Chimera Investment Corp (CIM) 2011 Q3 法說會逐字稿

Good morning and welcome to the third-quarter earnings call for Chimera Investment Corporation. At this time, I would like to inform you that this event 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 to 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 arraignments; 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 and 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 markets 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, Andrew. Good morning and welcome to the third-quarter 2011 Chimera Investment Corporation earnings call.

This is Matt Lambiase, President and CEO. And joining me on the call this morning, I have Alex Denahan, our CFO; Chris Woschenko, the Head of Investments; Bill Dyer, our head of Underwriting; Choudhary Yarlagadda, the Head of Structuring at FIDAC; and Jay Diamond, the Managing Director at FIDAC and a member of Chimera's Board of Directors. We're all here to answer questions after the prepared comments.

On November 18 the company filed its third-quarter 2011 10-Q. We made the filing later than usual because in conjunction with a review by our independent auditors, we determined that ASC 325 should be applied to determine the GAAP treatment of other-than-temporary impairments or OTTI related to our securities rated less than AA, as well as non-rated, non-agency RMBS and other subordinated RMBS that are not of high credit quality, and that that analysis had not been completed. The analysis is now complete, and after my comments, Alex will give a detailed explanation of ASC 325 as well as a discussion on how well the OTTI changes will be reflected in our GAAP reporting going forward.

However, I think it is important for investors to understand that this analysis is a non-cash change in our GAAP accounting results. This does not affect our previously announced book value or taxable income in any period. Chimera pays its dividends based upon its taxable income, not GAAP income, so the results of the change of a valuation to ASC 325 will have no impact on the company's prior or future dividend distributions.

Now this morning there are two items influencing our operating environment that I would like to discuss. First, as you know, the financial markets continue to be turbulent and the recent news of sovereign debt deals in Europe is welcome but probably not sufficient to calm the markets or the doubts of the capital adequacy of its European banks. European banks may be forced to raise large amounts of capital and required to sell assets in the near future. In our an opinion, it's most likely that they will sell non-core non-European assets like US dollar denominated mortgage-backed securities, CMBS, or corporate bonds.

When this happens, there may be a significant opportunity for those companies that have the ability like Chimera and the liquidity to take advantage of the selling.

Since the first quarter of this year, Chimera has adopted a conservative low leverage strategy which allows us great flexibility in the current market. We deliberately removed repo leverage from our credit investments and now 100% of our recourse borrowings are backed by US-agency mortgage-backed securities.

Because the company is operating at 1.2 to 1 recourse leverage ratio, we have the ability to either increase our leverage or sell highly liquid US agency mortgage-backed securities in order to buy distressed assets in the future, should the opportunity arise.

Second, there has been a major change in the jumbo prime lending landscape. On October 1, Fannie Mae and Freddie Mac reduced the conforming loan balance. And now $625,000 is the largest amount that they will guarantee. In the past few years, it has been very difficult for private capital to compete with the efficiencies of the US agencies. And now lowering the conforming loan balance should create opportunities for opportunities like Chimera who wish to purchase and securitize new jumbo prime mortgages.

We believe recently originated mortgages represent some of the best credit and underwriting standards seen in the industry in a very long time. Mortgage borrowers today submit to a thorough credit review and are also required to put significant money down in order to secure a loan.

In late 2007 and early 2008, the company underwrote, purchased and securitized over $750 million in jumbo prime mortgages, and those mortgages were tightly underwritten and have had excellent performance to date. The destruction of the mortgage securitization market and the encroachment of Fannie Mae and Freddie Mac into the jumbo prime mortgage space made it difficult to consummate profitable securitization since 2008. However, we believe this will be changing in the near future and Chimera, which maintained its underwriting and structuring abilities, will be able to capitalize on the new opportunity.

Sourcing recently originated jumbo mortgages. Securitizing them should create high-yielding long-duration investments backed by well underwritten credit that will benefit Chimera into the future.

I believe the company is currently very well-positioned. We continue to produce high real returns while operating at low leverage and maintaining significant liquidity. Chimera will be able to take advantage of assets outside of European banks if the prices are attractive.

And as we look to the future, we continue to lay the foundation of our new jumbo prime mortgage securitization platform. We expect to see more jumbo securitizations in 2012, and we want to be a meaningful participant in that developing market. The historical rates of return on the jumbo prime securitization business are attractive, and we believe Chimera has both the capital and the expertise to develop a meaningful franchise in the quarters ahead.

And with that, I will turn it over to Alex to discuss the recent accounting developments.

