Chimera Investment Corp (CIM) 2011 Q2 法說會逐字稿

Good morning and welcome to the second-quarter earnings call for Chimera Investment Corporation. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. (Operator Instructions). At the request of the Company, we will open the conference up for questions and answers after the presentation.

This earnings call may contain certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements, which are based on various assumptions, some of which are beyond our control, may be identified by reference to a future period or periods or by the use of forward-looking terminology, such as may, will, believe, expect, anticipate, continue or similar terms or variations on those terms or the negative of those terms.

Actual results could differ materially from those set forth in forward-looking statements due to a variety of factors, including, but not limited to, our business and investment strategy, our projected financial and operating results, our ability to maintain existing financing arrangements, obtain future financing arrangements and the terms of such arrangements, general volatility of the securities markets in which we invest, the implementation, timing and impact of and changes to various government programs affecting the capital markets and the economy, our expected investments, changes in the value of our investments, interest rate mismatches between our investments and our borrowings used to fund such purchases, changes in interest rates and mortgage prepayment rates, effects of interest rate caps on our adjustable-rate investments, rates of default or decreased recovery rates on our investments, prepayments of the mortgage on other loans underlying our mortgage-backed or other asset-backed securities, the degree to which our hedging strategies may or may not protect us from interest rate volatility, impact of and changes in governmental regulations, tax law and rates, accounting guidance and similar matters, availability of investment opportunities in real estate-related and other securities, availability of qualified personnel, estimates relating to our ability to make distributions to our stockholders in the future, our understanding of our competition and market trends in our industry, interest rates, the debt securities market or the general economy.

For a discussion of the risks and uncertainties, which could cause actual results to differ from those contained in the forward-looking statements, see Risk Factors in our most recent Annual Report on Form 10-K and all subsequent quarterly reports on Form 10-Q. We do not undertake and specifically disclaim any obligation to publicly release the result of any revisions, which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

I will now turn the conference over to Mr. Matthew Lambiase, President and Chief Executive Officer. Please proceed, sir.

Thank you, Rocco. Good morning and welcome to Chimera Investment Corp's second-quarter 2011 earnings call. This is Matt Lambiase; I am the President and CEO. And joining me on the call this morning I have Alex Denahan, our CFO; Chris Woschenko, our Head of Investments; Rose-Marie Lyght, the CIO and Manager, FIDAC; Choudhary Yarlagadda, the Head of Structuring at FIDAC; and Jay Diamond, a Managing Director at FIDAC and a member of Chimera's Board of Directors. We are all here to answer your questions after my comments.

As you know, the mortgage market has experienced significant volatility in the recent quarter. Many bullish mortgage investors who are encouraged by the falling unemployment rate earlier in the year had to reevaluate their positions in light of new and bleak data on home prices and home sales. The distress was further compounded when a well-publicized sale of a large distressed mortgage-backed securities portfolio held by the Federal Reserve did not go well. Many banks with residential mortgage exposure and mortgage insurance companies also came under significant pressure during the period.

So with all the volatility that we have experienced in the mortgage market in the last few months, I think it is important to highlight certain aspects of Chimera's portfolio. First, Chimera does not own pay option ARMs, home equity loans or second mortgage loans or securities in its portfolio. These assets saw a significant drop in price as the Federal Reserve had a difficult time liquidating the AIG Maiden Lane II portfolio during the second quarter.

The majority of the assets in the Maiden Lane II portfolio were home equity securities and the prices of these bonds and the ABX index which tracks them went down materially as the market tried to absorb the supply. Chimera is not involved in these types of securities and so the change in the level of the home equity ABX index is not a good proxy for the change in the value of our portfolio.

To date, we have been successful finding better risk reward in higher-quality sectors in the mortgage credit space. And while all credit has traded off in the second quarter, the bonds in our portfolio were far less volatile than the ABX index and home equity securities.

