were established at purchase in 2009-2010 and are highly conservative and the credit performance of the underlying collateral has exceeded expectations to date. Consequently, I believe that actual recoveries may approach 70% - 85%.

    Currently, the portfolio is trading at 0.96x economic book value. The portfolio consists primarily of private, non-rated mortgage-backed securities that are the subordinate and mezzanine tranches produced by 6 re-REMIC securitizations that CIM constructed in 2009-2010. If the portfolio realizes the recovery value estimated in the initial loss assumptions reflected in the accreted discount, an additional $2.22/share or 75% upside will be released over the next several years. If the ultimate recovery is to 70% - 85%, exceeding the initial loss assumptions, an additional $0.13 - $0.53 or 4% - 18% upside will be realized over the next several years.

    Currently, I believe that the portfolio is being marked very conservatively and would command a price in the 40% - 45% range if sold to a private buyer today. I base this assumption on reviews of the underlying credit performance of the collateral for the 6 securitizations, as well as ABX index performance of other AAA and AA rated mortgage securities issued in 2006 and 2007. The underlying loans are primarily Alt-A jumbo whole loans issued to borrowers with FICO scores above 700. The portfolio is not subprime, not option-ARM collateral. Basically, simple jumbo loans issued to high credit borrowers that happened to be issued at a market top for the underlying home.

    Consequently, I think there is a large margin of safety with the stock trading at book value which I believe understates current economic value. A permanent destruction of capital would require a change in underlying residential credit trends adverse to the portfolio. I believe the likelihood of this happening in the near term is nil, creating a highly asymmetric reward-to-risk profile for CIM.

    In addition, since the cash flow on the securitizations waterfalls down from the senior to the subordinate tranches and the securitizations have now been performing for 3 – 4 years, cash flow should increasingly be directed towards the sub tranches that CIM owns.

    The primary reason that CIM is mispriced is that it suspended publishing current financial statements after Q3 2011. Essentially, CIM was treating high credit quality and low credit quality loans identically and GAAP requires distinct treatment for each. Specifically, estimated and realized losses on high credit quality loans flows through the income statement, while such losses flow through both the income statement and the statement of comprehensive income for low credit quality loans. CIM filed its 10K for 2011 in March 2013, and is expected to file its 2012 10-Q’s and 10-K in 2013 following a change in auditor.

    Notably, the accounting restatement impacts GAAP income, but does not impact book value, cash flow or taxable income. The company has been issuing quarterly press releases stating book value. In addition, CIM has committed to paying a $0.09 quarterly dividend through the end of 2013 representing a 12% yield.

    CIM has sold off in recent weeks along with other mortgage REITS relating to interest rate fears. While CIM does have an estimated $3b agency portfolio that is primarily held to ensure compliance as a REIT and exemption from the ’40 Act, this portfolio is not the primary driver of CIM’s economics. The agency portfolio is levered 7x on $437MM in underlying equity, but these figures are estimated as the last portfolio data is for 12/31/12 and CIM may have well reduced the size of the agency portfolio since then as it was their only funding source available in the last 18 months since the lack of current financials has precluded them from raising equity.

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Financial statements should become current in the next few months. 
     
    Annaly who manages CIM will likely try and aquire the portfolio on the cheap (once financials are current) as they did with CreXus. Omega and Third Point are involved and I would expect a fight on price. Notably, given the accounting screw up, Annaly reduced their fee from 1.5% to 0.75% (no performance interest before or current) but also changed their contract to allow for them to be more readily fired as manager. I believe this gives great leverage in any merger negotiation.
     
    Finally, the cash flow can't be ignored forever even if they continue to temper down the marks on the portfolio. Cash flow should accelerate sharply in the next few years as cash waterfalls down to the sub tranches held by CIM

    Messages


    SubjectDividend sustainable?
    Entry06/26/2013 08:47 PM
    Memberaagold
    Do you think this $0.36/share annual dividend is sustainable?  In the writeup you made no attempt to determine that.  I notice that only $0.05 out of the $.09 quarterly dividend is estimated to be taxable.  So if the rest is return of capital, doesn't that imply the REIT isn't earning its dividend?  You mentioned that they may have reduced the size of their $3B agency portfolio, but wouldn't that make it even more likely that there will be a dividend cut?
     
    Thanks,
    aagold
     

    SubjectRE:
    Entry10/10/2013 02:17 PM
    Membergary9
    Just interested in an update and answers to a few questions
     
    (a) aagold makes a good point about the dividend. I believe they've said that of the 18c dividend in 1H'13, 15c was taxable income, such that 3c, or 17% was a return of capital. Why isn't that an issue? On a related point, if NLY starts charging a full management fee (the 1.5% rate), that further eats into your sustainable dividend rate.
     
    (b) The agency book - how much of a mark down do you think they took there in book value? Can you look at NLY and others to estimate this? What % of their earning is coming from that book. If they've had to hedge out more rate risk, that would eat into spreads and hence earnings/dividend power. 
     
    (c) if they write up the non agency book - don't they run into issues with 1940 Act requirements under the asset test? They own agencies for that reason, and the mix will shift to too much non agency. I guess this is a problem they can solve (sell appreciated non-agencies, re-invest in agencies)..
     
    Thanks

    SubjectRE: RE:
    Entry10/16/2013 10:37 AM
    Memberaquicap
    thanks for your comments. 
     
    It's certainly possible that the dividend could be reduced to be in line with taxable income once the accounting statements are current. However, I'm not certain that the net impact is universally negative.
     
    First, CIM and most mortgage reits appear to be trading off book value multiples centered on 1x, rather than being priced on yield. If you look back a few years, pricing seemed to be more off yield, with p/bv multiples floating. If the dividend is cut, appreciation of book value would accelerate, all else constant.
     
    Second, I think lifting the cloud of delinquent filing status puts the company in play and far trumps a potential dividend cut.
     
    Third, just because the dividend modestly exceeded taxable income in 2013 doesn't mean that it would necessarily do so prospectively. You have a lot of variables impacting taxable income in the short run..most notably prepayments and impairment losses that can shift markedly in the short run.
     
    Finally, it's not unreasonable to expect that the stock falls on a dividend cut...but let's say that they cut the dividend -17% from 0.36 to 0.30. On a $3.00 stock, that's still a 10% yield. The stock would have to fall to $2.50 to preserve a 12% yield. I would view that as a temporary impairment of capital given the substantial margin of safety afforded by the underlying assets.
     
    As to the agency book marks, it's hard to say. the last look at the portfolio is 3/31/12. NLY stock performance is -12% from 3/31/12 - 6/30/13 and book value is -19% over that period. The Bloomberg BMBS index is up +0.01% from 3/31/12 - 10/15/13. My best guess is the mark lies somewhere between those.
     
    '40 act issues - that's a great question and just another incentive they have to be conservative on the marks on the non-agency book. you answer your own question in that it's a problem that's easily solved, but i think the question itself higlights the underlying gap between book value and probable economic value.
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