Chimera Investment Corp (CIM) 2016 Q1 法說會逐字稿

Good morning and welcome to the Chimera first quarter 2016 earnings conference call. All participants will be in listen-only mode after today's presentation there will be an opportunity to ask questions. (Operator Instructions). Please note this event is being recorded. I would now like to turn the conference over to Mr. Matthew Lambiase, President and CEO of Chimera. Please go ahead

Thank you. Good morning and welcome to Chimera Investment Corporation's first quarter 2016 earnings call. I'll make a few brief comments this morning, and then Mohit Marria, CIO, will discuss the changes in the portfolio and afterward Rob Colligan, our CFO, will review the financial results for the period. Then we'll open up the call for questions. Before we start, I'd like to comment on the special dividend that the company paid in March. As disclosed in our annual report, Chimera's audit committee pursued remedies against parties relating to our accounting for non-agency RMBS and the restatement of our financial statement. The audit committee, Chimera's Board of Directors and management all determined that it was in the best interest of our shareholders to resolve these matters for $95 million.

It's characterized as taxable income for 2016 and resulted in the special dividend that we paid out in March. To obtain this positive result for our shareholders, we had to undertake certain confidentiality obligations which prohibit us from further discussing the matter. As such, we'll take no questions on this in order to protect our shareholders. Both management and our Board of Directors are very happy to put this matter behind us and move forward and we believe Chimera has a very bright future ahead.

As many on the call know, the rules for the mortgage market have been evolving over the last few years, and Chimera has worked diligently to stay at the vanguard of the change. Perhaps most important new regulatory change in the mortgage market are the risk-retention requirements for securitized transactions. These new rules require that all mortgage-backed securities must have an economic sponsor in the deal. The sponsor must have skin in the game. Sponsors are required to own a meaningful amount of securities in the deal and have the ability to hold these securities for an extended period of time. The goal of the new rules are to ensure that every new securitization has a sponsor who wants to see the deal perform well and is economically on the hook if it doesn't perform well. The logic of risk-retention is pretty clear. And I believe the rule will go a long way to stop the recurrences of the excesses that we saw in the mortgage market before the economic crisis. For Chimera and other mortgage participants with permanent capital, this rule is welcome. Risk-retention is nothing new to us.

As our business model has always been to evaluate mortgage credit risk and the structure securitizations on the credit that we like. Since the start of the company in 2007, Chimera has always eaten its own cooking and has never sold an equity position from securitizations that we've sponsored. I believe that the new risk-retention resolutions for mortgage securitization will benefit companies like Chimera who have permanent capital. The ability to understand mortgage credit and the expertise to structure securitization. In fact, I find it difficult to see a new mortgage market -- mortgage securitization market getting off the ground without companies like mortgage REITs taking an active equity retention role. In this light, yesterday we announced that Chimera sponsored and closed on a new $1.5 million non-agency mortgage securitization at the end of April.

This is our first securitization under the new risk-retention rules. The collateral in this deal is highly seasoned performing residential loans that were bought from a major financial institution. Chimera will retain a $225 million economic interest in the transaction. Proving once again that we can continue to add high yield and credit investments to our portfolio in meaningful size. The loans that are securitized in the new deal are similar in our Springleaf portfolio which were subprime at origination. We've experienced good credit performance and moderate prepayment fees on the Springleaf pool due largely to loan seasoning. These new loans are also seasoned. They have over 10 years of pay history, roughly 95% have been current for the past year and have an average loan balance of just over $100,000.

An important fact that these loans have been outstanding for 10 years, because pay history in our experience is a powerful predictor of future loan performance. The current favorable macroeconomic conditions have a meaningful impact on these homeowners ability to pay. On average, the monthly mortgage payment in this pool is about $700. And considering that rents have been increasing nationally, continuing to pay is likely the most affordable housing option available. These borrowers also feel the benefit of lower energy prices every time they gas up their car or fill their oil heating tanks. There's a massive transfer of wealth occurring from oil producing countries to the middle class of America and we think the credit quality of our portfolio will be stronger because our borrowers will have more disposable income and therefore greater ability to pay. It's our belief that the longer energy prices remain low, the better credit for our portfolio gets.

