I haven’t had a mortgage on my house in years. When I did, I had two strategies to cut my costs. First, when my rate was over 8%, I made extra payments. Compared to the mutual fund’s return I used to source those payments, the trade-off was reasonable. Second, I refinanced once the rate dropped 2%, about what I think the “experts” said was what homeowners should shoot for. I could not find if mREITs existed at the turn of the century when I had my last mortgage but whomever it was would have been disappointed in that both actions cut into what they expected to earn from my mortgage.
For those new to this investment vehicle, the National Association of Real Estate Investment Trusts (Nareit) provides this summary definition:
Mortgage Real Estate Investment Trusts, or mREITs, are companies that finance residential and commercial real estate. mREITs engage in a variety of financial activities in order to facilitate home ownership and the ownership and use of commercial buildings like office buildings, apartments and shopping malls. In addition to providing long-term funding for the homeowner or commercial property owner, mREITs may originate and service loans, perform capital markets activities like securitizations, and restructure or recapitalize troubled credits. mREITs generally focus on funding either residential real estate or commercial real estate.
While slightly dated, this Seeking Alpha article from 2017 gives a good overview: Mortgage REITs, Explained.
Like many mREITs, the Chimera Investment Corporation (NYSE:CIM) uses preferred stocks to help finance their business of mortgage investing. Besides the common stock, investors can pick from the fixed-rate Chimera Investment Corporation PFD SER A (NYSE:CIM.PR.A), two about to float, the Chimera Investment Corporation PFD SER B (NYSE:CIM.PR.B) or Chimera Investment Corporation 8% PFD CUM SER D (NYSE:CIM.PR.D), and one with more fixed-rate protection, the Chimera Investment Corporation 7.75% CUM PFD C (NYSE:CIM.PR.C).
After a brief review of the Chimera Investment Corporation, each of the preferred stocks will be covered then compared. Which is the better choice will depend on investor expectations for interest rates and their personal investment goals/needs: my thoughts are included in the concluding section of this article.
Chimera Investment Corporation Review
Data by YCharts
Since inception, CIM common holders have averaged a meager 4.45% CAGR. The popular PennyMac Mortgage Investment Trust (PMT) did 8.81% over the same period.
Seeking Alpha describes this mREIT as:
Chimera Investment Corporation operates as a real estate investment trust (REIT) in the United States. The company, through its subsidiaries, invests in a portfolio of mortgage assets, including residential mortgage loans, non-agency residential mortgage-backed securities, agency mortgage-backed securities secured, agency mortgage-backed securities secured by pools of commercial mortgage loans, business purpose and investor loans, and other real estate related securities. Source: seekingalpha.com CIM
Chimera describes themselves as:
We are a credit-focused hybrid mortgage REIT, meaning that our portfolio contains residential mortgage loans and both Agency and non-Agency mortgage-backed securities. Our hybrid approach allows us to maintain flexibility in portfolio allocation and liability management. Through the use of securitization and leverage, we aim to create long-term value for our shareholders. We invest in RMBS issued by third parties or issued or guaranteed by Ginnie Mae, Fannie Mae or Freddie Mac (Agency RMBS). Our Agency CMBS assets are primarily Ginnie Mae Construction Loan and Ginnie Mae Permanent Loan Certificates with prepayment protection.
The critical part of the Balance sheet shows the preferreds are well covered.
chimerareit.com 9/30/23 10-Q
The first column is 9/30/23 data; the second is 12/31/22 data. What it shows is the value of all four preferred stocks combined is covered by the stockholders’ equity, though the ratio is not one of the best amongst mREITs. Except for 2022 when the FOMC was pushing up the short end of the yield curve, CIM has shown positive earnings. As a later chart will show, the current yield curve is much more favorable to mREITs than the 2022 curve was.
Looking at the Balance sheet from another angle, shows that while it had a large drop in Book Value/share, it’s still 2X the current price of CIM.
seekinglpha.com Balance Sheet
As a sign, despite the price for the common stock, having some confidence in CIM as an ongoing entity, was their ability to increase their shares outstanding by 24% in the COVID year.
