Chimera Investment Corp (CIM) 2016 Q4 法說會逐字稿

Welcome to the Chimera Investment Corporation fourth-quarter and year-end 2016 conference call and webcast.

(Operator Instructions)

It is now my pleasure to turn the floor over to Emily Moore of Investor Relations. Please go ahead.

Thank you, Kristen. Thank you, everyone, for participating in Chimera's fourth-quarter and year-end 2016 earnings conference call. Before we begin, I'd like to review the Safe Harbor statements.

During this call, we will be making forward-looking statements which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that 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 statement disclaimer in our earnings release in addition to our quarterly and annual filings.

During the call today, we will also discuss non-GAAP financial measures. Please refer to our SEC filings and earning supplement for reconciliation 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 or specifically disclaim any obligation to update or revise this information.

I will now turn the conference over to Matthew Lambiase.

Thank you, Emily. Good morning and welcome to the fourth-quarter 2016 Chimera Investment Corporation's 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 Vic Falvo, the Head of our Capital Markets.

I will make a few brief comments, Mohit will then discuss the changes in the portfolio, and Rob will review our financial results. Afterwards we will open up the call for questions.

We witnessed high volatility in the fourth-quarter of 2016 as the10-year US treasury increased in yields over 85 basis points and the Federal Reserve increased short-term interest rates. In this very difficult bond market, Chimera's portfolio held up well and produced a positive total return for the period.

Residential mortgage credit bonds, which comprised the majority of our holdings, did not suffer the same negative price movement as agency mortgage backed securities or US treasury's did in the sell off. We believe that our asset mix and lower recourse leverage should help us to continue to produce solid returns even if we see more volatility in the future.

Overall, 2016 was a good year for Chimera. It was our first full-calendar year operating as an independent, internally managed company. Over the year, Chimera shares posted a 46% cumulative total return and since internalization in August of 2015, the Company has had a 60% cumulative total return.

Over the last 19 months, we've had a number of successes that have added value for our shareholders. We were able to internalize the management function without paying a breakup fee and lower the operating expense of the Company. We strengthened our operating systems by implementing new state-of-the-art third-party accounting and portfolio management systems.

We added experienced new employees in accounting, legal, and technology to round out our team. We repurchased $250 million of Chimera shares at a discount to its book value, at an average price of $13.94.

We recovered $95 million for our shareholders, which resulted in a special dividend. We diversified our capital structure and issued $145 million, 8% cumulative preferred stock, our first preferred issue, which was accretive to the common shareholder.

We executed a novel securitization with Freddie Mac, which enabled them to sell credit risk to Chimera in a structure that's never been done before. And most importantly, our portfolio team successfully purchased and securitized over $5 billion of season performing low-loan balance mortgages in three separate transactions; which enabled us to grow our earnings and raise our dividends in the fourth-quarter of 2016.

Looking forward, we feel good about our portfolio and believe that the recovering housing market makes legacy residential mortgage credit, one of the most attractive options for income investors. Our portfolio of over 90,000 low-loan balance mortgages is truly unique, and we believe it's well positioned to continue to produce high relative income for our investors.

Our confidence is evidenced by our Board of Directors announcing last night that Chimera expects to pay a $0.50 dividend for each of the four quarters of 2017. We hope this is a minimum, as our investment team is continuously looking for new and accretive investment opportunities with the goal to be able to grow earnings and increase our dividend in the future.

Now I will turn the call over to Mohit to discuss the changes in the portfolio for the period.

Thank you, Matt. It was another interesting quarter for both fixed income and equity markets. The unexpected results of the election marked a major stock market rally and a sizable sell off in the treasury bond market.

As Matt said, during the quarter, 10-year treasury yields increased by approximately 85 basis points, and the curse deepened roughly 42 basis points. Given the large move in treasury yields, agency mortgage spreads widened. However, mortgage credit spreads tightened somewhat, as a result of the risk on mindset following the election results, which positively benefited our credit strategy and overall performance.

At the peak, the legacy mortgage market was approximately $1.3 trillion. At the end of calendar year 2015, the estimated amount of outstanding disparities was $630 billion. And as 2016 came to a close, the market has further shrunk to approximately $550 billion.