As I've stated on other earnings calls, Chimera has a portfolio of unique mortgage credit assets that I believe would be very difficult for anyone to recreate in today's market. We've been able and we've been active in creating through securitization the bonds that we own in our portfolio. Being able to create the spoke credit investments, differentiates us in other participants who simply buy assets in the marketplace. In the period from 2009 to 2011, we were in the forefront of the nonage resecuritization market. We structured and retained a large portfolio of high yield and REMIC subordinate bonds many of which remain on our balance sheet today. In 2014 we purchased $4.8 billion of seasoned securitized residential loans and worked to restructure the financing by executing four new securitizations, we retained the high yield bonds from those deals. Today we start a new chapter in our history by being a pioneer in risk-retention investments. We believe that Chimera has the expertise and the capitol to be a significant player in the evolving mortgage market. The investments that we sponsor will go a long way to create both franchise value for the company as well as allowing us to continue to pay the high and durable dividend to our shareholders into the future. Now, with that, I'd like to turn the call over to Mohit to discuss the changes in the portfolio and the economics on our new securitization.

Thanks, Matt, and good morning everyone.

I will briefly review macroeconomic factors and then go investment activity for the quarter and lastly the securitization we completed at the end of April. Consistent with themes from prior quarters, Q1 started with significant volatility across rates, equities, commodities and credit. By mid February equity markets were down around 10%, and the 10-year Treasury rates touched 1.66%. In addition, credit spreads across fixed income markets experienced significant spread widening interquarter however, most of these markets ended the quarter largely unchanged. While the Fed may still raise rates this year, a combination of slower global economic growth and lower commodity prices will likely limit their ability. A more favorable interest rate outlook and wider spreads on new investments improves the portfolio's long-term potential. Our credit metrics remain unchanged, and the residential credit portfolio continues to perform well. Housing fundamentals remain strong as home prices, delinquency rates and household formation are all showing improvements.

The strengthening fundamentals continue to bode well for our seasoned non-agency mortgage portfolio. Given these strong fundamentals and wider spreads, we continue to evaluate new non-agency mortgage investments for incremental returns for the portfolio. In the first quarter Chimera continued to grow with agency CMBS portfolio, investing an additional $120 million. This sector saw some pretty dramatic spread widening in late Q4, which carried into Q1, and we were able to add to our portfolio at wider spreads. The steps in Q4 to rebalance the agency pass through portfolio were validated as we experienced slower prepayments during Q1, even with the significant valley in Treasury rates. Financing rates on the agency pass through portfolio, however, increased in the first quarter as a result of an interest rate hike in December

Our residential credit portfolio was largely unchanged for the quarter as we were able to invest paydowns back in legacy residential credit. Lastly, as Matt mentioned, we sponsored and closed on a new $1.5 billion non-agency mortgage securitization at the end of April. Chimera's horizontal equity investment in the deal is about $225 million, which from a structural standpoint is consistent with how we have executed prior securitizations. This investment is our first under the new risk retention rule. Under the new rule, Chimera has to retain this equity investment for at least five years. Senior bonds represent 70% of the capital structure, which were sold with an initial coupon of 2.95%. Unlike many other first loss residential credit investments, there was less structural leverage in this deal, providing a more stable return profile. We expect unlevered loss adjusted returns to this investment to be high single digits while levered returns can be in the mid to high teens.

This seasoned performing loan pool has similar credit characteristics as the Springleaf portfolio. The new pool is over 10-year seasoned, has a weighted average coupon of 7.35%, 90% of the pool has full documentation, and 95% of the borrowers are current for the past 12 months. With continued uncertainty around the global landscape, Chimera continues to find attractive credit investments in meaningful size to generate attractive risk adjusted returns for its investors. As discussed in prior calls Chimera may allocate capital from the agency portfolio to residential credit as opportunities become available.

For that, I will turn the call over to Rob Colligan who will discuss the financial results for the quarter.