Second, the vast majority of Chimera's mortgage credit investments were purchased at a meaningful discount to par. Owning bonds at a discount puts us in a significantly different position than a mortgage -- than a bank or a mortgage insurance company that underwrote their residential mortgage credit risk at 100 cents on the dollar.

Our discounted dollar price serves as a buffer to our invested capital as expected losses occur on the bonds. We assume and expect losses to occur on our discounted bonds and the yields that we book on these assets are adjusted for those loss assumptions.

Third, Chimera is operating with very low leverage. Our current asset mix is achieving a high relative return and allows us the flexibility to take advantage of opportunities. Roughly 80% of our capital is invested in discounted residential mortgage credit. We own these mortgage credit investments for cash without any leverage from repo borrowings or bank loans.

In a timely move in the first quarter, we increased our allocation to US agency mortgage-backed securities. Chimera now has roughly 20% of its capital allocated to a modestly levered US agency mortgage-backed securities portfolio. These securities are highly liquid Fannie Mae, Freddie Mac and Ginnie Mae pass-through securities, which have performed well in the last quarter. This position affords us great flexibility in the current environment.

Should credit prices become more attractive, we have the liquidity to buy and should the market begin to shed some of its volatility, we have the ability to increase our leverage. It is our view, however, that the credit markets will most likely continue to exhibit more volatility until the debt ceiling issues are resolved, Europe's sovereign debt crisis clears and the domestic economy starts to show stability and some job growth.

The turbulent market creates opportunities for companies like Chimera who are operating with low leverage and have liquidity. The combination of regulatory reform from Dodd-Frank, capital reform from Basel III and the general deleveraging of financial institutions has led and will continue to lead to portfolio sales and other asset trades. We are currently having discussions with both domestic and foreign banks regarding asset sales and restructuring opportunities.

We are in the unique position of having dry powder to take advantage of this environment and we are actively looking to add to our portfolio of high-yielding investments.

It is evident that the market's fear and uncertainty are driving yields and rates of return in the fixed income markets to ultra low levels. Three-month T-bills are at 8 basis points and the 10-year treasury is yielding about 270. At the same time, Chimera is producing a high teens return on equity while operating at a 1.3 to 1 leverage ratio.

Our credit investments, as we stated on previous earnings calls, are performing better than what we modeled when we purchased them and they are locked out from principal flows. With this structure, our team has built a portfolio that is intended to enable Chimera to continue to produce robust and high relative return even without significant leverage.

I believe Chimera is well-positioned. We are operating at low leverage. We are producing a high rate of return and we have the ability to take advantage of the opportunities that present themselves in the turbulent market. So with that, I will open it up to questions.

(Operator Instructions). Jason Weaver, Sterne Agee.

Good morning. Thanks for taking my question. First of all, I think you mentioned last quarter the reasoning behind the non-agency senior sales was related to downgrade risk on certain Re-REMICs.

Yes.

Could you just update us what you are thinking on that asset class now and if you are looking to reallocate there?

Well, I think the first quarter our thoughts were that owning AAA bonds in this environment with declining house prices and declining home sales, bonds could come under some risk from the rating agencies reevaluating their criteria and they could get downgraded. We are in the process of watching the rating agencies work and they have been reevaluating their criteria on mortgage credit and it has been a little choppy there.

And I think the other reason why we sold those bonds in the first quarter is because we wanted to take the risk assets off of repo and replace them with the agency -- replace that capital with agency mortgage-backed securities on repo. And I think the trouble in Europe is a real problem and I think you have to be very careful with the sovereign debt and some of the European banks, and we don't want to be in a position where we have credit assets out on repo with banks that are going to get into some kind of financial troubles. They want to derisk at a time when everybody else wants to derisk and it can get very choppy having those types of bonds on repo. You are much better with agencies or treasury bonds on repo in this type of environment and I think that move was very good for the Company in the first quarter.