As Matt stated during our quarterly review, we determined that the application of ASC 325-40, investments and other beneficial interests in securitized financial assets, should be applied rather than ASC 320-10, investments in debt and equity securities in evaluating our non-agency RMBS that are not of high credit quality for OTTI and the related interest income recognition.

The company considered the non-agency RMBS to be not of high credit quality when it does not have an actual or implied rating of AA or higher at the time of acquisition.

The difference between the two methodologies as explained in further detail in footnote 17 of our 10-Q, was primarily in the impact of the timing of cash flows on recognition of impairment and the determination of yield. It does not affect the actual cash flows we received from those assets or the severity of losses on those assets or how those losses compared to our expectations.

Notably, this analysis had no effect on the fair value of those assets, because our book value was not affected. We will perspectively correct these immaterial misstatements over the coming four quarters in Chimera's financial statements. The cumulative net effect on Chimera's previously reported financial statements is a decline in GAAP net income of approximately $16.2 million over the previous six quarters or less than 2% of previously reported GAAP net income. We have removed the reference to core income from our press release as the application of this standard does not permit the company to disclose data in a manner that would facilitate a meaningful calculation of core income from the GAAP financial statements.

As a REIT, we are required to distribute 90% of our taxable income. And going forward we encourage users of our financial statements to consider the quarterly dividend we declare to be a proxy for our estimated taxable income.

We expect the application of this standard may increase volatility in our GAAP reported earnings by taking impairments in one quarter followed by increasing accretion in future periods. We encourage you to review the disclosure in our Form 10-Q for more detailed information surrounding this change. We will now turn the call back over to Andrew to answer any questions you may have.

(Operator Instructions). Bose George, KBW.

Good morning. I had a couple of things. First, it looks like the discount accretion for the year, that number has been restated higher. I was just wondering, does that change also tie into the OTTI accounting change? Or is that something different?

Right. So the change in the OTTI impairment will essentially cause us to write down a bond in a current period to a lower cost basis and then future periods accrete a higher amount of discount. So you will see an impairment today being picked up as accretable discount in future periods.

So did you sort of retroactively write down bonds and then as a result there was just more accretion that went through the earnings in the last couple of quarters?

Sure. We reevaluated every CUSIP in the portfolio from 2007 forward that this may have applied to to determine the impact in each quarter and rolled it forward through every quarter.

Okay.

And that change, as I said earlier, was approximately $16 million.

Okay. And then just switching to the REIT taxable income, the $0.13 that you guys had for the quarter, I was just wondering how that was calculated? Just when we think of that as sort of the core number, I just wanted to make sure. I forgot how that was calculated.

Well, the taxable income number that we declare, when we declare a dividend we run our actual cash flows for tax and calculate our estimate of taxable income. Now tax is slightly different than GAAP or in this case more different than GAAP than it used to be. And so we declared a dividend based on our estimate of taxable income. As we have stated (multiple speakers)

But is there kind of some easy way for us to do it off the GAAP financials because I wasn't fully able to sort of reconcile the GAAP financials with the REIT taxable income number?

Unfortunately, we used to disclose what was credit losses, actual principal write-downs in the financials, and we no longer -- using 325 -- will disclose that line item. So it is difficult for us to tell you to back out a GAAP line item to get to a proxy for core. It is no longer there for you.

And that is why we would rather point you to what we declare in the dividend simply because that should be -- we have to declare 90% of our income so that should be a very good proxy for what our tax is.

Okay. But just in terms of forecasting it, I guess it does make it somewhat challenging for us, right, since we --

Unfortunate --

Because the interest income won't capture that and some portion of the loss, we would have to include, but it's kind of hard I guess for us to figure out that number. Is that fair?

Right. That's a fair statement. Unfortunately, the changes in GAAP are not necessarily more transparent. And so we are losing a data point that used to allow you to get there.

Okay, great. Thanks.

Jason Weaver, Sterne Agee.

Hi. Thank you for taking my question. I just had one clarification that I was struggling to figure out. Your entire purchase discount on the non-agency allocation -- is that what you're level accreting into your income per quarter?

We are accreting that -- that discount based on a loss adjusted yield, so we do not accrete to par. We accrete to an expectation of recovery on an asset.

You don't disclose that, though, do you?

No, we do not.

Okay. Thank you very much.

Steve Delany, JMP Securities.

Good morning.

Good morning.

I noticed there was a relatively large decline sequentially in the discount accretion, from about $79 million to $49 million. But the CPR -- we think of the accretion as maybe being highly correlated with prepays, but CPR was flat at 14%. Is there anything one time in the third-quarter accretion figure of $49 million that is connected to the accounting change?

In general, to look at the buckets on the assets, the agency portfolio picked up slightly, so we're amortizing a little faster on that.

