Chimera Investment Corp (CIM) 2016 Q3 法說會逐字稿

Good day and welcome to the Chimera Investment Corporation third quarter 2016 conference call and web cast. All participants will be in listen-only mode. (Operator Instructions). I would like to turn the call over to Matthew Lambiase.

Good morning, and welcome to Chimera Investment Corporation's third quarter 2016 earnings call. Joining me on the call this morning I have Rob Colligan, our CFO, Mohit Marria, our CIO, Bill Dyer, Chimera's Head of Underwriting and Choudhary Yarlagadda, our Chief Operating Officer. I'll make a few brief comments regarding the quarter, then Mohit will discuss the market and our portfolio and Rob will review the financial results. Afterwards, we'll open up the call for questions.

Chimera had solid core earnings in the third quarter of $0.68 per common share. Our increased core earnings quarter over quarter can be attributed to the new earnings from the $5 billion of loan securitizations we executed in the second quarter, changes of prepayment assumptions for the agency portfolio and the lack of securitization deal expenses in the quarter.

As we previously announced, Chimera closed three loan securitizations in the second quarter and because those transactions closed during the quarter, we received only a portion of the expected quarterly income in that period. In the third quarter, the new securitizations were on our books for the full three months and our income went up accordingly.

Going forward, we expect these deals to continue to add meaningful income to our core earnings. These new loan securitizations have increased the size of our mortgage loan portfolio. Chimera now owns over $8 billion of seasoned low loan balance mortgages that are financed through securitization.

We believe that these new assets will produce a durable income stream for our shareholders for years to come and last night our Board of Directors took action to increase the fourth quarter dividend to $0.50 per share. A part of this quarters increased earnings are attributed to lower long-term prepayment expectations for our agency mortgage-backed security portfolio.

We, like other mortgage investors, use a third party to provide agency prepayment assumptions for our portfolio. In this quarter, we implemented black rock solutions portfolio system and utilized their standard mortgage prepayment assumptions. Black rock forecast lower future prepayment speeds, which in turn lowered our amortization costs and caused a catch-up in quarter.

Chimera recorded no securitization related deal costs in the third quarter under like the previous period. We believe securitization has been a winning strategy for us. It's been the prime driver of our increased earnings and our ability to pay higher dividends. It's very important for investors to understand that in order for us to execute securitizations, we must incur expenses which relate to the legal, computational and the distribution costs of doing deals.

These deal expenses are realized up front in the month that we settle the securitization and they're subtracted out of our core earnings in that quarter. So, when investors see deal costs reducing quarters core income they should understand that they are incurred with the objective to increase earnings in the future.

By sponsoring mortgage securitizations, rather than just simply buying assets, we think that Chimera has demonstrated a unique competitive advantage. The bonds that we retain from these securitizations are expected to produce higher and more stable earnings over time than other investments currently available in the market.

Due to the way the deals are structured, the Company retains, the option to call and refinance these securitizations which may add additional upside in the future. We continue to look for opportunities to execute new securitizations and expect to incur deal expenses as a normal course of our business going forward.

Subsequent to the close of the third quarter, Chimera priced $145 million, 8% fixed rate cumulative preferred stock issue. In a recent volatile equity market there's been increased demand for $25 preferred stock issues because they have a exhibited less price movement at common stock while still delivering relative high fixed income for investors.

Chimera's issue met strong market demand and our deal was upsized from the launch. We're excited to expand our equity base to these new investors and believe that paying 8% for equity rather than our current 12% common distribution should be accretive to our existing common shareholders when the new capital is fully deployed. This new equity affords Chimera Investment the opportunity to continue to expand our mortgage portfolio and should help the Company to continue to produce a relatively high and durable income stream for our shareholders well into the future.

With that I'll turn the call over to Mohit to discuss the market and our portfolio.

Thank you, Matt and good morning, everyone. I'll briefly review the macro economic factors and then go over the investment activity for the quarter and provide a framework for the portfolio shifts (inaudible) beginning of 2016. During the third quarter, interest rate edged higher and the yields were flattened. They also edged lower during the quarter and helped spread products to out perform. Across most fixed income asset classes, spreads (inaudible) 10 to 25 bases points, helping book value for the quarter.

We remain cautious heading into Q4 as the upcoming elections and potential Fed action could create volatility heading into year end. Overall, portfolio activity for the third quarter was pretty light. There were no new securitizations, minimal changes in the agency and non-agency portfolio, and we continue to fully build out our agency's CMBS portfolio by adding an additional $50 million in new commitments this quarter. The net interest spread on agency securities increased quarter over quarter and Repo rates remained relatively unchanged for the second quarter.

