Chimera Investment Corp (CIM) 2014 Q3 法說會逐字稿

Good morning and welcome to the Chimera-Third Quarter 2014 Conference Call.

(Operator Instructions)

Please note, this event is being recorded.

I would now like to turn the conference over to Willa Sheridan. Please go ahead.

Good morning and welcome to the Third-Quarter 2014 Earnings Call for Chimera Investment Corporation. Any forward-looking statements made during today's call are subject to risks and uncertainties that are outlined in the Risk Factors section in our most recent annual and quarterly SEC filing. Actual events and results may differ materially from these forward-looking statements.

We encourage you to read the forward-looking statement disclaimer in our earnings release in addition to our quarterly and annual filings. Additionally, the content of this conference call may contain time sensitive information that is accurate only as of the date of this earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information.

Participants on this morning's call include Matt Lambiase, President and Chief Executive Officer; Rob Colligan, Chief Financial Officer; Mohit Marria, Chief Investment Officer; Bill Dyer, Head of Underwriting; and Choudhary Yarlagadda, Head of Structuring.

I will now turn the conference over to Matt Lambiase.

Good morning and welcome to Chimera's Third-Quarter Earnings Call. We had an active quarter. I'll make a few brief comments and Rob will report on the financial results and afterwards we'll open up the calls up for questions.

The first point is that Chimera's net income is up quarter-over-quarter and this is largely due to the fact that we added $6 billion of new agency mortgage-backed securities in the second quarter, and the last of those purchases settled in early July. And so now the run rate reflects the fully ramped position. The key takeaway is that the Company is operating at a relatively low overall recourse leverage ratio of 2.6 to 1, and is positioned to continue to produce a high dividend going forward.

In the third quarter we engaged in two significant transactions. In the first transaction, we were able to collapse an additional $93 million of [rerummaged] funds on our balance sheet. And this was similar to the executed in March. We deconsolidated these positions into more liquid, underlying bonds and we took profits on these transactions.

The second transaction we previously pronounced, Chimera purchased the subordinate bonds and the associated rights to call seven previously issued Springleaf mortgage-backed security deals. Those deals encompassed $4.8 billion of seasoned residential loans.

Over the next two years we will have the option to restructure these deals into new investments for our portfolio, and this option gives Chimera a deal pipeline without the costs or the risks of a traditional loan securitization conduit. The loans in the deals are on average seven years old and were originated with full documentation by American General Finance to be held in their portfolio. We believe loans originated to be held in portfolio performed better over time.

While the loans do have lower FICO scores than other loans we've securitized in the past, they are performing well and have strong pay histories. We feel comfortable with the credit of this portfolio, and believe it will be a source of quality investments for Chimera over the next two years as we exercise the calls, create new securitizations, and then sell off senior bonds in order to retain high-yielding credit pieces. Given the dearth of new issue bonds currently available in the non-agency mortgage market, especially those with seasoned collateral, we believe we'll be able to execute new securitizations at favorable terms.

In the fourth quarter we will complete the first of the seven planned securitizations. The bonds that Chimera will retain from that transaction, in my opinion, will have a better return profile than anything available in the secondary market or what could be created in the new jumbo loan securitization.

So looking forward, I believe Chimera is in a good position. We're earning a strong dividend while operating at low recourse leverage. Low leverage gives us a defensive posture to interest rates, and the flexibility to take advantage of large transactions like Springleaf when we see them. The Springleaf transaction should help to keep Chimera's dividend durable as we create high-yielding investments to meet our portfolio's reinvestment needs over the next two years.

And with that open it -- I'll give it to Rob to go through the financial results for the quarter.

Thanks Matt, and good morning.

The financial highlights I'll review will cover the third quarter and first nine months of 2014, compared to the second quarter of 2014 and the first nine months of 2013. Net income for the quarter was $378 million, up from $105 million earned in the second quarter. Net income for the first nine months was $582 million, up from $290 million earned in the first nine months of 2013.

It is important to note, net income on a GAAP basis includes several nonrecurring or one-time gains this quarter. We had realized and unrealized gains during the quarter related to this portfolio. The realize gains relate primarily to sales and exchanges of securities, some of which were previously impaired. And the realized gains -- unrealized gains relate primarily to the Springleaf transaction that Matt alluded to.

