Chimera: Does Massive Dividend Outweigh Risks?

| About: Chimera Investment (CIM)

The yields currently offered by REITs that invest in mortgage backed securities have been providing impressive, and in some cases double digit dividend yields. MFA Financial (NYSE:MFA) provides a 12.5% yield while Two Harbors (NYSE:TWO) provides a 15.7% yield. American Capital Agency (NASDAQ:AGNC) provides a 15.4% yield. Chimera (NYSE:CIM) currently yields 16%. In looking at these numbers, investors might wonder why they bother trying to make gains on any other stocks and just sit and collect over 10% from investments in the common stock of these REITs.

Chimera's portfolio is managed by Fixed Income Advisory Discount Company which is owned by Annaly Capital (NYSE:NLY), another high yielding REIT with a dividend yield of over 13%. FIDAC is a fixed income investment management company that focuses on managing credit, interest rate and fixed income securities. Unlike Annaly, Chimera trades both Agency guaranteed and private mortgage paper which is not guaranteed. Chimera also differs from Annaly in that it holds some commercial mortgage paper in its portfolio. Chimera's stock price is more vulnerable to changes in the economy, good or bad.

Here's the good news, Chimera has a slight advantage being a hybrid REIT in that it can move between Agency and non-Agency securities to maximize yield in the portfolio. Investors interested in dividends may prefer a diversified REIT as there is some uncertainty in the interest rate climate.

There is some speculation that long term rates could fall below 1%. According to the Chairman of the Federal Reserve, Ben Bernanke, it is possible that the premium on long term interest rates has fallen. This may mean that investors are becoming more optimistic about the economic environment, seeing more stable inflation and a decrease in economic volatility. The spread between long and short term rates has diminished which may lead to a stronger economy in the months ahead, which is all the more reason for the Fed to hang tight on its monetary policy. Lower interest rates could diminish mortgage earnings for a number of companies, there are still a lot of reasons to take a closer look at the industry.

And now for the bad news, Chimera had a change of auditors in March and delayed the fourth quarter filing, leading some to be concerned that there was something seriously amiss. Chimera filed a Non-Timely filing notice in January for the 2011 10K and in May for the 10Q for the first quarter of 2012. Ernst & Young have taken over from Deloittes as of March 15, 2012. Chimera has filed NT's for the three previous quarters and we have yet to see results.

The company announced that it had not completed its analysis and the review may result in non-cash changes in the accounting results of the company. The book value of $3.01 per share will not change as a result of this analysis. Book value at year end 2011 was $2.97 per share and taxable income was $0.11 per share. Dividend distribution is based on taxable income not GAAP income. There was some disagreement or issue with the GAAP treatment of the non-Agency debt and equity investments, beneficial interests in securitized financial assets and the receivables for loans and debt securities acquired with deteriorated credit quality.

Chimera has cut its dividend every year from $0.17 and $0.18 in 2010 to $0.14 and $0.13 to $0.11 in the last quarter of 2011 where it remains at this time.

The cookie cutter disclosure always states that there are no material disagreements between the auditor and the company but if there were not any disagreements, the only other reason an auditor would resign is because it is not getting paid. A good guess is that there were some discrepancies in the valuation of the company's assets. It appears there was some discrepancy with the valuation of the non-Agency assets in Chimera's portfolio. The company has yet to release its financial statements for the third quarter 2011, year-end 2011 and first quarter 2012. Speaking from experience, a public company does not like to release financial information that it has to amend at a later date.

Re-stated financial statements make everyone clear out fast which is probably why there have been no disclosure documents filed. While the company delays, investors have shown themselves the exit and those that remain in are being, in my mind overly forgiving and patient. What can it be that can possibly take this long to figure out? Either there are some very complicated trades and leverage positions that make a bottom line valuation determination impossible or the news is so very bad, the company is trying to figure out when and how to spin it to soften the blow. Maybe it is waiting for a turnaround in the economy that will increase the value of some of its holdings and we can all carry on, safe in the knowledge that there is no disaster looming

Competitively, Chimera always deals with its ability to acquire assets at favorable spreads over the borrowing costs. Chimera competes with other mortgage REITs, specialty finance companies, savings and loans, mortgage bankers, insurance companies and a whole host of other mortgage investment entities. There are many mortgage REITs with similar asset acquisition objectives. Other REITs will increase competition for the available supply of mortgage assets suitable for purchase. Some larger competitors have a higher risk tolerance or different risk assessments, which would allow them to consider a wider variety of investments.

Current market conditions may attract more competitors which will increase the competition for sources of financing. This will affect the availability and the cost of financing and can adversely affect the market price of the common stock. The foregoing is paraphrased from its 2010 10K filing. Perhaps Chimera was foreshadowing a change in the competitive landscape that would negatively affect its ability to continue to deliver strong returns to shareholders. Whatever it was for, it is evident that there are a majority of investors out there who don't like what they see. The stock is trading below its estimated book value. It may very well be the book value is not accurate and shareholders aren't waiting around to find out. Chimera is interesting and it is risky.

On the bright side, foreclosures are now starting to decline since the dark days of 2007 onward. Chimera hasn't come out and stated any really terrible things so investors could take the tact that no news is good news. Having tried to shed some sunshine here, my opinion is that I would avoid this stock for now. I have a deeply ingrained suspicion of any company that can't get its act together to publish financial disclosure in a timely manner. I am wondering if there is any point in entering the stock at these levels for the yield, maybe in this quarter, but I wouldn't hold out hope for the second half of the year.

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

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