Thanks, Mohit. I will now review financial highlights for the first quarter capital value at quarter end was $15.52 per share, an economic book value was $14.46, while both economic and GAAP Book values are down 1% this quarter on a total return basis, Chimera returned 5.4% on an economic basis and 5.1% on a GAAP basis when accounting for the dividend. GAAP's net income for the quarter was $83 million, down from $115 million last quarter. On a core basis, net income for the first quarter was $109 million, $0.58 per share, up from $100 million or $0.53 per share last quarter. First quarter net interest income was $138 million, up from $137 million last quarter. Yield on average interest earning assets was 5.9%, up from 5.8% last quarter. Our average cost of funds was 2.5%, down from 2.6% last quarter, and net interest spread was 3.4%, up from 3.2% last quarter.

Although it was a challenging quarter to manage interest rate risk, our net interest return on equity was 17.3% for the quarter, up from 16.5% last quarter. Expenses for the first quarter were $10 million, lower than previously forecast, and certain of our expenses post internalization are still ramping up. Specifically, we're implementing a new portfolio management system that will help to grow and scale our business. In addition, the first quarter does not represent a full run-rate for stock-based compensation as certain grants were given in the middle and end of the first quarter. On our last call we said expense is would be $13 million to $14 million per quarter but it may take us several quarters to build up to that run-rate. More importantly, we still expect our expenses this year to be lower as an internally managed company than they were last year when we were externally managed. Matt and Mohit both discussed the new securitization deal that closed this quarter.

Related deal expenses were approximately $4 million and will be included in the second quarter results. That concludes our remarks and we'll now open the call for questions.

We will now begin the question-and-answer session. The first question comes from Bose George of KBW. Please go ahead.

Good morning. On the securitization that you guys did yesterday, can you just give a little more detail on the funding side, just how much leverage, the cost of funding, et cetera.

Sure. This is Mohit. As I mentioned, the senior portion of the capital structure was 70%, which has been placed, and the initial coupon on that is two spot 95% and the under like coupon on the collateral is 7.35%. We have roughly almost three times leverage in the equity piece.

Recur, yes.

-- and if you're going to lever them up --

Yeah, just on the leverage on the piece that you retained.

The recourse leverage on the piece, it's got about a 35% haircut. So you could have about two and half or three turns of leverage on that.

Okay. Great. Just in terms of the market there, were there a lot of bidders for this asset? You know, it seems to be a fairly attractive asset for you guys. I'm just curious how the process went.

Yeah, I mean, I'm sure there were a lot of people interested in the asset type, I'm not sure of the number of bidders but it was definitely done in comp so we were able to acquire it and we're happy about the acquisition.

Great. And then just one more for me. You know, the JPMorgan securitization that was done last month, do you -- conforming loans, are there, you know, potential assets in there that you like or do you think those kind of securitizations could create opportunities for you guys in the future?

Yeah, I mean, when we looked at the FDIC Safe Harbor deal, I mean, we looked at obviously the credit investments there, comparing the first loss piece to that deal, which was the (inaudible) two slice, the equity investment in this pool is a lot greater, (inaudible)30, it's going to produce a more stable return profile for us, but that is something that we will look to do if that grows further.

Okay. Great. Thanks a lot.

The next question comes from Brock Vandervliet of Nomura Securities Please go ahead.

To pose this question. So do you -- how do you read that FDIC -- JPM/FDIC deal? Was that kind of a petri dish experiment or is that something that you think could really be a harbinger of future structures?

It could be a harbinger of future structures, but it is competing against the agency so we'll see how the agencies feel about it, (inaudible)or other credit transactions that they're doing to reduce credit risk that they have, see if Chase decides not to sell to the agency and issue securitizations on their own, that's less G fees, and, you know, again I think the agencies may have an issue with that going forward, but I think it is supposed to be something that's going to be an ongoing program from what we've heard.

Yeah, I think, Brock, for our purposes, risk-retention is important for perhaps the non-agency collateral that's out in the marketplace, the loans are going to be larger in size or older or seasoned like the Springleaf portfolio. In order to get the market off the ground, you need to have somebody take the equity pieces in those transactions, and I think that's where, really, our capital is going to be best allocated at the moment from all the opportunities we're seeing. If there's going to be a securitization market, you're going to need people like Chimera to sponsor the deals going forward, and I think there is going to be a pretty big pipeline of deals for us to do going forward.

