Until recently, I owned shares of CYS Investments (NYSE:CYS), which I decided to sell due to my concerns over valuation and the potential for price pressures as the Fed unwinds its balance sheet later this year. My intention was to swap out of the equity and into the preferred stock, which would allow me to keep exposure to the REIT and maintain a healthy source of income.
While I was looking into this (using my mREIT preferred update), I remembered writing on another mREIT preferred earlier this year: Chimera Investment Corp. (NYSE:CIM). I concluded that note with the following:
Chimera has an equity that has outperformed the majority of its peers and a preferred that out-yields the majority of its peers. Usually, it’s more of a challenge than this. I find the new Chimera Investment Corp. Series B preferred attractive and worthy of consideration for inclusion in an income portfolio.
In case you aren’t familiar with these REITs:
CYS Investments invests in residential mortgage pass-through securities for which the principal and interest payments are guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae, and collateralized by single-family residential mortgage loans.
Chimera Investment Corp. invests in RMBS, residential mortgage loans, Agency CMBS, commercial mortgage loans, real estate-related securities and various other asset classes.
First, an overview of the preferred stock of CYS:
Next, the preferred stock issued by Chimera:
Descriptions and details are nice, but it always comes down to pricing. The following is a snapshot of the pricing of CYS:
A 7.61-7.76% yield is nothing to sneeze at. In fact, it’s downright attractive. Then I looked at the snapshot of Chimera’s pricing:
Better yields and longer periods until they are callable – two things that get my attention. As with all investments, there are other choices. The following table shows a snapshot of some of these choices:
I know what you’re thinking: Why choose the CYS A, when the B has an additional year of call protection? The answer is pretty simple: It costs approximately 87 bps to issue a preferred stock, which means an issuer should be able to issue at the dividend rate – 87 bps – some savings. If the mREIT sector issues preferred stock at 7% and greater (the universe yields a 7.94%), then the CYS A isn’t economic to refund. This isn’t to say they couldn’t use debt (cheaper), but that I believe they would prefer to have perpetual funds outstanding.
There are “yieldier” options within that group, all of which are viable, but they are often considered higher-risk (I own both, but I have a different risk profile than some), and the yield pick-up (14-19 bps) might not be enough to offset the risk and the lesser call protection.
It is worth noting that the Chimera Series B is also a fixed-to-float issue, which mitigates the duration risk and is a more favorable structure.
Graphically, the stripped yield:
And the yield-to-call:
In order to determine whether Chimera is a better choice than CYS, a little historical perspective is in order.
For the following charts, I used the Chimera Series A, as it has more history than the Series B.
The chart above shows that the Chimera is currently trading below its average stripped yield, but the following chart shows that the CYS preferred is trading even further below its average stripped yield.
The following chart shows the stripped yield difference between the two preferred stocks:
As the chart above shows, the yield difference between the two is near its high of the year, which appears attractive.
The following chart shows the Chimera preferred on a “risk premium” basis, or spread to the 10-year risk-free rate:
While the spread to the risk-free is below its average, it is off its tights for the year and within 10 basis points from the average.
The CYS preferred is closer to its risk premium lows of the year:
Chimera’s preferred is also laying on its average “cost of stability,” or the yield difference between the equity and the preferred:
As is CYS:
From the above data, I believe the Chimera preferred is more attractive than the CYS preferred due to the structure (fixed-to-float), yield, call protection and valuation relative to the risk-free rate.
It is always helpful to look at the market’s view of the equity in order to determine what the “owners” think.
Total return shows a clear preference for Chimera:
CIM Total Return Price data by YCharts
The price-to-book value for both are highly comparable, but I will note that P/B on CYS has run up and is above average, while that on CIM has moderated.
CIM Price to Book Value data by YCharts
Finally, Chimera has been able to increase its book value, while CYS has gone in the other direction:
CIM Book Value (Per Share) data by YCharts
The equity charts appear to support the choice to swap into Chimera.
Disclosure: I am/we are long NYMT, MITT.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am most likely going to be long CIMpB in the near term.