It's also important to remember that we have elected fair value accounting for the Springleaf deal due to the size and the structure of the transaction. The fair value method will report changes to earnings, providing transparency to our investors each quarter. Please note, given this accounting election, we may experience larger changes in earnings, both positive and negative, in the future in relation to this portfolio.

Given the nonrecurring and one-time items included in GAAP earnings, we have added core earnings as a new measure, which removes these items. On a core basis, net income for the third quarter was $116 million, up from $83 million earned in the second quarter. Core net income for the first nine months was $282 million, up from $263 million earned in the first nine months of 2013.

Moving to book value, GAAP book value for quarter end was $3.50 per share, up 4% from the second quarter and up 8% this year. Moving to yield on the portfolio, the yield on average interest-earning assets was 6.1% for the quarter and 10.7% for the first nine months of the year. The average cost of funds, including swap costs, was 2.2% for the quarter and 3.9% for the first nine months of the year.

The net interest spread was 3.9% for the quarter and 6.9% for the first nine months. And the net interest margin was 4.3% for the quarter and 7.9% for the first nine months. As we discussed in the second quarter call, and as we expected, the change in our asset mix has reduced our net interest spread and margin, but aims to increase our return on equity.

Which leads us to our net interest return on equity. There is a table on page 68 of our queue which shows 15.6% for the quarter, up from 12% last quarter and up from 11.3% last year. The annualized dividend yield for Chimera, based on a $0.09 dividend and quarter-end stock rates of $3.04 was 11.8%.

That concludes our remarks and we'll now open the call for questions.

We will now begin the questions and answer session.

(Operator Instructions)

Douglas Harter, Credit Suisse.

Thanks. Matt, I was hoping you could -- as you do the first securitization of the Springleaf, the better returns, can you tell me where those are expected to come from? Is that lower funding cost, better advance rates, how are you thinking about the opportunity there?

Yes, I'll let Mo speak to that.

As far as the returns that we were expecting to get on the retained piece of the first call deal, it's primarily from two sources, one being the advance rate that we were achieving by selling the senior bonds and retaining the [messes], and second is also the execution of those senior bonds as Matt alluded to, new issue supply is somewhat limited in the non-agency space, and there's a proven track record for the Springleaf transaction so there's a large following and investor base and we've been able to tap that in Q4.

Great. And then Matt, in talking about your low leverage and the abilities to take advantage of bigger deals like this, I guess how would you se your capacity to sort of ramp that leverage further, or would further opportunistic acquisitions require some sale of agency or something else to kind of raise liquidity?

You know, that's a good question. It really depends on what the opportunity is as it comes up. When you're running 2.6 to 1 leverage ratio, recourse leverage ratio, it's pretty low, and we certainly have the ability, people will lend us more money to add non-agency assets if we see them. We -- if it was a very large transaction I would have no problem taking down the agency portfolio and using that capital if it would get us a higher rate of return and increase the dividend over what we're currently doing in the agency portfolio.

I guess just on that, I mean from a capacity, I guess how much capacity do you have to take down the agency from a sort of [whole cold] test or from a re-compliance test?

Yes, I think we have some room there. I don't think we're anywhere near the edges right now so we do have some room to adjust the portfolio and still be within our REIT requirements.

I mean, if you think about it like this Doug, we were beating our 40 Act requirements back in the first quarter with a much smaller agency portfolio.

That's helpful. Thank you.

Mike Widner, KBW

I guess a couple questions here, first, just the real basic and simple one. In your prior releases you had kind of consistently mentioned both GAAP book and economic book. I notice in this press release you sort of just talked about GAAP, I know you included both in the 10-Q but I'm just wondering if there's a reason why, if you're sort of implying that -- I don't know, I'll just leave it at that.

No, I don't think that there was any desire to highlight one over the other; obviously we disclosed both. But we're leaning towards the straight textbook GAAP results for our official communications. But the economic are there for people's reference, we haven't taken them out of our documents.

Okay, that makes sense. I mean this quarter, you know, the GAAP book improved a fair bit more than the economic book. Wondering if you could talk about specifically why.

Sure, well, I think a lot of it has to do with -- the big trade was the Springleaf transaction. The Company purchased, I think, approximately $770 million worth of actual bonds, and yet we're consolidating $4.8 billion worth of loans on our balance sheet.

