Chimera Investment Corp (CIM) 2016 Q2 法說會逐字稿

Good morning, and welcome to the second quarter 2016 earnings call for Chimera Investment Corporation.

Any forward-looking statements made during today's call are subject to risk and uncertainties which are outlined in the Risk Factor section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statement disclaimer in the 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.

Please also note this event is being recorded.

I would now like to turn the conference call over to Mr. Matthew Lambiase. Mr. Lambiase, the floor is yours, sir.

Matthew Lambiase. Thank you, Mike. Good morning and welcome to Chimera Investment Corporation's second quarter 2016 earnings call.

Joining me on the call this morning, I have Mohit Marria, our Chief Investment Officer; Rob Colligan, our CFO; Choudhary Yarlagadda, our Chief Operating Officer; and Bill Dyer, Chimera's head of Underwriting.

I'll make a few brief comments this morning about how we've positioned the Company, and Mohit will discuss the activity in the portfolio, and Rob will review the financial results. Afterward, we'll open up the call for questions.

But before we start, I'd like to say, as a team, we're excited to be celebrating our first anniversary operating as an independent internally-managed company. We've come a long way in the course of the year, and I could not be more proud of my team. The hard work and the dedication of the men and women at Chimera made the transition seamless and successful, and I believe that together we have a great future ahead of us.

In the second quarter of 2016, we materially changed Chimera's asset mix by reducing our interest-rate risk and increasing our mortgage-credit exposure. We purchased approximately $5 billion of seasoned performing loans and sponsored three securitizations to finance the purchase.

We structured and sold senior bonds from the securitizations and retained the high-yielding subordinate bonds.

Under the new risk securitization (inaudible) rules, Chimera has committed to consolidate the loans on the balance sheet and retain our investment in the deals for at least five years.

An important feature of the securitization is that all the principal paydowns from the underlying loan collateral go to retire the senior bonds first, leaving Chimera's credit investment locked out from prepayments. In the low-yield environment, having less reinvestment risk is beneficial and having longer duration high-yielding bonds will help the Company continue to produce its dividend stream into the future.

In these securitizations, Chimera has retained the option to call each transaction at any time after four years. This allows us to seek better financing terms in the future.

In order to fund the purchase of the credit funds from these three securitizations, Chimera reduced its agency portfolio by roughly $2 billion and used cash and repo borrowings to fund the balance.

Our agency portfolio, as we've stated on other earnings calls, is liquid and a ready source of capital to fund more attractive investments. In the current market, with a flat yield curve, higher financing costs and faster prepayment speeds, it's an easy decision to sell agency mortgage-backed securities, because our credit investments should require less recourse leverage and produce more consistent recurrence over time.

Being able to produce consistent returns and to continue to pay our dividend stream is our primary objective. The addition of these new loan securitizations, along with our high yielding Springleaf loan portfolio, I believe will go a long way to help us meet that objective.

In a yield-challenged fixed-income market, our investment team has been able to assemble an $8.8 billion portfolio of current low loan balance, seasoned, higher coupon mortgages. We now have over 96,000 loans on our balance sheet with an average balance of just $92,000 and an average coupon of just under 7.25%.

These loans were originated on average over 10 years ago and have been performing well. Chimera acquired this loan portfolio at a discount dollar price. We believe that over time these assets will perform better than other assets currently available in the mortgage market due to their moderate prepayment speeds and their improving credit profile.

In the two years that we've consolidated the Springleaf loans, we've seen stable prepayments. Consider that in the last six months of very low interest rates, this portfolio has experienced a 9% constant prepayment rate and has an average coupon over 7%.

Over the same period, 30-year Fannie Mae 4% coupon bonds paid at over 17% CPR. One of the reasons that prepayment rates are moderate on this portfolio is due to their low loan balance. High up-front fixed costs make refinancing low loan balance mortgages less economical for the borrowers.

Lower prepayment speeds for our portfolio means more stable cash flow and less principal to reinvest. We like the credit profile of these borrowers. The loans are over 10 years old and the borrowers have been through a severe credit cycle and continue to pay.