Chimera and our first major portfolio innovation a few years back, created a large portfolio of re-remic from legacy mortgage bonds. The securities we created for investment, continued to generate attractive returns for the portfolio and the senior security solds have acted as a buffer to our portfolio from the pay downs that have occurred.

At year end, we had nearly $2 billion re-remic outstanding, representing 61% of our original $3.2 billion investment of consolidated re-remics. Consistent with the improvement in housing market, these securities continue to perform well in both delinquencies and prepayments and continue to generate mid-high teen yields for our portfolio.

Mortgage loan securitization is not new to Chimera. Unlike most investors in legacy mortgage bonds, Chimera can utilize accreditation and loan credit analysis experience to capitalize on the opportunity to purchase new seasoned mortgage loans.

We have securitized over $10.5 billion of loans in our history. In each of these deals, Chimera owns a subordinate position and has never sold [other] subordinate investments. So, when the new risk retention regulations came into effect, Chimera was prepared to assume a leadership position.

Inclusive of the $5.8 billion loan securitization conceded in 2016, Chimera now has nearly $8.9 billion in loan securitizations outstanding, while retaining $1.8 billion. Additional details of the outstanding consolidated loan securitizations can be found on page 5 of the quarterly supplement.

This quarter we closed on $185 million securitization CIM 2016-FRE1, which was a Freddie Mac pilot program. At any length, Chimera generated similar returns (inaudible) earlier in 2016. Some of the detailed -- deal highlights are as follows.

[The loans were 130] (inaudible) [reperforming with an average of 70] Freddie Mac provides term senior financing at a financing rate of 2.35%. Chimera retained just over $70 million in subordinate holdings while suggested deals from low-to-mid teens.

Although the deal size is not overly impactful to the portfolio, it is important for us to enter it and establish a potential new source of supply with the [GSC]. In addition, we refinanced Springleaf 2013-1, resulting in new issue of CIM 2016-4 and CIM 2016-5. Though we did not materially reduce our capital commitment, we were able to reduce our financing cost on our investments from 4.07% to 3.5% saving us over 55 basis points.

We have now resecured 5 of the 7 original Springleaf notes and have Springleaf 2013-2 and 2013-3 remaining. These deals are currently callable and we continue to evaluate refinancing opportunities.

Subsequent to year end but not reflected this quarter, in January we closed on CIM 2017-1, which is a new loan securitization totalling $525 million. The loans and economics are substantially similar to those issued in CIM 2016-1, CIM 2016-2, and CIM 2016-3.

Also in January, we acquired approximately $330 million of season performing mortgage loans between (inaudible)near future. We will provide more details on these transactions on a first-quarter 2017 earnings call.

As we look forward in 2017, we remain committed, supplying capital to areas of our business with the highest returns and driving our earnings power, while also maintaining an disciplined approach to risk management and protecting book value.

With that, I will turn the call over to Rob.

Thank you, Mohit. I will now review financial highlights for the fourth-quarter of 2016.

GAAP book value at year end was $15.87 per share and our total return on GAAP book value was 1.2% based on the quarterly change in book value and fourth-quarter dividends. GAAP net income for the fourth quarter was $219 million, up from $173 million last quarter.

On a core basis, net income for the fourth quarter was $121 million or $0.65 per share, compared to $129 million or $0.68 per share last quarter. Deal expenses for the fourth quarter were approximately $4 million or $0.02 per share.

Net interest income for the fourth quarter was $154 million compared to $156 million last quarter. The yield on average interest-earning assets was 6.9% compared to 6.5% last quarter.

Our average cost of funds was 3.4%, up from 2.9% last quarter. Our net interest spread was 3.5% compared to 3.6% last quarter.

Our total leverage for the quarter was 4.1:1, down from 4.4:1 last quarter, while recourse leverage ended the quarter at 1.8:1. Our net increase return on equity was 19.5% for the quarter, compared to 20.2% last quarter and our return on average equity is 28.8% for the quarter, up from 23% last quarter.

Expenses for the fourth quarter, excluding servicing fees and deal expenses were $12 million. For 2017 we expect expenses, again, excluding servicing fees and deal expenses, to be $12 million to $13 million per quarter, which is lower than most companies in our sector and we continue to deliver cost savings discussed during Chimera's internalization of management in the third-quarter of 2015.

That concludes our remarks, and we will now open the call for questions.

(Operator Instructions)

Bose George, KBW.