So really, if you think about it, if we were to look at -- we have the right by buying those $770 million worth of Springleaf bonds we have the right to call all the underlying bonds in the structure. And the bonds in the structure are not as valuable as the underlying loans themselves.

So the difference between -- the difference between the value of all the bonds in the structure and the value of the loans is roughly $160 million and that's the difference that we -- that's going to be the cash flow of this transaction over the -- that's what GAAP is telling us, is what the value of those cash flows are going to be over the next two years as we exercise these calls.

Yes that makes sense (multiple speakers)

Yes, that's one of the reasons just to add and why we put those numbers in the financials. Sometimes the underlying collateral moves faster than the bonds that we actually own, and sometimes it's the other way. So we like to put out both statistics so that you could see on a relative value basis how the portfolios are moving.

Great, appreciate that. So I guess I had some more detailed questions on the Springleaf transaction just because it seems rather significant, shall we say. You know, as you indicated you bought about $770 million worth of bonds. I was wondering if you could sort of help me understand what you paid for those, and as you indicated, I think it was $139 million write up of the assets; I thought there was also (multiple speakers)

Of the loans. The $770 million worth of bonds increased a little bit in value over the quarter, just like all non-agency bonds did in the quarter, they went up a little bit. It's really the loans that we don't actually -- we're consolidating but we actually own the securities at the moment. So the $770 million of what we own went up a little bit; what we're consolidating is the bigger value change.

So I guess that's sort of what I'm trying to make sure I understand, and -- now again, so you bought the $770 million worth of bonds, is that basically the price you paid for them, or is that just what your -- the net that you're carrying them at, I guess that's the first piece I'm trying to put my hands around.

(Multiple speakers) that's the price we paid for the securities, yes.

Okay, so that's the purchase price and you're saying there's very little appreciation in that, or (multiple speakers).

They went up a little bit over the quarter, but nothing -- obviously not $140 million like the loans.

I mean, that's the piece that I was trying to figure out is, you know, and tell me if I have this wrong but I mean it was, like you said, $139 million effectively fair value gain that flowed through GAAP income on the asset side, and then there was also, I believe, a $30 million, $29.5 million decline that flowed through GAAP on the liability side.

That's right.

Okay, so net, this contributed $169 million.

To your GAAP book value, right.

Your GAAP book value. Okay, so I think I get that. One piece that I didn't entirely follow is, I believe the 2011 piece is, I don't know if it's seller-financed or it's back on repo, can you explain that piece to me and how that sort of shows up in the financials?

When you say the 2011 piece, the 2011 piece of Springleaf? Or --

Yes, the Springleaf 2011-1. There was mention in the queue that, and I don't have the exact wording in front of me but it's structured on repurchase with, you know, somebody. Also as I look at sort of the liability side, I mean the number -- I was just having a hard time making the math add without assuming that piece is somehow financed elsewhere, I think the line item would be -- well, I don't know, does the question make sense?

Yes, I understand it's a little bit complicated. In the Springleaf deals at the third anniversary of each deal, there's a call right. So when we acquire the entire portfolio, that first deal was ready to be called and the deal that Matt talked about, in the first Springleaf deal that we collapsed and are in the process of resecuritizing now and will close that in the fourth quarter, that was almost essentially 100% financed from time of acquisition through when we ultimately restructure, sell, and create a 2014 I think [sim one] will be the deal name which will disclose the economics in the fourth quarter.

So there's really very little, probably no equity from a trading perspective in that deal from time of acquisition through time of ultimate securitization.

Okay, I got you, because I mean what I was just trying to figure out was if I look at, like on the balance sheet the securitized loan balance is $4.8 billion, over on liability side the securitized debt at fair value is $3.7 billion so there's a $1.1 billion difference between the two. It's obviously not $1.1 billion in equity so I'm trying to figure out what happened to that other [$350 million] and I think what it says in the queue and what you're telling me is that probably shows up in payable for investments purchased and that's part of the resecuritization process basically.

That's right. You know, I think we did have some, if you look at the payable for investments purchased, that $848 million, we had about $500 million of agency purchases that crossed over quarter-end and the rest of that is Springleaf's.

Got you. Okay appreciate that, and I guess for a final one, if I may.

