Chimera: Well-Positioned, High Yielding REIT

| About: Chimera Investment (CIM)

Summary

Chimera pays a strong and stable dividend yield of 13.7%.

The company is preparing well for a higher interest rate world, through re-positioning their portfolio.

The company is also very cheap with a low beta, but investors should buy for the yield, not with the expectations of quick capital appreciation.

Investors looking for a REIT that's positioned well for the future, cheap and paying a very high dividend yield need look no further than Chimera Investments (NYSE:CIM). Even among REITs, which generally pay out generous dividends, Chimera stands above the rest, with a 13.7% yield. Moreover, this yield has been generous for quite a while, with the 5-year average dividend yield standing at 14.2%.

Some investors may worry about the payout ratio, which is currently 153%, but this is misleading, due to the way that Chimera makes money, and reports earnings. The company makes money primarily by borrowing money, and buying RMBS (residential mortgage backed securities), which pays out interest to them. Their profit comes from the spread between the rates they pay, and the rates they earn from the RMBS they buy. However, the company also buys hedging instruments, such as interest rate swaps and the RMBS they own fluctuates in terms of fair value (i.e., what they would get if they sold it right now).

Due to these two factors, they use two different metrics for reporting earnings -- net income and core earnings. Net income includes the changes in the value of their hedging instruments and RMBS, while core earnings just takes into consideration the income they're earning from the interest rate spread, and associated expenses. This makes core earnings a better proxy for examining whether Chimera can pay out dividends, since it is related to the actual income they're producing from core operations, rather than including simple changes in asset values. On a core earnings basis, Chimera has had a payout ratio between 80%-90%, which makes sense, given that it is a REIT. For 2015, the payout ratio was 81% for example ($2.37 a share in core earnings). Core earnings also show more steady growth, vs. net income, which tends to fluctuate between very high points and low points.

Chimera is also preparing for the future very well. In the coming years, interest rates will be climbing, and Chimera has been re-positioning its portfolio to account for this. They have been adding on more non-agency RMBS, instead of agency RMBS. The benefits of this are that the non-agency variant often has variable interest rates, and thus are less susceptible, in terms of fair value, to increases in the interest rate. Having a variable rate also allows their interest income to grow. In their 10-K, Chimera includes a chart showing what will happen with a plus/minus change of 50-100 basis points:

Click to enlarge

Their portfolio value will fall overall with a rise in the interest rate, since fixed rate RMBS will fall in value when interest rates rise (while their hedging instruments rise in value), but the increase in net interest income is four times the decrease in portfolio value. Moreover, rising interest rates tend to cut down on prepayment rates, (where someone refinances or pays off their mortgage with a lower interest rate) as you are less likely to refinance with a higher interest rate.

Other REITs like Two Harbors (NYSE:TWO) create similar charts, and the increase in net interest income with a 50 basis point rise is merely 1.7%, while their portfolio value will still fall .6%. This is a less favorable ratio than Chimera, on both a relative and absolute basis.

Macroeconomic trends are also relatively favorable for the company, with both the Case Shiller HPI having risen significantly in recent years, and the number of delinquencies and foreclosures plummeting. Both of these can be seen in the two charts below:

Lastly, the stock has minimal downside risk. The variance for it is low, possessing a beta of .6 only, meaning that it'll go down less should the market start selling off again. Moreover, Chimera is very cheap from a valuation perspective, possessing a 11 P/E from a net income perspective, and an even lower P/E of 6 from a core earnings perspective. The P/B is also only .9. Being cheap and having a low beta does not guarantee that the stock will not plummet, but it does significantly reduce the risk of it. In the short run the stock is unlikely to increase significantly either, given its low beta and general lackluster trading action. Therefore, I recommend investors who are looking for a strong and safe dividend yield buy Chimera, but investors should not expect quick capital appreciation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.