Chimera At A Discount: Part 2

There are two issues I wanted to address in response to my writeup yesterday of Chimera. How can I trust the book value of a company that is not up to date on their financials?  What about their agency mortgage exposure?

How can I trust the book value of a company that is not up to date on their financials? Before I tackle this I want to point out again that the book value is not at issue in the restatement. I view Chimeras portfolio as two separate portfolios: a levered agency portfolio and an unlevered non agency portfolio. On the agency side its difficult to see how the book value can be wrong as the securities are relatively simple to value. It is far more likely that any mispricings are on the non-agency side. Chimera has roughly $3.1 billion in equity. They hold roughly $2.6 billion in RMBS, mostly junior securities. The dealer marks on Chimera's portfolio are 67 bps lower than Chimera's marks. From speaking to people in the industry dealer marks on junior RMBS are very tough and conservative. In the current regulatory environment its difficult to see how the numbers could be that far off. Chimera also holds a roughly $285 million portfolio of securitized loans. These loans are prime, jumbo, first lien residential mortgages. This is a seasoned portfolio with average FICO scores of over 750 and 75% LTVs. They are priced slightly below the remaining loan balances. Its difficult to see how these loans are so mismarked as to drastically change the valuation of the company. If there is a drastic mispricing of Chimera's assets I cannot figure out where it could be.

I believe that pure play agency mortgage REITs such as Annaly Capital Management and America Capital Agency Corp. are at risk. Agency mortgage REITs make money two ways. The spread between agency securities and treasuries plus off of the yield curve. As a result of the Fed buying agency securities there is no more spread between agency and treasuries once one accounts for prepayment risks. There could even be losses if prepayments come in high. This leaves the agency mortgage REITs as a levered play on the yield curve. Agency mortgage REITs have already started to sell off and its possible that Chimera gets lopped in with them. Chimeras agency exposure is relatively small and any decline in sympathy with the agency mortgage REITs would be an opportunity. If one is worried about the agency mortgage exposure I would recommend shorting a pure play agency mortgage REIT against 15%-20% of the dollar value of this position.

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