And then if you look at the individual categories of asset classes, on the non-agency portfolio, they in general slowed, so we accreted less discount on the non-agencies, and amortized faster on the agencies. So you did see a quarter-over-quarter decline of close to $0.03 in accretion. And that is simply due to -- we had slowing prepayments associated with broader market implications.

Okay. So it really was just the speed and not anything related to the accounting change specifically?

No, no -- no. It was related to the speed. And as we've said before, the assets are performing relatively in line with our expectations. And there was no material change in the credit quality of the assets.

Yes. And I think Steve, just to go at that point, we did see the pay downs slow in the quarter. And I think a lot of it had to do -- and again it's hard to ever pinpoint one specific reason why anything pays, especially when you have as many bonds as we do, but I think the Robo signing lawsuit getting settled, and also I think everybody knew that there was going to be new and initiatives to keep people in their homes through modifications. I think that made the servicers slow the resolution process down. And this is all a matter of timing. It's a matter of if the slow it down now, you're going to probably see those cash flows in the future.

Okay. Thanks, Matt. And then just one final thing, your non-agency portfolio held up from a fair value standpoint very well in the quarter. I realize all of the news on the ABX and the prime ex, and that doesn't always relate to the quality of bonds that you own. But you had the subordinate bonds -- only went down about 1.4% of par to $41.9 million from $43.3 million. Is that September 30 mark, is that based on third-party pricing? It's Level 2, so I assume that it is.

We mark the bonds internally and the we send them out to three dealers. Now, in aggregate, on the portfolio, we are 0.69% higher than the average of the dealer marks. So we are very close to the average of the dealer marks on the portfolio as a whole. But just keep in mind, we have a tendency on the subs to mark them what I would consider rather conservative. And so the general movement in the market, you would not -- I think that you see them -- the market value move on the subs but it was not as --

Yes, I think the important, the operative thing here is we have the same system in place that we have always used to market the portfolio. And there is nothing that is changed this quarter over any other quarter. And sometimes -- you know I remember the first quarter people were yelling at us that the prices did not move up fast enough. And now they are not falling I guess as fast as some people might have thought. The fact is the assets that we have are not rated by -- a large amount of them are not rated. They are stable; they're private securities. And they just you know -- they are marked to -- generally, the dealers when they mark them, are marking them to a yield basis, and that yield basis hasn't really changed dramatically.

And I will tell you, just in the level of portfolio activity, when we were -- we've been bidding on bonds and we haven't been buying anything. And I think the first time we've bought anything significant, which happened maybe two weeks ago; the first bond that we've purchased close to levels on our portfolio. So it's the same methodology that we've always used.

Great. That's helpful color. Thank you very much.

(Operator Instructions). Daniel Furtado, Jefferies.

Good morning. Thank you for taking my questions. What's -- do you have a kind of a estimate for what the approximate size of the agency portfolio needs to be to satisfy REIT rules?

Well, on an unconsolidated basis, it needs to be -- 55% of the assets need to be hopeful qualifying. So we typically run within a very comfortable margin above that number. And so we do have room if we would like to unwind that agency position, to use the liquidity to purchase other assets, we have ample room to do that.

And when we think of that, we think of the non-agency -- should we think of that as the 55% of the fair value of the non agencies? Or when you say 55% of assets have to hopeful qualifying, when we run that calculation ourselves and we look at your non-agency book, should we be -- we should, I would assume, be looking at the fair value of that portfolio?

It is 55% of the total portfolio, or the fair market value of the entire portfolio.

Understood. Thank you. And then, how about progress that's been made so far? Matt, I appreciate your comments on the jumbo securitization side. Kind of what are you seeing in that front from a ground-level perspective?

Well, I think it's kind of an interesting market. Obviously, Fannie Mae and Freddie Mac getting out of it should open up some opportunities.

I also think that the banks who have been funding these jumbo mortgages over the last two years and putting them into their portfolio are getting kind of full. And I think that there is going to be some opportunity there for private capital to come in.

We think that sourcing and developing sources, interesting sources, for these mortgages is where we've been spending an awful lot of our time. And hopefully we'll be able to articulate that better in maybe the next earnings call. And we really do hope that we're going to be actively making securities in 2012. I think we're seeing enough demand out there from people who want to have jumbo prime mortgages, and we think the investors are there for the -- to buy the AAA securities. So it looks -- it feels to us like the market is going to start to open up here going forward.