We recognize the full benefit of the quarterly run rate on the most recent $5 billion in loan securitizations while the (inaudible) portfolio and the Springleaf portfolio continue to prepay and perform consistent with previous quarters. Since the beginning of the year we have made a number of portfolio shifts that we believe will produce more sustainable and durable income streams into our future.

We have decreased our overall agency portfolio from $6.5 billion at year end to $4.4 billion at the end of Q3. The agency CMBS portfolio has increased in size by $321 million to $1.27 billion in current face and that represents 34% of our agency holdings up from 18% at year end. As previously stated, the agency CMBS portfolio has similar returns as residential agencies but offers added benefits to investors through explicit call protection versus no call protection available on our residential mortgages.

This enables us to more effectively capture the net interest spread and reduce volatility in the stream of earnings generated from that portion of the portfolio. As our agency portfolio has become smaller, the residential mortgage credit portfolio has grown in size from $8.4 billion at year end to $12.3 billion at the end of Q3. This growth has predominantly been generated by the loan purchased last quarter and securitized with Chimera acting as a deal sponsor.

We believe the combination of stable and improving housing market and the added benefit of seasoned small balance loans offers one of best risk reward investments in the market today. Close to quarter end we closed on the Freddie Mac pilot deal announced on July 26, 2016, refinanced Springleaf 2013-1 into new securitizations and continue to look for more securitization opportunities to produce attractive risk adjusted returns for shareholders.

With that, I'll turn the call over to Rob to discuss financial results.

Thanks, Mohit. I'll review financial highlights for the third quarter. GAAP book value at quarter end was $16.18 per share and our total return on GAAP book value for the quarter was 5.6% based on the increase in book value and the dividend paid. GAAP net income for the third quarter was $173 million, up from $74 million last quarter.

On a core basis, net income for the third quarter was $129 million or $0.68 per share, up from $96 million or $0.51 per share last quarter. Lower projected prepayment speeds on our agency book added approximately $0.05 to core earnings.

We also earned additional income from the three securitizations Chimera sponsored earlier this year. In the third quarter we did not incur any deal related expenses compared to $13 million, or $0.07 per share in the second quarter. And we do expect at least $4 million of deal expenses to be incurred in the fourth quarter of this year.

Going forward, excluding deal expenses, we expect core earnings to have a run rate in the low $0.60 per share. Net interest income for the third quarter was $156 million, up from $138 million last quarter. The yield on average interest earnings assets was 6.5%, up from 6.2%. Our average of cost of funds was 2.9%, up from 2.8%, and our net interest spread was 3.6%, up from 3.4%.

Total leverage for the quarter was 4.4 to one, down from 4.7 to one last quarter while recourse leverage ended the quarter at 1.9 to 1. Our net interest return on equity was 20.2% for the quarter, up from 17.6% last quarter. Expenses for the third quarter excluding servicing fees and deal expenses were $11 million.

We continue to implement new systems to help grow and scale our business which will add to our expense run rate going forward. Although, on a percentage of equity basis, we expect our expenses to be lower than most companies in our sector.

We noticed that our Operator didn't provide the standard intro before this call so before we take questions, I need to mention that any forward-looking statements made during today's call are subject to risks and uncertainties which are outlined in the risk factors 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 statements disclaimer in our earnings release in addition to our quarterly and annual filings. During the call today we may also discuss non-GAAP financial measures. Please refer to our SEC filings and earnings supplement for reconciliations to the most comparable GAAP measures. 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 the information.

Now we'll open the call for questions.

We will now begin the question-and-answer session. (Operator Instructions). The first question comes from Doug Harter, with Credit Suisse. Please, go ahead.

This is actually Josh on for Doug. So yields were up in on the quarter. I'm curious if these higher asset yields that you guys saw are sustainable going forward and how much we should think about that?

This is Mohit. Yes, I mean I think the performance of the portfolio has been pretty consistent quarter over quarter as we've said. Prepayment default severities have been pretty consistent and have actually trended lower in Q3. So I think the sustainability of the yields reflected should be a good reflection of what's going to be coming in Q4 and forward.

Great, thanks. And then one question on the Freddie Mac pilot deal. Any updates on how that's going? And, any word on if there's going to be more opportunity in the future for some risk retention? And just how you guys are thinking about that?

