Is Chimera the Best Value in mREITs Today?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Chimera (NYSE: CIM) may just be the best bargain in the mortgage real estate investment trust (mREIT) sector. It may also be the biggest risk, because its dividends and share price are modest when compared to more traditional mREITs.

The company is currently paying a regular quarterly dividend of 9¢ per share. Yet it was trading at a price of $2.37 per share on Aug. 9. The high dividend indicates that the company is capable of earning cash, but its dividends have been falling in the past few months.

On March 28, 2012 and Dec. 27, 2011, Chimera paid dividends of 11¢ per share. In September of last year, Chimera paid 13¢ per share, and as recently as Dec. 29, 2010, Chimera was paying dividends of 17¢ per share.

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The drop in dividend payments seems to coincide with a loss of share value for Chimera. The company's share value has fallen from around $3.25 last September to less than $2.25 in late July. It went up slightly with the market rebound in early August, yet as you can see from the chart above, Chimera lost 18.6% of its share value over that ten-month period.

Why has Chimera lost much of its value, while mREITs such as PennyMac Mortgage Investment Trust (NYSE: PMT) have seen their value increase in recent months? PennyMac saw its shares go from $17.88 in June to $22.06 on Aug. 6. The last dividend PennyMac paid on May 14 was 55¢ per share.

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This difference in value is really surprising because PennyMac and Chimera are essentially in the same business. They buy riskier mortgage paper, much of it without a federal guarantee, and package it into securities. Chimera is managed by the Fixed Income Discount Advisory Corp. or FIDAC. FIDAC is a subsidiary of Annaly Capital Management (NYSE: NLY).

The purpose of Chimera is to provide a way for Annaly to invest in riskier paper that is not guaranteed by Freddy Mac or Fannie Mae. PennyMac does pretty much the same thing, yet it has a higher value than Annaly. On Aug. 9, Annaly was trading at $16.80 per share. Why do two companies with similar business models have such different results?

Part of the reason is that PennyMac is a full-service loan company that offers a wide variety of products. Its specialty is buying up troubled mortgage assets, which includes some FHA paper.

Another is that Chimera has run into some trouble lately. The company issued a press release stating that its interest income for 2008, 2009 and 2010 was $411 million less than it had previously announced. That means Chimera made $1.48 billion rather than the $1.88 billion it had previously reported. This loss was detected when the company adjusted its books to stay in line with Generally Accepted Accounting Principles, or GAAP.

The same press release stated that Chimera's net income was actually $695 million lower than it had previously announced. That means Chimera has suffered some serious losses and its managers may have tried to hide them. For investors, that means the stock was not worth the value it was trading on the market.

Value investors of course will wonder what is the value of Chimera's underlying assets. Does it have other assets or potential leverage income that could generate cash in the long run? The answer interestingly enough seems to be yes. The same press release stated that accumulated other income actually increased to $735 million from $695 million. That seems to indicate that the company has other sources of income. The restatement is not supposed to affect the company's actual cash flows or taxable income.

Is Chimera a good value at current price levels? Perhaps. The company is still paying out a healthy dividend, despite the recent dips. It is also gaining in value and has demonstrated the ability to pay a dividend in spite of the recent problems.

Chimera might not guarantee the big dividends of a PennyMac or an American Capital Agency (NASDAQ: AGNC). PennyMac has a dividend yield of 10%, while American Capital Agency boasts a dividend yield of 14.9%. Yet it doesn't come with the bigger share price either. That makes it a bargain in this sector, despite the volatility associated with it.

The case of Chimera does demonstrate something that all mREIT investors need to keep in mind. This business model is not straight forward or simple. These companies can make a lot of money, but they do it by taking serious risks in the market that involve a lot of complex moves. That makes them hard to track and evaluate via traditional value investing methods.

Even mREITs that are paying nice dividends could be concealing serious problems such as Chimera's over-reported interest income. That makes the sector too volatile for some investors, but it is also what creates the opportunities here. mREIT investing is for those who like big dividends not the risk averse.

BillEdson11 has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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. If you have questions about this post or the Fool’s blog network, click here for information.

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