Okay. Great. That's exciting. As another follow-up in terms of the structure are you able, based on your prior answer, are you able to place additional leverage on that equity piece that you --

Yes, we are. The unlevered deal that Mohit says is going to be between 9% and say 10%, we think, loss adjusted, and then if you take that and we can you know get haircuts to 30%, 35%, you can lever that up, you can get, depending on the tenor, how long you want to borrow for, you can get between 15% to, say, 20% levered returns on that. So we think it's a pretty attractive use of our capital.

And the risk retention rules allow for financing of the equity slices. Full recourse.

Got it. Okay. Great. Thank you.

The next question comes from Joel Houck of Wells Fargo. Please go ahead.

Good morning. Just saw you guys had a couple billion dollars of repo that matured in April, I was just wondering if you could talk about environment kind of real time and also what strata you guys rolled that into going forward, term.

On the non-agency side, we rolled the credit with no problem, and in fact extended the maturities to 12 months. On the agency side, given the uncertainty surrounding the Fed and potential rate hikes, we've kept that shorter, between 30 days to 90 days, just as we sort of get more clarity on if the Fed will go -- a lot of dealer communities building in the worst-case scenario of the Fed going so its increasing rates longer term so we're just balancing that for near term clarity from the Fed.

And Joel, I would just add to that, saying that the repo market is kind of interesting from our vantage point, is that we're seeing more credit available to us and we're bringing more people in to look at non-agency repo than agency repo. I think the dealers and the people on the street are more interested in doing the higher haircut, wider margin repo transactions than they are doing the agency repo. So, you know, I think that it's been fitting pretty well into our business model, the agency repo market.

Great. And has there been any -- , can you discern the availability versus U.S. and non U.S. banks?

You know, it's -- we haven't seen any problems from either, so, you know, we've been -- we haven't seen any changes whatsoever from the funding position from international to domestic banks.

All right, guys. Thank you very much.

The next question comes from Steven DeLaney of JMP Securities. Please go ahead.

Thanks. Good morning, everyone, and congratulations on a strong quarter to start the year. I wanted to go back to your new $1.5 billion deal. When you put a press release like that out before your earnings call I guess you can expect to get a few questions. My angle on it is, I assume you're going to consolidate this, right? You're the control bond at the bottom. And I guess this is to Rob. When you consolidate this, those whole loans then on your books, they would be then good assets for meeting the 40 Act exemption, is that correct?

Yes.

Okay. So that leads, I guess, into thinking about portfolio strategy going forward. Just in terms of, how you're allocated, I guess your asset allocation at March, you had 45% agency, and Mohit, does this type of structure, when you compare the ROEs that you were describing here, do you find that this -- the new transaction, would you say that it offers higher levered returns than what you currently see available on the -- in the agency market?

Yes, I mean, definitely it's more accretive than the agency portfolio, but, again, we balanced that over the course of the quarter as I -- I --. I know exactly where you're going, Steve, and I think we all would agree with you. You know, it's hard for anybody who is a participant in the mortgage market not to say that a levered agency portfolio doesn't have its challenges at the moment when you look forward, right? I mean --

Yep.

Flattening yield curve, increasing funding rates--

Prepays.

Prepays. We are always evaluating that. One of the things that you do here be we're not a total return manager per se, we're really about making sure -- and the goal number one of the investment team when they come into work every day is to think about the dividend and make sure that we earn enough money to pay out the dividend to our shareholders. That's job number one. So while we like something, we really have to find other assets in order to move things around because we always want to pay the dividend. But you are squarely -- we are all in agreement with you in the challenges of the agency book at the moment.

Yeah, and I guess the greatest benefit of the agency book, I think I've heard, you know, many portfolio managers describe, is just liquidity. You can't beat the liquidity, right?

Yeah.

And you guys, in this crazy world, having a good slug of liquidity is always, both playing offense and defense. I guess my final --

How good a slug you need.

That's right. My final comment is, we were really impressed with your book value performance. You know, we thought it could be down anywhere 2%, 2.5%, and it was only down 1%. The lesson there for us -- if there is one, just trying to look at generic legacy collateral prices, did you notice something of a wide disparity in terms of the credit sell off that we saw in January, February, and, you know, more seasoned loans, better structures? I guess my question is, what do you think it was -- the characteristic about your credit bonds that allowed your book value to hold up better than maybe some?