Sure. First, on the Freddie Mac as I mentioned in the prepared remarks, the deal has closed as of the end of October. And, it was pretty well received. We think it's going to be accretive to the portfolio in terms of this retention piece that we're going to be holding. We see yields on that, high single digits and levered returns of double digits easily.

I think there is opportunity to continue to work with the GSCs. We have plenty of product to sell so we could evaluate each pool on a stand alone basis as it comes for sale. And as far as just risk retention opportunities as we've mentioned all throughout the year, we think we have an added benefit of being able to securitize stuff on our shelf, retain the risk with permanent capital which should be accretive for our shareholders and we will think there's definitely opportunities to continue growing that business for us.

Yes. This is Matt and I would just like to say that we are seeing ample opportunity to do more securitizations. I think Chimera's space in the market right now is still buying the loans that are highly seasoned, that banks don't want to, or no longer want to service that type of product. Like the $5 billion that we bought in the second quarter, those are highly seasoned mortgages and frankly, we're buying a lot of this paper from banks because they no longer want to have it. And I think we're going to see more of that. Getting these assets off their balance sheets. And as we go forward, we think that that's probably the best place for us to deploy our capital and do securitizations and hold the B-notes as risk retention.

great. Thanks for the time, guys.

The next question comes from Bose George with KBW. Please, go ahead.

Good morning. Just to follow up on the opportunity to purchase more loans. This year obviously you did some very large transactions. When we think about what you're seeing out there, I mean could we see things that are as meaningful or do you feel like a lot of the activity has already happened, or how would you characterize it?

You know, it's one of those things, Bose, we're always looking around for these opportunities. We bought the Springleaf portfolio back in 2014 and then we sat relatively quietly for a year or so, year-and-a-half before we got the portfolio that we securitized this year. So when the things come, they're kind of sporadic. Unfortunately there's no direct market. We have to wait and see what the market brings. I would say that currently we are seeing several packages that could be meaningful for us. I think the forward supply, I don't know if we're going to find $5 billion per se but I think we're seeing enough interesting legacy paper. In the next two quarters I would say we'll have more securitization.

Okay. That's helpful. And then just in terms of the portfolio composition, since the you meet the whole pool test with these loans, can the agency residential portfolio just continue to run off?

I'm fully aware that most people don't buy our portfolio, our stock for the agency portfolio. And frankly, we use it more to meet the whole pool test and also to service liquidity on our balance sheet. I'm pretty comfortable with where the agency portfolio is right now in terms of size. It could be smaller. We could definitely take it down and use it for our liquidity should we see a big opportunity and we need capital out of our portfolio. But I would say that our agency portfolio roughly if you wanted to talk about it, should be roughly around the same type of size going forward. And I think generally we look at it as more liquidity than opportunity per se.

George, to Matt's point, in Q2 we did sell the agency portfolio when the $5 billion became available. I think we're at a good spot on the agency portfolio. I think both from a return perspective as well as a liquidity perspective going into Q4 here. We did have the equity raise of $140 million. That gives us some additional capital to deploy in Q4 to the extent opportunities become available and opportunities we're evaluating.

And I think what you will see, Bose is as the prepayment's on the residential agency mortgage backed securities come in, we're going to probably not reinvest into residential RMBS, agency stuff but we are going to go into agency, the CMBS. And I think you'll see the portfolio over time hopefully will be more agency CMBS because we like the prepayment story and it's easier for us to hedge and it's all around a better product.

Okay, great. Actually, does the agency CMBS meet the whole pool test as well?

Yes.

Okay, thanks.

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

In the 10-Q there's a line item called reclassification two from a non-accretable difference. Can you explain at what point the security gets changed or moved to that, would be reclassified so that it impacts that number? And the second part of that question is how, if any, where would see that on the income statement? The underlying reason for the question is you guys are targeting kind of low 60s core earnings run rate but the dividend is still around $0.50 so I'm trying to reconcile the higher core number versus where the dividend sits.

Yes. I'll take those in order. The reclassifications to or from the accretable generally come from changes in forward cash flow projections. With the increased projections we'll have more accretable yield move into that bucket if we see a little deterioration, you'll see a subtraction. So that's a good table to look at what the future income will be over time.

Okay.

When you do have an increase or decrease in cash flow assumptions, obviously that will work its way into our mark-to-market, so you'll see it that way as well. As far as the dividend, obviously core excludes certain items including impairments and, take for example recently the larger losses on hedges. That's a real loss for tax but it's excluded from core. So we have a few items like that, that deviate from core earnings to tax earnings.