Good morning. It is Eric on for Bose. Now that we are almost a decade beyond the financial crisis, do you think homeowners are any more or less sensitive to changes in housing prices versus pre crisis?

Do you think there might be other, perhaps, more germane factors that have emerged over the last few years, which may impact the credit profile of low to middle income borrowers? Which you think might be getting overlooked right now?

Well, that's a really interesting question. I would say that the big difference right now that you are seeing in housing valuations and especially in the housing values of the properties that we financed in our portfolio; is that with an average portfolio of 90,000 some odd loans, less than $100,000 balance, you are talking about the -- how the $125,000 home values.

Those homes, haven't been over built in this market, and you are seeing steady price appreciation in that market. I think it's been pretty solid. The other thing that you are not seeing really, is the excessive lending. The price gains that we are seeing, I think are sustainable. Actually, I don't think there's a lot of -- supply in that market.

I think if anything, the housing crisis there can actually appreciate with inflation in the marketplace, and I don't think it's a bubble at all. Especially what we're -- the home values that we have -- that we are funding.

And the only place we do see, where the homeowner is sensitive to the level of rates and HPA, is on the prime jumbo side. We have seen the origination stuff -- stuff that we originated in 2012, paying a lot faster than the loans that Matt just eluded to, which is why we shifted our focus in 2014 to the season performing low loan balance story.

That's a helpful answer. For the re-remic bonds that you list on slide 6, what is your approximate assumption for the average remaining life of those securities?

The senior bonds, which is $350 million outstanding from the original $3 billion. I'd say the average life is anywhere between two to three years. The subordinate bonds, the $1.9 billion, probably have an average life between six to seven years.

Got it.

Based on performance which we have seen over the last eight years. (multiple speakers)

Go ahead. I'm sorry.

And I think when we look at CPR's on the re-remic portfolio, in general, that's been coming in relatively slow. You would think that has been nine or so CPR.

I think the weighted average CPR experience on the remic portfolio is between 8 to 10 CPR based on seasonals.

Got it. I was just going to say, modeling this out, we can expect that yield that your booking to continue for the foreseeable future?

Yes, absolutely.

Thanks, guys. Appreciate it.

Brock Vandervliet, with Nomura.

Hi, guys. If you could just talk generally about sourcing new -- tapping new sources of credit. Any details on where this $330 million that you purchased came from and just more broadly, Springleaf has been great for you, but what -- what general opportunities are you focused on here in 2017?

Right. The good news is that so far this quarter, the first quarter 2017, the company has about -- we have completed one $500 million transaction and we will probably have another one that will be about $300 million.

The good news for everyone is that we are able to find, I think investments that we like and are going to be accretive to the earnings stream of the company. That is always a risk, but you say can -- you find assets?

To the point that Mohit made in his comments is that we've done a deal with Freddie Mac, which is a very interesting risk transfer -- structure that they've never done before. No one has ever done it before, and I think it was successful for us. I think it was successful for them, and I think that [sales] could be a very large source of assets for us to securitize in the future. Freddie Mac and Fannie Mae are looking for different ways to shed risk on their balance sheets and they have been very creative.

I think that they have, frankly, a lot of risk that we would -- that we would put on our balance sheet if we got the right financing and the right terms for it. If you talk to them, you are talking about billions, maybe tens of billions of dollars of assets that could come out in the next couple years.

Okay. Great. Just as a follow-up, could you talk about how you are thinking about the dividend?

You obviously took it up in the fourth quarter. Your earnings continue to beat us and the rest of the [three] though.

Well, I think -- listen, we want to raise the dividend. Ideally, the idea is to find more good assets and grow our earnings, is job number one here, but I think being cautious is important. We are in a very volatile market, and I take Janet Yellen at her word. She says that she might raise rates three times this year, which means higher funded costs for us.

I really don't want to be in a situation where I cut the dividend. I want to see what happens with the Fed. I want to see what happens with the market. I want to go -- in a thoughtful fashion rather than just bringing up the dividend. I think -- but if we get to the end of the year and we are able to grow our balance sheet and grow our earning assets; absolutely, we would love to raise the dividend.

Okay, great. Thank you.

Doug Harter, Credit Suisse.

Thanks. First, a point of clarification. The securitization that you said you did in the first quarter. Was that newly acquired assets or assets that were already on your balance sheet?