This is obviously a significant part of the portfolio at this point, and just trying to think about how to model the economics of that. If I go by what you've shown in the queue and here in the press release, it looks like your expecting asset -- or you've experienced asset yields on that of about 7.03% was the percentage, I mean is that a fair assumption for the interest income component or I guess I'm thinking about how -- maybe that's even -- I guess the question is how to model it and I mean I guess what I'm thinking about is you're showing a 7% asset yield, about a [3.25%] cost of funds. We got to do something with the fair value assumptions as well, but I mean how do we think about flowing that through?

I think that would he a good way to start, you use the, you know, the spreads and one of the reasons why we broke that Springleaf deal as a separate line item was exactly for that reason, so you can look at the average coupon on the portfolio and the financing and attempt to model out. Now, what you're seeing, obviously, this quarter I wouldn't expect the large on the recur, but then again it's a $5 billion portfolio so you say $160 million is roughly 3%-ish.

Again, I think a big move in one quarter, but we could have some big swings as I mentioned in my comments up or down, just given the size of the portfolio. I don't know, Mo, if you have any other comments from a modeling perspective, the loan share.

No, I think, Bob, you're right. I mean the biggest thing to focus on is the coupon on the earning assets minus where we would finance it to the securitization market, that's a good way to model the Springleaf transaction collective.

Yes, and then of course we have to model some rundown in fair value as the principal runs down.

Absolutely.

So I lied about one more, I guess just help me understand the -- and then I will stop, but help me understand the collateral [under there] and these arms, are they fixed rate? I mean 7.03% seems like a high yield for stuff that's seven years old and if it's arms they would think they'd be in there active reset predominately, so I guess I'm just trying to understand the coupon and how that may or may not change, and then the same thing on the liability side, I mean are there step ups or step downs or that's all going to get called away anyway and we won't need to worry about it?

Sure. On the collateral side these are primarily all fixed-rate assets, and as Matt alluded to these are lower FICO borrowers but loans are originated in 2005, 2006, so there's plenty of pay histories for regarding all of these loans. As far as performance, the performance has been matching pretty good on these securities, but even if something was nonperforming there's enough coupon to work with in terms of modification to get the person current again.

As far as the liability side of it goes, most of the liabilities are also structured as fixed-rate securities, and there is no step-up involved in all of these securities except, as Rob alluded to, every three years these securities will become callable and at our discretion if we feel the economics are there to call these deals. Bill could allude to some more on the collateral side.

Yes; Matt mentioned the FICO scores and that this transaction there were some FICOs that are lower than some securitizations we've done in the past, and while FICO scores are a very useful tool when we're reviewing loans, this portfolio has seasoning which is even better. And to the extent that these loans have performed, 70% of the loans in the portfolio have never missed a payment and we've had on average seven year seasoning.

Yes, as an old credit analyst I certainly appreciate that seven years of payment history is better than a FICO score on a mortgage so I appreciate that. And just last piece on the collateral, I mean do you see interest-only, are they just for purposes of sort of thinking about paydowns, are they out of their IO periods, are there still IO?

Now most of them are not interest-only, maybe a handful, a very small percentage of the portfolio will be, but -- and even that should be coming up for reset, I mean most of these would be 10-1 IOs, which again, like a said, with the seasoning that the portfolio has they should be approaching that reset period now, over the next year or so

Those are, you said, small portions so I mean for the most part it's pretty close to fully amortizing.

Yes, they're fully amortizing loans.

Okay. Great, I will stop there, appreciate all the thoughts and comments guy, and nice quarter.

And if you have other questions as gives a call

I will do.

Joel Houck, Wells Fargo.

My question on slide 2, the recourse debt to equity in your residential portfolio was only like 0.4. As you guys, you know, complete the securitization program, where do you see -- can you tell us where that kind of levels off? I was just going higher but how do you think about total recourse leverage on the credit book as this plays out?

Well, this transaction, as I said before, we purchased $770 million worth of bonds. Mohit and the investment teams sold roughly $270 million worth of non-consolidated credit bonds in our portfolio to fund the equity and then we used the remainder in a one-year committed facility.

And I think as we start doing the securitizations over the course of the year, we're going to be paying down that facility. So I would imagine over the course of the year you'll see less recourse leverage on the credit book

Less recourse leverage?