Okay, thank you. Also touching on what you said in your comments, Matt, what we saw into the second quarter with the technical overhang related to both the Maiden Lane II and the European sales, what do you see ongoing? Any meaningful pressure on your non-agency book even though they are not of similar quality?

We would have hoped that we would have seen more pressure on the high-grade part of the mortgage credit market. We hadn't seen a big selloff in the paper that we have been trafficking in and trading in. And I think a selloff would mean -- the way the Company is set up right now is we can take advantage of it. I mean we are actually -- this volatility is actually I think a good thing for us the way we are set up.

Okay, thanks, guys. Solid quarter. Look forward to talking to you soon.

Bose George, KBW.

Good morning. I had a couple of things. First, just can you comment on investment opportunities in the market right now, just what kind of unlevered returns? And just on the funding side, what is going on in the Re-REMIC market?

Sure. I will have Chris (multiple speakers).

(multiple speakers) the underlying collateral dependent on the bond, you are going to find something at about a mid-7s kind of yield that will restructure into the low teens depending on what kind of splits you get from the rating agencies.

And you said mid-7s for the unlevered yield?

Mid-7s for the unlevered yield on the collateral and then once we sell off the seniors, we would own the subs in the low teens.

And the Re-REMIC market, has there been much activity there recently?

No, there hasn't.

Is that based on sort of lack of investor demand or (multiple speakers)?

I think there is a little bit of uncertainty regarding the rating agencies. And you can't really (inaudible) the bottom piece where you used to be able to. So it is not quite as attractive of a trade as it was before.

Great, thank you.

Doug Harter, Credit Suisse.

Thanks. Matt, I know you said -- I know you guys aren't in subprime or pay option bonds. Given that those have sold off more, is that something that you would look at today or is that something you guys kind of just have a bias against?

Well, I would say with regard to pay option ARMs specifically, we hate them. We probably will never buy them here at any price. We just don't like them at all. With regard to home equity securities, they are not cheap enough for us to care. The majority of the bonds that were in the Maiden Lane II portfolio were longer home equity bonds that were floating rate in nature. So they have an awful lot of tail credit risk on them and you don't get paid a lot of coupon for owning them upfront. So they really don't fit well into our business model. I mean at some price, we would probably care about them, but at the moment probably not.

Great. And then I was just hoping you could help us understand on the credit losses that have been flowing through, is there any amount or how should we have a sense of that amount going forward? Obviously, there is a large amount of discount that you bought these bonds for, but trying to figure out what that credit component is going to look like going forward.

I believe we've said in earlier calls that the credit losses have come in to date lower than what we expected, but we do expect them to continue to come in. We don't disclose -- they will be lumpy based on how the actual securities pay and write-offs flow through the security, so we do expect them to be lumpy, but in general we are not expecting them to mitigate in the near future. And we expect that they will continue to come. We have $2 billion in discounts that we obviously don't expect to receive all of that back.

Okay.

Stephen Laws, Deutsche Bank.

Hi, thanks for taking my question. Matt, a couple of questions, and I guess maybe you could just talk to your thoughts on leverage and then ROEs on the portfolio. If we adjust the fourth-quarter results for kind of a slow deployment of capital raised late in Q3, we have seen ROEs come down, core ROEs come down six quarters in a row.

Now that said, if we somewhat adjust the leverage to try and back out the repos tied to the agency assets, it looks like leverage on the non-agency portfolio has come down quite a bit as well from kind of early levels last year. Can you maybe talk about what is driving those decisions, what would it take for you guys to take a different stance on leverage so we would see ROEs turn back the other way? Or maybe a better way to ask the question is just simply where do you see ROEs trending to in the next two to three quarters?

Yes, I think that is great. I think the first thing is that our return on equity I think is terrific for a company that is as low levered as we are. I think we are in as defensive a position as you can be in the mortgage credit space. I think we raised capital in the fourth quarter and as everybody saw in the fourth quarter and beginning of the first quarter, the credit market rallied significantly. People were getting very bulled up on the economy and thinking things were going to get better and unfortunately those hopes and those expectations changed late in the first quarter.