Great. Thank you for that. And the way we should think about your ability to access that, I mean we kind of run our own calcs on what this 55% should be, assume some of that agency portfolio burns off. And then depending on timing, I know on the non-agency side, you have a -- your taxable income is higher than the cash flows that are coming off that portfolio. But do we kind of fast forward into the future where taxable income has been net down because of realized losses and then you're able to retain some of those cash flows on the subordinate portfolio to then kind of reinvest in that -- in the new issuance market?

Well, I think right now, we have quite a bit of liquidity to go after the jumbo prime market. You know, like I said earlier, we have the ability to either lever up the agencies more if we want, because they're relatively low levered, or we could sell them and take that capital and go after the jumbo prime market that way as well.

There are some people offering warehouse lines to us to warehouse jumbo prime mortgages before securitization. So there are a lot of different ways for us to use the capital that we currently have to pursue that market.

Do you remember the first part of the question too?

No, I think that was pretty much it. Those are all my questions, and thanks for your time.

[Davey] Richards, Pine River.

Hi, actually it's [Brett Brian] from Pine River. I just wanted to understand tax versus GAAP income -- one clarification on the accretable yield for the non-agency. I think you guys clarified that you accrete the yield to the loss adjusted so it doesn't go to par. Does tax go to accretable to par then, or something less than par on those securities? Just to help us model the taxable income, I'd appreciate it.

Sure. For tax, you accrete to par until you realize an actual principal write down. So you set your assumptions on the day that you purchase the asset. You cannot change your assumptions. And as the paydowns come in, you accrete your discount towards par until you actually have a principal write down.

Okay, great. I just wanted to make sure I understood how to model the yield differentials, so I appreciate that. Thank you.

Sure.

Bose George, KBW.

Thanks. Just wanted to check, what was the REIT taxable income last quarter?

We were right around $0.13.

Okay. Then in terms of the decline in the spread, so you noted about $0.03 impact for the decline in the spread -- what was the offset since your REIT taxable income stayed roughly flat quarter over quarter?

The taxable income is not driven by the GAAP income, so the taxable income stayed relatively constant. And you have to keep in mind that on tax, the assumptions are set on your date of purchase.

So that change in the spread really doesn't impact REIT taxable income?

No.

Okay. Okay, great. Thanks. I wasn't sure.

Daniel Furtado, Jefferies.

Hey, sorry, Alex, I'm just trying to follow up on the Pine River question there. So you said the assumptions on day one, you accrete it to par on tax until a loss is experienced on that specific CUSIP or that security. And then do you continue to accrete -- like let's say it's 100 -- you have a 5-point loss, so do you continue to accrete to 95? Or does that first instance of loss allow you to reestimate what your -- kind of bring the entire accretion back down to something significant -- lower than actual expected or experienced losses to date?

So you take the loss into account, so you essentially will not go above 95 after that point in time but you do not change your purchase assumptions. It just removes that accretable discount from your tax book.

Got you. Thank you for the clarification.

Arren Cyganovich, Evercore.

Hi, thanks. If you could talk about your agency book a little bit, the CPR at the end of the period was 11%. So a little bit lower than some of the peers that I have seen. What is in the makeup of that portfolio that has that at a fairly low CPR?

(inaudible). They are pretty plain-vanilla securities. We stick with fixed-rate pass throughs. We do have a position that is a lot of jumbo conforming paper, and the idea is we're buying premium so we're trying to pick pools that are going to pay a little bit slower.

I think generally speaking it is all 30-year and 15-year paper and it has been performing pretty well.

Okay. And then on the jumbo side, you mentioned the fact that the GSEs I guess will have a little lower at 625, but I guess there was legislation passed by the Senate saying that the FHA would then have the extended limit. Is that going to impact your (multiple speakers)?

Yes, it should have some impact. We'll see how exactly that all kind of pans out in the near future. Obviously, FHA with the insurance guarantees makes a higher coupon. But, you know we'll see how that all kind of pans out.

I think the operative thing for us is Fannie and Freddie have been pretty big in the space. And having them out is -- I think opens up some opportunity there.

Okay. And then lastly I guess Shannon Funding through -- your parent company -- how are you going to be able to utilize that source? Is that business up and running. I know it was kind of a relatively new business.

Yes, I mean I think -- you know, we're looking at a whole bunch of different opportunities there. I mean Shannon is really -- it is an Analy company. Chimera doesn't do business with affiliated parties on a one off type of a basis. I think one of the things we could do there is potentially show rates out to their clients and close directly. We're still in the process of determining how all that all kind of processes out and works out.

Great. Thank you.

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

Well, thank you for all participating in the third quarter 2011 earnings call for Chimera Investment Corporation. And we look forward to speaking to you early next year. Thank you.

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 10005697, again, 10005697.

This concludes our conference for today. Thank you for participating and have a nice day. All parties may now disconnect.