Chimera: Wait On A Pullback To $2.50

| About: Chimera Investment (CIM)

Chimera (NYSE:CIM) is loosely related to the largest mortgage REIT, Annaly Capital (NYSE:NLY). A subsidiary of Annaly acts as investment advisor for Chimera. Investors might view the two as similar, with both in the mortgage REIT business - one large and one small. However, the two companies work with distinctly different business models, and the current state of the mortgage backed security - MBS - business may push the investment results of the two stocks in different directions.

Over the last year, Annaly has outperformed Chimera, although both share values have declined. The Annaly share price is off 10 percent, and the value of Chimera shares is down 28 percent. Using the most recent dividend payments, Annaly yields 13.5% and the Chimera yield is a few basis points under 15%.

The results from Annaly going forward from here will be primarily driven by interest rates. The Annaly MBS portfolio is almost entirely composed of agency - Fannie Mae, Freddie Mac and Ginnie Mae - backed securities. There is little chance of losses from mortgage defaults. The risk lies in a shrinking yield spread between what the company can earn on its mortgage portfolio and the rate the company pays to borrow money to leverage the rate earned on the portfolio. If the interest rate spread tightens, Annaly will be forced to cut the dividend and the share price will probably decline. If the spread widens, positive things will happen for shareholders. The spread has tightened in each of the three previous quarters, compared to the preceding quarter.

Chimera takes a different approach to MBS investing - the company buys distressed, non-agency backed securities. These mortgage securities primarily hold mortgages originated before the housing and financial crisis and the loans are not backed by any government sponsored agency. There is a significant risk of default, foreclosure and principal loss from individual mortgage loans backing these securities. On the flip side, these securities are purchased at significant discounts to the nominal principal value, producing high current yields and opportunity for capital appreciation. Investing in distressed mortgage securities is the junk bond version of mortgage investing with comparatively high yields. The main risk is that more homeowners will default than is calculated for in the security pricing. A positive would be if fewer homeowners lost their homes and continued to pay on their mortgages or even were able to refinance.

Going into the rest of 2012, if the economy continues to improve, it could be very positive for the value of Chimera's MBS portfolio. A recent report by Amherst Securities Group on the non-agency MBS market indicated improving metrics for always-performing and return-to-performing loans backing this type of mortgage security. An improving employment picture may be the best news for non-agency MBS investors. Any slowing in foreclosure rates will produce very positive overall returns with these securities.

Chimera Investment has been forced to delay the release of the 2011 year-end results due to problems with the company's chosen auditor. The auditor firm was replaced in mid-March. As a result of the change, the 2011 year end results and the 2012 first quarter financial results will be released pretty close together. The press release discussing the auditor change stated the problem was determining GAAP values of investment securities and any changes to past results would be non-cash items. On March 1, Chimera management did announce a first quarter dividend of 11 cents per share, the same rate paid for the 2011 fourth quarter.

The final quarter of 2011 results may continue to show a decline in net income earned compared to prior quarters. If the fourth quarter results end up better than for the third quarter, that will be a strong positive. The 2012 first quarter results should show a definite improvement over the final results of 2011. Economic factors in the first quarter of 2012 have been relatively strong, and those factors should be a positive for Chimera. Another income statement item to watch is the net unrealized gains on securities held for sale. Once the new auditor puts some official numbers on the year end results, the first quarter earnings release will show whether the Chimera mortgage portfolio value is trending higher or lower.

So far in 2012, the Chimera share price has gained 17%, but remember, it is still down nearly 30% from a year ago. Investors looking to bottom fish may want to wait and see if the shares will drop back to the $2.50 level where the stock stood at the start of the year. If the year end numbers - when they are finally released - cause the market to dump the stock, another buying opportunity may be at hand.

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