And I think our return on equity is extremely strong to the amount of leverage we have. I don't see us increasing the leverage on our balance sheet in this environment with the challenges that we have in the global economy happening. Europe is a mess. I mean I think the debt crisis issue will get put behind us this week hopefully, but Europe is really the ongoing problem here and how it affects the banks. And you have got to remember, especially in the credit space, when you are borrowing money against credit assets, you are only as good as the people lending you the money. And I think a lot of these banks could be in some serious trouble going forward.

So it is better for us to run a low levered balance sheet and produce this type of return and be around with dry powder to go after the opportunities of these guys that are going to be forced to sell stuff. And we are talking to quite a few different institutions, both domestically and internationally, to hopefully pick up some of their assets when they are selling them.

Great. And I guess a follow-up question, just as far as capital raises going forward, kind of multi-part question. One, can you talk about whether or not you would look at the deal as being accretive or not based on the GAAP book value or the recently released economic book value metric? And secondly, maybe comment towards reallocation of capital, existing capital versus new capital in that do you view the agency RMBS portfolio, which is half the portfolio on a fair value basis, as a source of capital to redeploy into non-agencies as you see pricing change or is that a segment of the portfolio we should look at as being fairly constant and any growth would be through -- any growth on the non-agencies side would be through new capital being raised?

As any investment manager, I know the people on this call know, is when you see things change, you have to make adjustments for it. That is what we did in the first quarter. We thought that the bid was very strong for our non-agency AAA bonds. We sold them and we took the capital and we reinvested it into agency mortgage-backed securities as a place that we knew was going to be safe through the turbulent times we are going to go through.

And I think if things get cheap enough, we will certainly go to our agency mortgage-backed securities portfolio as a source of liquidity to go after mortgage credit when things cheapen up significantly. And I think that is -- hopefully that is what we are articulating to everybody here is that that is our intention is when we see stuff, portfolios or bonds or whatever, get cheap enough, we are going to go first to our liquidity sources, which is the agency.

Great. So I should read that that we will see that agency investment come down likely before we would see another capital raise?

Those things -- we have a policy here, we don't like to talk about capital raising and our capital markets activity, but we consider all these things as avenues of opportunity when we see it.

Great, thanks a lot for taking my questions, Matt.

(Operator Instructions). Ken Bruce, Bank of America-Merrill Lynch.

Thanks, good morning, Matt.

Hey, Ken, how are you?

Good, thank you. And you?

Well, thanks.

Good. I was hoping you could provide a little bit more context just so we can reconcile a couple of the statements that have been made. So I understand current unlevered yields mid-7s for something that you could get in the low teens. I guess that doesn't quite reconcile with the lack of access to the Re-REMIC market, so I am a little -- I guess I would like to just understand how you would get into the kind of mid-teens type return on a new investment if the market is kind of closed out or how we should think about that?

I think right now the market is -- you buy the underlying securities in the 7 to 8 type yield range unlevered and then when you Re-REMIC it, you get to the low teens type of return on it to our loss assumptions. I think that is what the current economics of the Re-REMIC business is.

I would say that the rating agencies have been more and more difficult with re-rating and making assumptions on collateral in the present market. And I think things are -- certainly the activity in the Re-REMIC market is certainly more quiet than it has been in the past.

All right, so I guess just to maybe kind of follow on to one of your earlier questions, so your returns are going to be drifting down to wherever the current returns are in the market. It sounds like that is going to be, call it, low to mid-teens. That is based on the position that you have taken. That is not a bad -- I'm not trying (multiple speakers).