Home prices have been steady, and there's been a limited new supply of homes at this price point. The homeowner's average monthly mortgage payment is approximately $800, which compares favorably to renting a similar apartment. Staying in the home and continuing to pay on their 10-year-old mortgage is most likely their cheapest housing option.

We also believe that lower energy costs have a great impact on these borrowers. They have experienced a real increase in their disposable income this year every time they gas up their car or fill up their heating-oil tank.

It's our view that the cash flows that come from these mortgages will be stable, and we have structured these mortgages into bonds that are high yielding, long duration Bespoke Investments for our portfolio.

The universe of non-agency securities available to purchase has been shrinking every month since the crisis. Being able to create our own Bespoke Investments gives Chimera a competitive advantage over those who simply just buy bonds in the market.

The Chimera team has put together an investment portfolio that is truly unique and it's proven once again that Chimera is ahead of the curve when allocating capital in the mortgage market.

In 2009, we told investors about the opportunity in (inaudible) market and we executed over $10 billion of those transactions, and many of those high-yielding investments still remain on our balance sheet.

Today, we believe the best opportunity in the mortgage market is in seasoned performing mortgages, and our team has purchased and securitized over 8.8 billion of them to date. The size and scale of our accredited investments in these transactions would be difficult if not impossible to reproduce, and, more importantly, they'll be on our balance sheet producing high relative income for years, years to come.

In a very difficult fixed-income market, we believe that our portfolio sets us apart and that investors will see real differentiation as Chimera continues to consistently produce its strong dividend into the future.

Now, I'll turn the call over to Mohit to discuss the details and the changes in the portfolio for the quarter.

Thanks, Matt, and good morning, everyone.

I will briefly review macroeconomic factors and then go over the (inaudible) activity for the quarter.

The second quarter was characterized by spread tightening across the board as the market checked out the volatility experienced in Q1 2016. The largest check out was the post practice sell off in risk, though that was extremely short lived with the markets having retraced well through pre-practice levels.

Interest rates, on the other hand, continued to slide lower with 10-year yields falling below 1.5%, and, as a result, have put rate hikes by the Federal Reserve on hold for the near term. While the Fed may still raise rates this year, we believe slower global economic growth will likely limit their ability.

In the second quarter, we initiated a substantial portfolio allocation shift. As Matt mentioned, this quarter we sponsored three identical securitizations on our shelf totaling approximately $5 billion. The underlying loan pool for these securitizations has some similarities to our Springleaf portfolio and is over 10 years seasoned.

This loan pool has a (inaudible) average coupon of 7.35% and an average loan balance of 107,000. 90% of the pool has full documentation. 95% of the borrowers are current for the past 12 months, and the loans were purchased at a discount to par value.

The senior bonds and these securitizations represent 70% of the capital sector and were sold with an initial coupon of 2.95%. Our equity in that has been, over the three deals, totals $769 million. We expect unlevered loss adjusted returns on this investment to be high single digits, while levered returns are expected to be mid to high teens.

The 1.5 billion CIM 2016-1 transaction settled on August 29th and the aggregate 3.5 billion CIM 2016-2 and -3 settled on May 31st. So Q3 should begin to reflect full run rate performance of these investments.

With the growth of the residential credit portfolio, we reduced our interest-rate sensitive agency and (inaudible) portfolio in the second quarter by over 2 billion, the combination of 3.5% and 4% coupons.

Along with the reduction in the agency MBS portfolio, we terminated 2.3 billion in future contracts and interstate swaps. The remaining 3 billion of the agency MBS portfolio is highly liquid and a potential source of capital should other mortgage credit opportunities arise.

Our agency CMBS portfolio continues to grow and we added over 160 million in new commitments this quarter and is now 1.3 billion in total.

Investment activity this quarter produced the following end results for the portfolio. With the combination of Springleaf and the new loan pool, we now own a high-yielding, small-balance residential loan portfolio totaling $8.8 billion. Through securitizations, we added 769 million call protected high-yielding mortgage assets.

