3 Things to Watch With Chimera Investment

Chimera Investment (NYS: CIM) is a real estate investment trust, or REIT, within the U.S. that invests in residential-mortgage-backed securities, residential and commercial mortgage loans, and real-estate-related securities.

Today, let's look at three things investors should be watching regarding Chimera Investment, as they will provide us better insight into the company.

1. Fed Funds target rates
The mortgage REIT business is anything but glamorous, but it can be quite profitable if the stars align and the Federal Reserve's policy targets on the Federal Funds rate remain low.

Mortgage REITs make money on the difference between the cost at which they borrow and the rate at which they lend. This difference, known as the net interest margin, tends to be wider when interest rates remain low and consumers are out looking for loans to take advantage of, as opposed to when rates begin to rise. Therefore, understanding the Fed's policy toward interest rates will go a long way toward understanding how profitable mREITs will be.

In recent months, net interest spreads have been tightening which have caused those bountiful mREIT profits to shrink considerably. American Capital Agency's (NAS: AGNC) second-quarter results highlighted a sequential 66-basis-point drop in average net interest margin while Two Harbors Investment (NYS: TWO) noted a 30-basis-point drop in net interest margin over the previous quarter. With its ability to purchase a large amount of non-agency loans, Chimera may have a bit more flexibility on net interest margin, but it's nonetheless worth keeping an eye on.

2. Leverage and agency vs. non-agency loans
With relatively small operating margins, the way mREIT's pile on the profits is by issuing shares and using the cash from those share issuances to leverage their MBS portfolios. This strategy can work wonders when the conditions are right, but a rapid deterioration in the real estate market can also cause this house of cards to come crashing down as the Fool's Dan Caplinger has cautioned in the past.

One really important factor worth keeping an eye on is what type of risk an mREIT is willing to undertake. Traditionally popular mREIT's like American Capital and Annaly Capital Management (NYS: NLY) invest only in agency-backed securities. This means most of their investments are backed by the full faith of the U.S. government and are free of losses in case of a default. That's not the case with Chimera, Two Harbors, or Invesco Mortgage Capital (NYS: IVR) which both own a mixture of agency and non-agency assets (although the ratio of non-agency to agency-backed loans is actually quite small for Invesco). Typically, this means non-agency-based companies offer lower leverage ratios, but come with the added risk of unsecured loans.

3. Dividends and restatement
Let's be honest without ourselves; the real reason Chimera is an attractive company is its 15% dividend yield! Keep in mind, though, that there's more behind a yield than just the number on paper. In fact, Chimera's quarterly payout has dropped five times since 2010. But, don't worry; Chimera has stuck to its guns about paying out a consistent $0.09 per quarter through the remainder of 2012.

Another key aspect worth watching is the company's earnings restatement. Earlier this month Chimera released the findings of its year-long accounting investigation and determined that it'd need to restate earnings from 2008 through 2011. At the heart of the issue is the way it accounted for earnings from bonds purchased at a discount. The resolution negatively affects earnings during the four-year period by $695 million with net interest income dropping by $411 million. This may sound awful, but now that investors have a potential resolution to this issue, Chimera may be able to move on and get back to a regular reporting schedule.

Foolish roundup
Now that you know what to watch for, it should be easier to analyze Chimera Investment's successes and pitfalls in the future, and hopefully give you a competitive investing edge.

If you're still craving even more info on Chimera Investment, I would recommend adding the stock to your free and personalized watchlist so you can keep up on all of the latest news with the company.

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The article 3 Things to Watch With Chimera Investment originally appeared on Fool.com.

Fool contributor Sean Williams has no material interest in any of the companies mentioned in this article. You can follow him on Motley Fool CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.The Motley Fool owns shares of Annaly Capital Management. Motley Fool newsletter services have recommended buying shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 that's always of interest, without charging interest.

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