I would also say that our book value probably went down a little bit more, just a little bit more than other people in the space in the fourth quarter, so maybe there was that in there.

Again, the credit performance of the portfolio has remained pretty consistent throughout this volatility over the last six months. Mid Feb credit spreads were extremely wider but have retrenched back by the end of the quarter. Again, as our levered bonds continue to lever, we're just pricing them at a lower point on the curve, but, I mean, I think there's nothing different than what others sort of experienced in the quarter as well. But I would differentiate between CUSIPS and loans. Loan pricing over the quarter was pretty sticky, in fact, I would say flat quarter-over-quarter, where as CUSIPS prices, depending on the amount of leverage imbedded in them, maybe slightly down from Q4 to Q1.

Got it. Well, thank you for the comments. Appreciate it.

The next question comes from Sam Martini of Omega. Please go ahead.

Hey, guys, good morning. Just two questions. First of all, you've got around $800 million sitting in agency. Our understanding of this transaction is that there may be more to do just following up on Steve's question. Is there anything that would prevent us, not saying you would want to, but assuming the economics made sense, is there any amount of that agency book that you need to keep for 40 Act compliance or is that entire equity piece subject to reallocation?

I think we're -- you have to have some -- you have to have whole pools. So there's always a balancing act between how much you're going to keep on your balance sheet and how much you're going to reallocate to other things. I mean, as I said to Steve, I mean, it is forefront in our mind about the challenges of the agency portfolio and we're constantly looking at ways to maximize value and maintain the dividend stream for our shareholders. So, I mean, we are -- it is not lost on you us, the challenges of the agency market.

And am I thinking about it the right way, Matt?

Sam, Rob. I just wanted to add to that, with the Springleaf deal and now this new deal, we're less reliant on the agency trade than we were, say, two years ago. So we're constantly looking to see if we can do other things to optimize the structure and obviously provide a great yield to the investors.

I'm sure it's not unfair to say a significant piece of that equity is able to be reallocated, there's no constraints on it that wouldn't just render it an algebraic exercise as opposed to regulatory or other exercise.

What we've said on other calls is, at any time we would probably have at least $2 billion to $3 billion on a gross basis of agencies and that probably hasn't changed too much.

Okay. And am I thinking about it right that if I took your returns and I just scribble out the numbers from your supplement, that it's about a 10 point, that it would be about a 10 point pickup to the levered agency book? Is that kind of the right zip code in terms of ROE?

Fully levered? Yeah, I mean, I think it's -- it's definitely a pickup.

And then I'd be interested, given there's this opportunity for accretion, I'd be interested to hear your thoughts on raising the dividend versus buybacks. You didn't repurchase any shares. You've been active in the past. Clearly some of the stocks that, you know, have gone after higher and higher dividend increases were not rewarded in the market. So I'm curious, as you've clearly got a path towards growing earnings now, which is exciting, what your thoughts are on raising the dividend versus repurchasing shares versus other uses. That's all for me. Thanks.

I think -- all those things are -- really, it's about trying to figure out and when we look at the market, trying to figure out -- the first and foremost thing is to keep the dividend and keep it durable. So how do you do that? And of course, you know, with the agency portfolio and the challenges that you have with the flattening yield curve, prepayment speeds, rising interest in the borrowing costs, if we can transition the things that keep the portfolio, keep the earnings constant or more durable for a long period of time, I think we're at a good spot. We did not buy back stock in the period. We still have the ability to. You saw the outstanding $100 million. And I would say that we are finding some really great opportunities to invest right now in our company. And I think, and I'm betting that the franchise value of doing these risk retention trades is going to come to fruition sometime in the future. I don't think we get benefit for it at the moment but I think if we continue to show the market that we're able to find really quality investments and do it in size and be meaningful, I think that at some point the market will give us the bump to our share price that we deserve.

And have it done against only a handful of folks who can compete with you instead of everyone under the sun. It's exciting stuff. Thanks so much, guys. Thank you.

Thanks.

Thanks.

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

Well, I would like to thank everyone for participating in Chimera's first quarter 2016 earnings call and I'd just like to reiterate that we are very excited about our future and we look forward to speaking to you next quarter on our earnings call. Thank you.

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