83% of our equity capital is now allocated to mortgage credit, an increase from 73% in Q1. Our recourse leverage ratio from repo funding has decreased from 2.6 to 1 in Q1 to 2.0 to 1 at the end of Q2.

Post-quarter end, we announced, on July 26th, that we were the winning bidder for Freddie Mac's pilot structured sale of seasoned mortgage loans that Freddie Mac currently guarantees. We will acquire and simultaneously secure (inaudible) up to 199 million of loans. That's Freddie Mac purchasing the senior (inaudible) of the securitizations at par. This transaction is expected to close by October of 2016.

We continue to use securitization as a primary vehicle for financing our long-term mortgage credit investments. With a challenging landscape (inaudible) to markets, we believe our portfolio remains well positioned to produce attractive risk-adjusted returns for shareholders.

I will now turn it over to Rob to go through the financial results for the quarter.

Thanks, Mohit. I'll review the financial highlights for the second quarter.

The portfolio changes during the quarter have added approximately 5 billion of consolidated loans while reducing 2 billion of agencies. These changes have increased total leverage from 4.0 to 4.7 to 1, while reducing recourse leverage from 2.6 and 2.0 to 1.

Capital value up quarter (inaudible) was $15.78 per share and economic book value was $14.65. Our total return on GAAP book value for the quarter was 4.8% based on the increase in book value and the dividend paid.

(Inaudible) income for the second quarter was 74 million, down from 83 million last quarter.

On a core basis, net income for the second quarter was 96 million or $0.51 per share, down from 110 million or $0.58 per share last quarter.

We did incur 13 million or $0.07 per share of deal-related expenses in connection with the 5 billion of loan securitizations we sponsored during the quarter. Excluding the deal expenses, earnings would have been consistent with last quarter at $0.58 per share.

Debt interest income for the second quarter was 138 million even with last quarter. The yield on average interest earning assets was 6.2% ,up from 5.9% last quarter. Our average costs of funds was 2.8% ,up from 2.5% last quarter, and our net interest spread was 3.4 percent, even with last quarter.

Although it was a challenging quarter to manage great risk, our net interest return on equity was 17.6% for the quarter, up from 17.3% last quarter.

Expenses for the second quarter, excluding servicing fees and deal expenses, were 11 million, as certain of our expenses post-internalization continued to ramp up. Specifically, we're still implementing new systems to help grow and scale our business.

Importantly, we expect our expenses this year to be lower as an internally-managed company than they were last year when we were an externally-managed company.

That concludes our remarks. We'll turn the call back over to Mike for questions.

Thank you, sir. (Operator Instructions). The first question we have comes from Bose George of KBW. Please go ahead.

Thanks. Good morning. It's Eric on for Bose. Excuse me. Hey, good morning, guys.

Hoping you can tease apart for us the non-accretable discount that you're holding for the three new securitizations. And if you can review the methodology that you used to change that number around over time that would be great.

When you say change the number around, clarify a little bit?

Just the path of that non-accretable discount over time.

Sure. The non-accretable discount would be the difference between, you know, your purchase price and par on discount that we don't expect to earn, right? So when we buy, you know, some of these pools, we don't expect to earn every single dollar. Our loss adjusted yields are still very positive, but we do have (inaudible) of the bond or loan that we don't expect to recover to par.

Over time, you know, we do have, and you'll see in a roll forward, the accretable and non-accretable discounts occasionally, and it's been somewhat of a pattern that if the credit performs better than our underwriting, some of the non-accretable discount can actually move to the accretable discount and become a component of yield in the future.

That answer your question or do you have anything else that you want clarified?

Yes, as of today, what is that non-accretable discount number for the three securitizations?

I don't have that number in front of me. I'll come back to you on that.

Okay. What is your cumulative default assumption on the three deals? Can you share that number?

