While I don’t think that Chimera Investment Corp.‘s (CIM) common shares are such a good deal for investors right now, the mortgage REIT’s relatively new Series B preferred stock looks like a good deal. An investment in the preferred stock layer comes with certain advantages and disadvantages that are worth discussing and Chimera Investment’s latest preferred stock issue has some unique characteristics, too.
I recently penned a piece on Chimera Investment in which I argued that the risk-reward combination at today’s valuation point was not appealing, long term. In fact, I sold Chimera Investment earlier this year because I was (and still am) concerned about the rate of price appreciation we have seen in the last two years: Chimera Investment’s share price has risen ~34 percent over the last two years and shares now sell for about book value, leaving limited upside on the table in my opinion.
While I am not a big fan of Chimera Investment’s common shares, the preferred stock layer is an entirely different kind of deal. Preferred shares offer income investors a higher degree of principal safety than common shares because preferred stocks rank above common stocks in the capital structure. In the event of financial trouble, preferred shareholders have ‘preference’ over common shareholders, meaning they have to get paid before any common shareholders get their money back. As a result, preferred shares tend to have a much lower level of volatility compared to common shares, reflecting a lower degree of risk.
Specifically, I think Chimera Investment Corp.’s 8.00% Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock (CIM.PRB) is an interesting alternative to the mortgage REIT’s common shares (which I believe continue to be at risk of a correction).
Chimera Investment’s Series B preferred stock is unique in the sense that it will pay shareholders an eight percent coupon based on the liquidation preference value of $25.00 until March 30, 2024. On and after that date, the mortgage REIT will no longer pay fixed dividends, but will switch over to floating-rate payments based on three-month LIBOR plus 5.791 percent per year, which is generous.
REITs often issue preferred stocks in an attempt to diversify their capital sources and raise cash for investments. The Series B, for instance, was issued to raise capital for the acquisition of residential mortgage loans (and other mortgage assets) and to pay for general corporate expenses. Mortgage REITs often have multiple classes/series of preferred stocks outstanding, and Chimera Investment Corp. is no exception.
Source: Chimera Investment Corp.
Since Chimera’s Series B preferred shares sell for $25.97 at the time of writing (reflecting a 3.88 percent premium to liquidation preference value) the effective yield currently sits at 7.7 percent which is lower than Chimera’s common stock yield of 10.6 percent. The Series B pays a $0.50/share quarterly ($2.00/share annual) dividend, and provides investors with a high degree of dividend visibility.
There is a lot to like about Chimera’s Fixed-To-Floating Series B preferred stock. For one thing, investors can lock in a very decent 7.7 percent cash flow yield today, and the Series B can be expected to be much less volatile than the mortgage REIT’s common shares. On the other hand, income investors ‘pay’ for a higher degree of principal safety by accepting a lower yield on the preferred shares. The Series B has very limited upside, too. I think the change to floating rate after the 2024 ‘maturity date’ is an attractive feature and the margin is generous. Buy for income and principal protection.
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