Okay. That's helpful. Is there some way that I know the tax concept is kind of an annualized concept but is there some way to better understand or model that for analysts? Because we get asked all the time in our coverage, who has the ability to raise the dividend, who's more likely to cut it. In your case, the core earnings numbers are signaling a raise which is generally a good thing, but we just want to make sure we can properly calibrate the correct cash flow generation that goes to either increase or decrease the dividend.

No, you're right. We, like a lot of companies in the space, disclose the tax (inaudible) once a year. I think the increase in core did give some comfort to the Board to actually increase the dividend this quarter and we'll reassess early part of next year like we've done in past years.

I would just add to that that it was pretty linear over the course of last year. We were earning in the mid 50s on a core rate and we're paying out $0.48. Now we're saying our core is going up. Rob said we will probably be in the low 60s and that has gone up and that's why the Board feels more comfortable with increasing the dividend. I think the same GAAP between the two will hold constant going forward.

Okay. That comment is very helpful. Thank you very much.

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

Just as follow-up. That's impressive you're giving the guide on earnings going forward. It sounds like you're still going to keep the pattern you've had in the past in terms of in the first quarter, you give a dividend target for the full year ahead, is that correct?

It's always up to my Board to determine what they want to do. I think, and I think management here thinks it's a good thing to do. And I would have a high degree of confidence that they want to continue to do that. But it is their option.

Yes, okay. And Rob, just a confirmation of a couple of numbers. The shift in prepay assumptions, that added a $0.05, correct?

That's right.

And the deal expenses, the $4 million in the fourth quarter, what is that tied to?

So it's for some of the deals that we're doing in the fourth quarter. And just to go back to the $0.05, that's a non-recurring number. That's kind of an one-time. Obviously, when you look at the agencies you have those catch-up adjustments that sometimes cause some noise. So that $0.05, I take that right out when you're projecting fourth quarter and into next year.

And as (inaudible) we called and we resecuritized one of the Springleaf transactions in the fourth quarter and then also we closed the Freddie Mac deal, the pilot program with them. So those are the deal costs that we're going to have to back out of core for this period.

Okay.

It should be good for income going forward.

Yes. Is there any further developments from Freddie in terms of how much could be behind this initial transaction? Obviously, a lot. But has there been any indication from Freddie that they would scale this up?

The deal literally closed last Friday. I think everybody's going to do a postmortem but it's a success from both Freddie's standpoint and our standpoint. And you referenced, obviously they have a large amount of loans that they potentially sell. I think this is just another avenue for them to explore and I think it will get some more traction in the months ahead. Just not sure the magnitude of what that could be. Nor the timing.

They have a lot of paper. I think both agencies have a lot of mortgages that they would like to sell and they're trying to figure out new avenues to get those securitized, to get the risks off their books. And I think we were excited to be part of this transaction with them and hopefully it's successful and it's something the regulator wants to do more of and we think there could be a lot of opportunity ahead. They haven't told us what the size going forward could be.

And what do you think is the advantage of this structure relative to other avenues they have to sell volume?

Well, you know, if we were to buy those loans and securitize them on a private label, we would have to take market risk and find buyers for the AAA bond and they would probably trade, the senior bonds would trade at a much wider spread. The structure that we did of Freddie Mac is actually guaranteeing the senior bond or they're taking it back so it has a much lower funding cost and that makes the deal far more attractive for us. It removes the execution risk of doing the securitization and it actually lowers the funding costs of the deal which, those are two material things that add liquidity and our desire to do the type of transaction.

Got it. Okay. Thank you. Great quarter.

Thank you very much.

The next question comes from Trevor Cranston with JMP Securities. Please, go ahead.

All right, thanks. Just want to follow up on the question about taxable earnings versus core. Can you say if there's any meaningful difference in between the income recognition on the securitizations you've done so far in terms of recognizing discount accretion for core earnings but potentially maybe that not being as linear for tax?

There's some impact there. As an example when we call the deal, cases not all but in most cases there's actually some gain that we would trigger for tax that on a GAAP perspective that transaction is treated just like financing. And so there's no gain or loss on (inaudible) and restructuring of a new deal. But from a modeling perspective, those are sporadic in nature and lumpy. So somewhat difficult to give an exact number on that.

Okay. Got it. Thank you.

(Operator Instructions). 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 for participating in the third quarter 2016 Chimera Investment Corporation's earnings call. As you can see from our earnings we're all very excited about our position and our portfolio and we're going to be very excited to talk to you next year for the fourth quarter. Thank you, again.

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