Hey, Eric. Yes. This is Mohit. We're liquidating or our assumption is to liquidate about 21% to 22% of the pool.

Great. Thanks, Mohit.

And the last question from me is there an effort to get any future (inaudible) deals rated?

Yes, I mean, we evaluate that on each deal that we do, if the economics make sense to include a rating. But given the strong demand for the (inaudible) we haven't really needed a rating agency. I think people are comfortable with a credit profile of the loans.

Yes, I think that's been kind of the thing that underscores this whole market is that there's a thirst for high-quality access out there. And we were able to price three transactions in the quarter and sell billions of dollars' worth of senior bonds without any ratings on them. And I think that just goes to the fact that, in this market, it's just very hard for large institutional buyers to find high-quality assets, and whether you have a rating or not, you know, it doesn't really matter. I don't think the economics would be that significantly different.

And, for us, it's about timing, you know. If we had to go through a rating-agency process on those three deals that we did this quarter it would have taken probably months and months to get their arms around that. And, you know, the investors are -- the senior buyers are all very sophisticated people that can do their own credit work.

So I just think that for us the market is evolving to the point where we probably don't need to have the rating agencies actively involved. And, if you want, the securitization 2.0 that we're so involved in with the sponsorship of these deals is really becoming more of an adult swim in the marketplace, where you're not seeing -- you're seeing a lot of the deals getting done with just, you know, a couple of margin investors getting involved, buying the seniors and taking out the subordinates.

Um-hum. That's very helpful, Matt. Thanks. Thanks, guys.

Next, we have Brock Vandervliet of Nomura Securities.

Thanks for taking my question. How much flexibility do you have with respect to the whole pool of tests or any other (inaudible) constraint in terms of running down the agency book to fund these, you know, non-agency structures?

Yes, this is Rob. I'd say we do have a little bit of room. You know, we disclosed in the past -- I don't think it's changed -- is we have -- we would need about $2 billion of agencies. Obviously, these new deals help, as compared to the old (inaudible) deals, which did not meet the (inaudible), but given the new loan securitization that we have done it has actually helped (inaudible) on the agencies.

I would say, you know, we could take the agency book down to about 2 billion in aggregate before we're close to any -- breaching any of the tests.

Yes, but I would also say, Brock, just to that point, is that just managing the company, it's nice to have liquidity, and it's nice to have, you know, more than you probably need to make the bare minimum of comfort. So, you know, we'll probably keep -- We'll probably keep more than the bare minimum on our balance sheet just because we do like to have liquidity.

The agency, the Ginnie Mae project loans that we've been acquiring and we have commitments to buy are very liquid, but, then, again, you know, I think, you know, our choice is not to really sell them to take down the portfolio.

So I think you're always going to see this kind of where we are is a pretty good comfort level for us in agency mortgages at the moment, but -- And I think we're going to be adding to the agency CMBS over time.

Okay. Great. And can you give us any further color on this Freddie Mac transaction in terms of the type of (inaudible) collateral behind that? I don't have that press release in front of me, but it looked like whatever efforts Freddie had made in the past there were quite small. Any sense of how large this could be?

Well, before I let Mohit talk about the deal and the opportunity, I just want to caveat everything, saying that, you know, we're in the process. Bill and his team are doing due diligence on the loan pool. The final statistics on the pool and the loans haven't been set yet. We have an idea. We have a target collateral pool, but we're still working on it. So just keep that in mind as we go through this. I mean, so I don't want to give too many details on it, but Mo can probably just talk to the bigger picture.

Sure. As far as the collateral on this transaction goes, as Matt says, we're still finalizing, but what was put in the press release was it's about 130 month seasons. It's got a 70 LTV. The prepayment history is spotty. That's not like the, you know, Springleaf and/or the pool that we acquired in the second quarter, but, again, the LTV is offsetting that, and, I mean, these are (inaudible)-eligible assets. So from that standpoint, we've got comfort.

As far as the opportunity set, you know, I think it's in the billions. I mean, I think Freddie Mac obviously has a very large loan portfolio, and I think it could be up to $20 billion, so -- what they may have to sell in the coming years.