Those were newly acquired assets. The $500 million -- the CIM 2017-1 was newly acquired, $500 million.

Thanks for that. Any sense as to the Freddie Mac transaction, any sense as to when -- when or if there could be a second transaction and how you would think about competition for your ability to acquire the subordinate pieces of that?

I would just say in general, dealing with Fannie Mae and Freddie Mac, that they are highly competitive situations always. They do nothing one off.

Even the small package that we bought in the pilot program was a competitive bid. That's mitigated with the fact that they just have a tremendous amount of supply.

So we should be able to find things when they do actually have a cell program on or they figure out that this is more than they want to do going forward. I really don't have a window into what they are thinking. We have been told that there might be another package this year, but aside from that, we really don't have a window into what either one of the agencies is thinking.

Got it. Then just on that Freddie Mac. Obviously, the financing that they provide -- them buying AAA makes that financing very cheap.

I guess how do you think about -- given your expertise on sort of doing securitizations -- in your ability to get your own financing. Do you think that them -- levels the playing field and opens it up to -- other buyers that might not be as sophisticated as you? I guess how do you think about the pros and the cons of that attractive financing?

I mean, obviously, for this particular transaction, it was of course -- first one of its type as Matt said. The financing was a large portion of what attracted us to the load package.

I thought the credit work that we did on it on a stand alone basis. I think that does make it competitive, as Matt said. Anything the GSC's do is in a competitive bid style.

I think that providing term financing at the top of the capital structure gives other people who may not have done securitization in the past a window into doing it. Underlying foundation of the credit work, if you are not comfortable with the credit, irrespective of the financing you can get; that's got to be the basis of our credit decision. I mean investment decision.

That makes sense. Thank you.

Jim [Delow] with Wasatch.

Good morning, guys. Rather than the classic congratulations on a great quarter; I just want to say, Matt, thanks for recapping the year 2016. I've been watching this stuff for a long time.

I don't recall any team hitting it as well as you guys did this whole cycle. It's been a pleasure to watch. Congratulations.

You listed your accomplishments for 2016. The one thing missing was issuing stock accretively. We are now in 2017, and you could probably fill in -- that space on your spreadsheet if you wanted to. I'd like to hear your thoughts about that.

Well, I think our common stock yields around 11%. Personally, I'm biased on this. I think my stock is always -- under priced, and I think there are other people in our space that trade 100 basis points or so tighter in yields. I think that there is room for our company stock to trade in tandem with other people to do the same thing in our space. I think selling something at 11 when it should be trading at 10 or 9 or something like that -- it's hard for me to get excited about doing.

I would say that I'm very happy with Vic's effort here to do preferred stock issuing. We were able to raise capital in the preferred market of [8%], and that is capital and it was accretive. The assets that we put on against that capital have been accretive to our common shareholders, which is a good thing.

My druthers, frankly, would be to figure out ways to reduce the cost of our capital. Whether it's -- have the stock trade up higher and to get closer to some of our competitors or more a preferred issuance. I think that makes sense.

And how much more -- how much more deals of the size that you have done so far this quarter could you do -- could you on board with your current [dry powder]?

Hey, Jim. This is Mohit. We have the ability, obviously, we did $800 million.

So far this quarter we have the ability to add more. Obviously, the magic of securitization reduces our overall investment needs, it's all subject to the credit profile that we are acquiring and what type of advance rate we could get through securitization.

I think we are -- we have ample capital at the moment to execute, I don't think there any proximate need. Then again, if great opportunities come up, that changes very quickly.

In this market, and I will tell you, I think I have the best guys working here to find assets. Gee, they -- find great things for us to invest in on a regular basis, and I'm constantly surprised at their creativity and their work ethic.

It's a great job. Enjoyed watching it, and look forward to the future.

Thanks very much.

(Operator Instructions)

Leon Cooperman, Omega Advisors.

Thank you very much. I think one has to say, we have to give you a shout out. You guys have done a great job. I agree with the previous questioner where he, basically, praised you for the job you have done. I would like to add my praise. I would like to also say, I agree with your answer to his second observation regarding stock issuance. I think it makes no sense, when issuing stock when stock is undervalued, so I would agree with the tone of your response.