When rates fall from the recent peak in mortgage rates, refinancing or repayment occurs, the mREIT holding the mortgage or MBS must reinvest the proceeds into the prevailing interest rate environment, which logically means less income going forward. When rates are rising, rollover risk might occur as the short-term financing used is rolled into higher cost debt.
Reviewing and comparing the preferreds
Factor A Pfd B Pfd C Pfd D Pfd Common Issued 10/6/16 2/22/17 9/13/18 1/15/19 6/1/07 Issued $145m $325m $260m $200m NA Coupon 8.00% 8.00% 7.75% 8.00% NA Coupon calc fixed 3moSOFR+ .26161 +5.791 3moSOFR+ .26161+ 4.743 3moSOFR+ .26161+ 5.379 BOD set Price $21.11 $23.44 $20.21 $23.13 $4.96 Yield 9.4% 8.5% 9.6% 8.6% 8.7% Call date 10/30/21 3/30/24 9/30/25 3/30/24 NA YTC NA 31.7% 21.1% 38.1% NA Click to enlarge
All the preferred stocks are cumulative and not eligible for the 15% tax rate. CIM did not miss any payments during the COVID meltdown. I say all are converting to SOFR but apparently CIM is rethinking at least B’s switch. Details on that were well covered by Colorado Wealth Management in their The Preferred Share Dilemma Chimera Created For Themselves article.
As a reference, here is how the 3-mo SOFR has changed.
Data by YCharts
“Normal” SOFR could be between 2.5-3% if pre-COVID levels return. At today’s rate, the coupon for both B and D will top 11%, so I expect both will be Called. I would suspect that might have supported both prices and has caused the current yield to be 80+bps below A with a matching coupon. For investors who agree, they either get a YTC over 30% or hold a preferred with a floating coupon over 11%. I only one gets Called, it will be the B Pfd as it has the higher fixed component. For A to be the best for CIM to be Called, the SOFR would need to be near 2%, which it was pre-COVID. When C becomes Callable in 2025, it will rank behind B and D as it has the smallest fixed component. So, in summary:
A provides 2nd best yield and lowest Call risk current.
C provides the top yield and if the SOFR retreats below 3%, it becomes the least likely to be Called.
Hold B over D if hoping for a Call event in late March. This assumes both go to SOFR which has become uncertain for B. Hold A if you do not want to be Called.
B has a major price risk if CIM converts this preferred to fixed at its 8% coupon rate versus what today would be a floating coupon of over 11%. If 11% is what investors want and get with D, B would drop in price by 28%!
The best world for mREITs would be a normal yield curve as most borrowing is short-term and their mortgage investments are at the longer end of the curve. Below is the current UST yield curve.
Ideally, the “normal” upward-sloping yield curve is the best environment for mREITs. As the next chart shows, there is a tight correlation between mortgage rates and the 10-year UST.
One projection of where the 3-mo SOFR and 10-yr UST yields are moving to is shown next.
If correct, short-term costs as represented by the 3-mo SOFR will drop below the 10-Yr UST yield by the start of 2025, which would be very favorable to mREITs.
So along with your view on what the FOMC will do with interest rates in 2024 and where both ST & LT rates are going long-term, Chimera Investment has added extra risk not only to holders of the B Pfd with their second thoughts on floating the rate at the end of March, but to all four issues and the common stockholders. Investors saw that when other mREITs decided not to convert to the original not SOFR-based formula. Something for current and prospective holders to add to their due diligence.
A look back
In December 2022, I first looked at these assets in my Chimera Investment mREIT Offers 4 Preferreds: A, C Reviewed Here. Despite rates climbing in 2023, prices are up yields down since then, probably forecasting where investors see rates moving this year.
Then, as now, the final decision will depend on what investors think the FOMC will do from here, plus the higher Call risk compared to a year ago versus each individual’s investment goals.
Chimera Investment Offers 1 Fixed And 3 Fixed/Floating Preferreds (NYSE:CIM)