Yes.

Okay. And as you guys -- as you said you have capacity to take down the agency book.

Yes.

How are you thinking about the convexity profile given that you have a very good hedge in terms of the credit book, are you more out to hedge less in the agency book or are you just going to play it down the middle?

You know we are -- believe we're range-bound and in terms of interest rate view and we are hedged to that view, and I think that we're pretty conservative in our hedges, so I think right down the middle of the lane.

Okay, alright, thanks Matt.

Steve DeLaney, JMP Securities.

Not to beat a dead horse because I think great color on Springleaf in response to Mike's questions. But going back, not so much how you funded the $770 million, but when we look at the consolidation, the 4.8% asset and the 3.7% senior note liability, that would leave us with credit of $1.1 billion and obviously you indicated you bought $770 million.

It seems to me there's another $200 million or $300 million of a credit entry, and I was just curious if that represents some type of a credit reserve you may have set up on the $4.8 billion of loans. Just help me try to understand the difference between the $1.1 billion and the $770 million purchase price, thanks.

Yes, sure, Steve. If you look at the balance sheet in our payables for investments, that number was $848 million, there's $348 million of that relates to the Springleaf 2011 deal that we're in the middle of resecuritizing.

Got it, okay, you did explain -- (multiple speakers)

You're going to get back down to that $770 million-ish number.

I get where I need to be. Okay, thanks, sorry about that, you did comment on that.

And I guess, looking forward, this is obviously a very creative and opportunistic way, opportunity for you to access whole loan collateral. And if we just look out next year and beyond, are you guys thinking about trying to set any infrastructure in place that would allow you to sort of directly aggregate or source whole loans for securitization going forward regardless of whether we're talking about private jumbo, NQM? Just kind of thinking out what Chimera's going to look like from a platform standpoint going forward, thanks.

Yes, thanks, Steve. We have been looking and we continue to look at those opportunities. For our purposes, we purchased loans in the past through forward commitments with PHH back in 2008 and we had the capability, we still obviously have underwriting and the ability to securitize here in-house.

What really is the difference right now to us is that the economics of the jumbo prime securitization market really aren't there to build out the infrastructure, in my opinion. The issue is that you want to hire a lot of people, put loans up on a warehouse and then take the risk of poor execution on the securitization. The economics are really razor-thin and the bonds that you take back in the new issue of securitizations, to the way we look at things, just look not as attractive as other opportunities.

I would tell you that if those things were to change, if the economics on the jumbo prime securitization were to change we would be in it wholeheartedly and we would be building out an origination infrastructure and spending the money to do it. But until the economics are there, it just doesn't seem like something that makes an awful lot of sense for me to do at the moment, and this -- one of the reasons why we thought this deal was terrific is because it does give us two year's worth of new issue bonds to bring to the marketplace without really any of those infrastructure costs

Sure, understand, makes sense, and of course, I guess, one thing we have to watch and see is whether that RMBS 2.0 market does morph into non-NQM products that might look a little bit more like the kind of loans you bought here, the collateral you're buying here under Springleaf.

And we've been all over these opportunities and looking at them and trying to make them work, it's just, it's very, it's unfortunately, and it's just frustrating for, I think, everybody in the space, the economics really aren't there the moment

And just one less thing, I know this is presumptuous given that -- and great work on the step-up in core earnings because you are fully covering in excess of your $0.09 dividend. I believe that the Board had indicated in an earlier press release that it intended to pay, or expected to pay, a $0.09 dividend for the fourth quarter. I was curious whether the sharp rise had increased, is that something the Board might revisit or should we -- when we think about the dividend, should we think about 2015 might be the first time the board might take a look at the dividend in terms of possibly increasing it? Thanks.

I think the fourth quarter, we've already announced that we're going to pay the $0.09. That hasn't been declared yet. But we announced that.

Yes

I think 2015, I think the Company, we want to see how the portfolio acclimates and where the run rate of the Company is and I think the Board will make a decision then.

Well thanks for the comments and the color. Helpful.

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

Thank you very much and thank you, all of you, for joining us on the earnings call. I just want to thank my investment team here, they've done a terrific job this quarter, really finding some great opportunities that's going to create long-term value for our shareholders and we all look forward to speaking to you on the fourth quarter earnings call.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.