2011: The Year Chimera Prepared for Carnage

As 2011 draws to a close, it's worth it to take a peek at our investments to see what's working and what's not.

That's what we aim to do today as we pull out the instant replay and consider the year that was at Chimera (NYSE: CIM  ) .

A few Foolish facts about Chimera

Year-to-Date Stock Return (25%)
P/E 5.0
Dividend Yield 16.1%
1-Year Earnings-per-share growth (8%)
1-Year Book Value Per Share Growth (1%)
CAPS Rating (out of 5) ****

Data from Morningstar, S&P Capital IQ, and Motley Fool CAPS.

What happened at Chimera this year?
What a difference a year makes. Chimera's stock didn't have a three-peat banner year after the 20%-plus gains of 2009 and 2010. But investors don't buy mortgage REITs for stock appreciation -- they're after yields. Chimera's payouts partially compensated for its stock decline, though quarterly payouts have fallen from $0.17 to $0.11 since last December, largely because of big losses on investments.

But on the whole, residential mortgage REITs like Chimera have hit a bonanza over the past few years. As the Federal Reserve lowered overnight interest rates to nearly 0% to support the struggling economy, Chimera's cost of borrowing has held much lower than it otherwise would have, pushing up its interest-rate spread -- the difference between the interest rate it collects and the rate it borrows -- to a whopping 4.9% as of last quarter. The interest-rate tailwind was the key reason I purchased shares of the stock for the real-money publicly facing Dada Portfolio that I co-manage.

However, Chimera follows a slightly different model from most other residential mortgage REITs. By taking more flexibility with the assets it buys, it can achieve even higher interest-rate spreads than its competitors. It compensates for this higher level of risk by using less leverage:

Company

Interest-Rate Spread

Leverage

Chimera 4.9% 2.9 times
Two Harbors (NYSE: TWO  ) 4.5% 6.7 times
Invesco (NYSE: IVR  ) 2.4% 7.3 times
Armour Residential (NYSE: ARR  ) 2.2% 11.1 times
Annaly Capital (NYSE: NLY  ) 2.1% 7.2 times
American Capital Agency (Nasdaq: AGNC  ) 2.1% 9.5 times
CYS Investments (NYSE: CYS  ) 2% 8.9 times

Source: S&P Capital IQ as of most recent quarterly data.

In the hands of a capable management team, such an approach allows a REIT to take advantage of mispricings in the market. In the hands of bumblers, the style can hasten a company's demise.

Chimera barely issued any stock in 2011, a far cry from the $1.3 billion raised in the last quarter of 2010 alone. Its stock has traded for an average of just 0.95 times book value. To not issue stock in today's trigger-happy environment shows unusual restraint.

Steady as she goes
For 2011, Chimera took some light blows and ratcheted down its risk in response to the financial storm blowing through Europe. The Fed reiterated that it's going to hold rates low for some time as the economy slowly recovers. Assuming lenders continue to consider Chimera a solid borrower, the trouble brewing in financial markets might present fresh bargains for this opportunistic REIT.

I think Chimera could see some good places to invest in the new year, but our analysts have selected a different stock that they believe is poised for tremendous growth in 2012. Find out which company in our new free report: "The Motley Fool's Top Stock for 2012." Thousands have already requested access, and it'll be available for only a limited time. So get in now -- it's free.

Ilan Moscovitz doesn't own shares of any company mentioned. The Motley Fool owns shares of Annaly Capital Management and Chimera Investment. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 28, 2011, at 4:39 PM, plange01 wrote:

    cim was one of the best buys of the year a great dividend and as a added bonus its price is very low!

  • Report this Comment On December 29, 2011, at 11:24 PM, depsee wrote:

    Why would one disregard the potential for the dividend to be cut further due to more "big losses on investments". Also with the overnight interest rate at 0 there's only one way for that to go from here, which would negatively impact that interest rate spread. Not sold on this one.

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