And I would say this, Ken, you have to think about it. The majority of the investments that we have made, these Re-REMIC subs that we own, don't get paid down in principle, right? So they are not going to get a lot of principal flows, they are not going to pay down significantly for some period of time going forward. So that return is going to be pretty strong going forward. And then on top of it, you are talking about the reinvestment risks, right, into the low teens, which is -- if you think about it, just the environment that we are in, we've got a 270, 10 year and then 8 basis points on the three-year T-bill, I mean you know nothing wrong with 14%, 15% ROEs.

No, I am not trying to (multiple speakers).

Especially not with taking on a significant amount of leverage to get them. We have to be somewhat realistic in terms of the market. We are trying to produce really high returns and not take a significant amount of leverage risk in the credit book at this point. And that is not to say that we won't take credit leverage going forward, we won't increase leverage going forward, just not at this moment.

Right, I am not trying to be antagonistic here; I am just trying to understand kind of what the dynamic in the portfolio is going to look like as we try to model it going forward. And I guess could you remind us how much of the subordinates portfolio today is actually receiving principle or how much of that is locked out?

Really very little of the subs are receiving principle.

Okay. And I will follow-up with that later. But could you just remind us as to -- you have got now -- you have always had a very conservative view in terms of how the housing market was going to play out, clearly the FIDAC and the Annaly view from the top of the house and that appears to be kind of factored into the discount that you have got for the existing portfolio. Do you find yourself revising your expectations as you look at new investments? Has that -- I guess the degree of weakness that you see in the housing market changing at all?

To date, no. I think we were very negative and we continue to be negative on the housing market. And the way that is kind of reflected in our cash flows and in our valuations is really talking about recoveries when loans go into default. And Chris and the team haven't changed their recovery assumptions and they are still much higher than what we have been actually witnessing in the remittance reports that we have been getting, so we are still negative.

We haven't changed the way we looked at credit. I think what stops us a little bit from buying credit like in the first quarter is that a lot of other investors started changing their loss assumptions to the positive and we never did that and we became a noncompetitive bid in the marketplace for credit.

I think we turned out to be right after all and I think we are continuing to be negative on the housing market. We think that there is still more to go in terms of the housing market to go down in price and we are probably going to see weakness in housing for the foreseeable future. I think all that coupled together means that there is going to be a lot of opportunities for us in this kind of turmoil and unsettled market to find great opportunities to invest.

Right, understood. So you basically have a very conservative view. You are waiting for prices to wash out some more and (multiple speakers).

That's right. That's the reason why we are at such a low leverage ratio, we are not borrowing money in the credit space, so bank loans or on repo and we are waiting to see, I think, another downdraft here and I think that is going to be a great opportunity for us.

And then ideally the rating agencies or just the securitization market effectively begins to function a little bit more routinely.

Well, we would love that. We would love the rating agencies to function.

Okay. I will leave it there. Thank you very much.

Daniel Furtado, Jefferies.

Good morning and thanks for the time, Matt and everybody. Hey, just a couple quick questions. Do you have any whole loans on the balance sheet right now?

We have the original or the legacy deals that we did back in 2008. If you remember, we bought, when we first started up, about $1 billion worth of whole loans from PHH Mortgage and we securitized them and those are the only loans that we have at the moment. It is the Company's intention, however, to get back into that business, the jumbo prime origination business and we have been actively setting up the foundation for that business in the last quarter or two. But we have nothing at the moment on the balance sheet.

Understood. And the last quarter or two, you kind of -- it's been an increased focus as opposed to, call it, like a year ago (multiple speakers)?

Yes, absolutely, absolutely.

Great. And then from the standpoint of the repo that is on the balance sheet, can I assume that that is all agency or --?

It is 100% agency.

Okay, great. And then you were speaking about it like being ready for a downdraft with Ken earlier and just kind of hypothetically speaking, if you saw the downdraft, how would you -- let's say you want to take leverage higher on the non-agency book, like what would be the process in which you would do that?

I am not so sure we would just take leverage higher on the non-agency book in a downdraft. I think you'd probably sell the agencies and use the capital to buy credit investment.

