Many people are familiar with Annaly Capital Management but fewer are familiar with its subsidiary Chimera Investment Corporation. Annaly only invests in agency mortgage securities while Chimera invests in private mortgages as well as agency securities. Chimera is managed by FIDAC, another subsidiary of Annaly.
Chimera pays a 13.4% dividend and I estimate that its economic book value is greater than $3.00 (GAAP book value is even greater but does not reflect reality). Chimera currently trades at $2.62 and would need to appreciate by 14.5% in order to reach my estimate of economic book value. Chimera last reported economic book value of $2.87 as of June 30. The type of junior mortgage backed securities that Chimera holds have risen strongly since then and I estimate that the economic book value is now above $3.
What is the catch and why does such a discount exist ? Chimera has dropped precipitously in recent years as some of their securities had not performed as expected and they are delinquent in their SEC filings.
GAAP accounting treats investment grade securities and non investment grade securities differently. Chimera used the investment grade accounting treatment on non investment grade securities. The difference amounts to which line item the income flows through, interest income or other. The end result is the same. The book value and the cash flow are unaffected by this. Chimera is delinquent in their filings as they correct these errors going back a few years.
The securities that Chimera holds have underperformed other private label RMBS in recent years. This is reflected in the market value of those securities and in turn Chimera's economic book value. I don't believe an additional discount needs to be applied to Chimera.
Chimera trades with a large margin of safety due to its significant discount to economic book value. I believe that over time that it will trade back to economic book value. Investors are being paid 13.4% while they wait. This is an attractive risk/reward in a market with few bargains.