Chimera Investment Stock: Potential Dividend Cut (NYSE:CIM)


Evkaz

Chimera Investment Company (New York Stock Exchange: CIM) now has a dividend yield of 15.9%, which could be a red flag given that the mortgage real estate investment trust was unable to cover its dividend with distributable earnings during the last quarter.

A a strong labor market and, consequently, another significant rise in interest rates could further weigh on the company’s valuation in the coming weeks.

Despite the fact that Chimera Investment is already trading at a significant discount to its book value, it seems that the market, and not without reason, is anticipating a change in dividend policy. The title of Chimera Investment is blocked.

Chimère investment portfolio

Chimera Investment’s portfolio was valued at $13.7 billion at the end of the second quarter, with the majority of its investments in residential mortgages.

Chimera Investment’s portfolio as of June 30, 2022 consisted of residential mortgages (87% of the portfolio), non-agency mortgage-backed securities (10% of the portfolio) and agency commercial and residential mortgage-backed securities (3% of the portfolio).

Portfolio overview

Portfolio Snapshot (Chimera Investment Corp)

Robust net interest spread, but interest costs are rising

Chimera Investment, as a mortgage real estate investment trust with a large investment portfolio, generates profits just like any other mREIT. It buys credit-funded mortgage assets with high yields and profits from the difference between the yield on those assets and its borrowing costs. Typically, this business only works if mortgage trusts incur significant debt.

Chimera Investment generated a good net interest margin from its mortgage asset buying, holding and selling transactions in the second quarter.

The gross return on total assets of Chimera Investment’s portfolio was 5.5%, up 0.1 percentage points from the previous quarter. That said, Mortgage Trust Funding Expenditures increased from 2.3% in 1Q-22 to 2.7% in 2Q-22 in response to recent central bank interest rate hikes. As a result, Chimera Investment’s net interest spread decreased by 0.3 percentage points quarter-on-quarter to stand at 2.8% in 2Q-22.

Net interest spread

Net Interest Spread (Chimera Investment Corp)

However, threats to Chimera Investment’s interest rate spread are growing as the central bank continues to raise interest rates. Indeed, given the subdued strength of the labor market in August and sustained inflation, the central bank should approve the third massive interest rate hike at the end of September.

The central bank has already raised interest rates by 225 basis points this year, to a range of 2.25% to 2.50%, and the Fed is expected to raise interest rates by 75 basis points later this month, lowering Chimera Investment’s net interest spread in the future.

Deterioration of dividend coverage

The portfolio and book values ​​of mortgage real estate investment trusts were pulverized in 2022 as credit spreads widened and interest rate volatility increased at the short end of the yield curve.

As a result, Chimera Investment’s earnings available for distribution have consolidated over the past year, falling to $0.31 per share in 2Q-22. Chimera Investment’s earnings available for distribution, which are important in establishing the safety of the trust’s dividends, were down 43% year-on-year.

Profits available for distribution

Earnings available for distribution (Chimera Investment Corp)

Unfortunately for Chimera Investment, the trust’s distributable earnings fell below the quarterly payout of $0.33 per share in the second quarter, implying the company paid more than it earned. The payout ratio fell to 106.5% in the last quarter, implying that the trust will likely reduce its dividend payout going forward.

The payout ratio

Payout ratio (table created by author using trust information)

P/B-Multiple

As credit spreads widened and interest rate volatility increased, mortgage real estate investment trusts began to trade again at (steeper) discounts to their book value, due to investor expectations of steep declines in book value.

Shares of Chimera Investment are currently trading at a 37% discount to their book value, implying that the market expects significant losses in book value and lower dividends.

Chart
CIM Price to Book Value data by YCharts

Why Chimera Investment Could See a Higher Valuation

A reduction in interest rate volatility, especially at the short end of the yield curve, would help reduce uncertainty in the mREIT market.

Borrowing costs for leveraged MREITs will rise as central banks continue to raise rates, putting pressure on their net interest spreads.

That said, a deterioration in the labor market, lower inflation and slower rate hikes would provide relief to the mortgage trust sector.

My conclusion

Chimera Investment’s distribution criteria based on earnings available for distribution deteriorated in the second quarter, increasing the likelihood that the trust could realign its dividend with its (lower) earnings.

Furthermore, the substantial discount to book value, along with the high dividend yield, indicates that the market has become much more wary of Chimera Investment in recent months.

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