Got you. Got you.

It is one way or the other, but the nice thing is we bought the agencies back in the first quarter. They performed extremely well, as you can imagine, during this rally here. So it has been good. So they are at a good -- at the current moment, they are at a nice profit position for the Company.

Great. All right, well, thanks a lot.

Stephen Mead, Anchor Capital Advisors.

Good morning. Can you provide a little bit more sort of color on the agency portfolio? And I don't know whether you took the leverage up say from the first quarter on that portfolio and I was trying to get a sense of, in terms of contribution to quarterly dividend, what the agency portfolio does for you.

At the end of the first quarter, the agencies were a little over five times levered; at the end of the second quarter, they are a little over six times levered. We have some assets that were unsettled at the end of the first quarter.

With regard to the contribution of the agencies to the portfolio, we provide an annualized yield in the press release to give you an idea based on the face of the contribution of their income to the portfolio.

Yes, this is Rose. The agencies currently at their leverage ratio are producing mid to high teen ROEs.

And what is the composition of the agency portfolio at this point in terms of --?

It is a combination of, as Matt had said in his comments, of Fannie, Freddie and Ginnie 15 and 30-year pass-throughs. So they are straight fixed rate pass-throughs, no structure in them.

And then do you -- I mean how much hedging or swapping do you do on that portfolio?

We do have swaps on the portfolio currently. We have about $950 million of swaps against the agencies. That is something that Chris and myself and the team monitor and we will look to add swaps as we see fit as we do with all the companies.

And your CPR on the agency side?

It is about mid-teens, right? 17? Sorry, that's the entire portfolio. (inaudible) actually lower on the agencies.

The agencies are at about a 7%.

Sorry, the entire portfolio is (inaudible).

The agencies are a 7%?

Yes.

Yes.

And then what kind of ROE do you need to generate on the non-agency side to in a sense move the portfolio more aggressively to that paper?

Well, the hold trade has got to be a [PIK] yield, right? So we are going to need to pick up yield to unwind the agencies.

Yes, okay.

And it comes down to the risk, moderating the risk in the different asset classes. I mean each asset class is going to have different risks associated with it and as managers, we are going to have to make decisions on which risks we feel more comfortable with taking at those yield levels. Obviously, in the first quarter, we made a decision that the risks we were comfortable taking at that time were more in the agency space and that is why we moved slightly over to that area, but I don't necessarily know if it is a 1-for-1 yield differential, but I think you have to take the whole risk associated with each asset class into consideration.

Okay, one last thing. There were others in the REIT space, mortgage REIT space that (inaudible) capital with the statement that the non-agency space now offered adequate returns or attractive returns. You sound like you are much more in the camp of waiting for better returns than what others have seen.

Well, I think the difference is that if you're -- there is non-agency repo available in the marketplace. This Company and the management currently here doesn't want to go out and borrow money against non-agency bonds. Just because we take the risk, it is not worth the reward to the shareholders in the long run.

I think while the banks are still having the kind of troubles that they are having and I think the banking system is a lot weaker than perhaps people -- or at least I think they are a lot weaker than some people think. Until things settle down, we don't want to do that and we are not going to take the leverage up there for the foreseeable future until we see things calm down. And I think that is the more prudent way to do it. I think we have the luxury of doing that and not chasing after a lot of yield in this market because we have -- we have put a lot of risk on at very cheap prices earlier and we get to run at low leverage, keep our powder dry and wait for some opportunities to come around right now. It is a very nice position to be in and still be able to produce I think one of the highest returns in the sector.

Okay, no, that is fair. Thanks.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Lambiase for any closing remarks.

Thank you, Rocco and thank you all for participating in our second-quarter 2011 earnings call and we look forward to speaking to you in the third quarter.

Ladies and gentlemen, if you wish to access the replay for this call, you may do so by dialing 877-344-7529 or 412-317-0088 with an ID number of 10002677. This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.