Yes, and I would just say that the operative thing, I think the thing that's so interesting to this transaction specifically is that Freddie Mac is going to take care or is going to take the senior bonds off of the transaction, which, when you're doing one of these types of pools of loans, having the execution risk is always an issue. So with them taking the senior bonds off and distributing them later, that's the innovation and the thing that we think is so interesting to the transaction.

And, you know, it is a pilot program for us. $200 million is, you know, doesn't really move our needle, but we do think that it is very interesting for the future, because I think whether Freddie Mac -- and I think Freddie Mac has been really innovative in looking at new ways to get out of the credit risks that they have on their balance sheet. I think once, you know, I think we're working with them to figure out the legal structure and to do it, but once this is done, I think there'll be a lot of other people coming in the space. I think the deals could, you know, get more liquid, and I think, you know, the other guys, Fannie Mae might come into the market and do the same thing as well

So I think the opportunities, that could be very large, but, you know, this is nascent, this is early stuff and it's a very small deal for our balance sheet, but, you know, we think there's going to be good opportunity there going forward.

And as sponsor of the deal, our biggest risk is execution on the senior sales and Freddie Mac guaranteeing to purchase an attractive source of (inaudible) financing, if you will.

Okay. Thank you.

(Operator Instructions).

We just wanted to follow up. Rob wanted to follow up with something here.

Yeah, just to answer the other part of the question from Eric this morning, the non-accretable discount on the loan pool was about 500 million, just so he has that number.

Thank you, sir. (Operator Instructions). It looks like we have a follow up from Brock Vandervliet of Nomura Securities.

I think you're losing a few this morning with some of the conflicts --

I think it's a (inaudible) morning, yeah.

Exactly. Hey, you mentioned the CPRs. Could you just give a little color, say, Q1 to Q2 on what you saw in terms of the prepayment dynamics?

On the agency or the non-agency portion of the --

On the non-agency.

Yes, I mean, again, even with the significant value of rates from December through June 30th, the non-agency stuff was pretty flat. I mean, I think we're still experiencing high single digits on a weighted average basis. I think the portfolio in the aggregate is probably around 8 to 9 CPR , and that's flat quarter over quarter.

Yes, and then, of course, agencies --

Yes.

-- have picked up. And I think, you know, it really underscores these loans, and particularly, you know, there's just not a lot of available financing for some borrowers out there. And I think the small loan balance, if you think about it, you have a $92,000 loan that people have been paying for 10 years and, you know, do you really want to incur several thousand dollars to refinance that and lower your payment? The payback period is so long on that that I think that gives us some idea of safety in terms of voluntary prepayments.

And, if anything, I think we've seen maybe voluntary prepayments trickle up going into the summer here, which is kind of unusual, but we haven't seen a spike up in these prepayments. I think in a very difficult mortgage market, where, you know, you have, you know, flat funding costs, low yields and (inaudible) prepayments, and everything's at a premium, you know, when you look at all the different options that you can have on your plate as a mortgage allocator, a mortgage money allocator, having money and having these types of loans in big size is a real, I think, a real benefit to our shareholders, because I don't believe that they're going to see a pickup in prepayments, and I think we're going to be harvesting this coupon, and I think we really feel that this is probably one of the best places to invest in the mortgage market today.

Great. Thanks.

At this time, we're showing no further questions. We'll then conclude the question-and-answer session, and I would now like to turn the conference back over to the management team for any closing remarks. Gentlemen.

Well, I'd just like to thank everybody here on my team at Chimera for making our transition to a self-managed company so successful.

And I'd like to thank all of you. I know it's a busy morning for a lot of companies. I'd like to thank you, all of you for participating in our call and making it to the end. We look forward to speaking to you again in three months.

And we thank you, sir, and to the rest of the management team, also, for your time today.

The conference call is now concluded. At this time, you may disconnect your lines. Thank you again, everyone. Take care and have a great day.