My question is in the following area. I think it's clear from your actions, but I just want to give you the chance to state it. Your priorities in the use of free cash flow. I'm assuming the way you are at now is you want to have more asset growth and followed by the dividend; and that if the stock got down to a level where it was cheap relative to underlying asset value in a more meaningful way, that stock repurchase could also be used?

That would be question number 1. Priorities, as things stand now, what are your priorities for the use of your cash flow?

That is correct. Just to echo what Mohit said in his comments, is that the universe of the mortgage market is shrinking. I think there is a scarcity aspect to the assets that we have on our balance sheet.

To the fact that we can buy things today and have them on our balance sheet for, in some cases I think some of the deals we are doing look like they could be on the balance sheet for five, seven years average life; and have that high-yielding asset on our balance sheet when there's not a lot more of it being made. I think is a great place to -- be trying to grow your portfolio and trying to expand the portfolio with those types of assets. That's the priority number 1, is for us is to get as much of the credit that we like, in the story that we like, and to grow the portfolio.

Certainly, yes, if the stock ever -- we have the ability to buy back stock. We have $100 million authorized. If the stock were ever to trade down, yes, we would certainly -- contemplate, buying back shares. But right now, I think we've -- been successful and we've been proving that we can find accretive investments for our shareholders, and that's really job number 1 here.

Got you. The second question, I think the world we are heading into is one I call normalization. We had $14 trillion of sovereign debt with negative interest rates, now down to $4 trillion.

I think the world we are looking at, is more growth, more inflation, higher corporate profits, higher interest rates. So I said to you, in three years time, the Fed funds rate would be 2% and the 10-year [government] 4%. Would you expect this company would earn less or more money than it earns today? If say Fed funds went to 2% and the 10-year government went to 4% and it took us let's say two years to get there?

I think -- I'm going to hand it to Mohit. You want to answer that Mohit?

Leon, I mean, we do have -- some of our assets mix is not just fixed rate so we do have some adjustable rate assets within the portfolio. Which as rates go up should help income growth.

On the flip side, obviously some recourse leverage where we borrow money, I higher funds rate should ease into that. I mean, I think -- all else equal, we should be flattish to may be slightly down, but obviously we are going to have reinvestments that will be invested at the higher rates, so I think there could be some interest income growth two years from now.

Got you. And last question. As you guys intend to run the business, you've run it extremely well. What kind of -- what's the realistic return on equity over a cycle that you guys think you could achieve?

I think our return on equity should be in the low double digits. I think anywhere between 11% to 13% is something that we proven that we can produce on a regular -- over a long period of time. I think -- that makes sense to us.

We've been trying to manage the company and try to take less recourse leverage risk. We've been bringing down our leverage, and I think we are running as conservatively as we can and still producing a very high dividend for our shareholders. We think about it every day.

Got you. Again, I want to thank you for the excellent job you have done for all the shareholders.

Thank you very much. I appreciate that.

Brock Vandervliet, Nomura.

Thank you. You've come a long way in terms of the changing balance sheet composition and the deemphasis of agency MBS.

However, assuming a change in the agency MBS market, perhaps driven by the Fed shrinking its own balance sheet or some other outside dislocation. Would you ever look to build that back up or strategically are you just much more focused on credit now and that's just not realistic?

I think we are always kind of opportunistic. Right now agencies are not exactly the best assets in the world. I don't think anybody is really looking at Chimera saying, I want to buy it for their agency portfolio.

Most people know that we use that for hopeful testing and for liquidity on the balance sheet. In the current market, it's not something that we feel that we would want to allocate more capital too.

Right.

I would say that if things were to widen out, we certainly have -- one of the nice things about operating the business the way the guys have put the portfolio together, is that we are operating a low leverage ratio and you can expand the balance sheet if something gets really inexpensive. We would definitely look at that and we would definitely try to take an opportunity if we saw something there. At the moment, it's not something we would allocate a lot more capital to.

I would say the same thing for other assets too in the mortgage space. We haven't really been in the cast and stacker bonds, the CRT bonds, but should they ever really trade down in a dislocated fashion, we have the ability to add them to the portfolio too. We like to think that we are opportunistic and nothing is 100% off the table at any time.

Thanks, Matt.

Thank you.

This concludes today's question and answer session. I will now hand the program back over to Matt Lambiase for any additional or closing remarks.

Well, I just want to really personally thank my team here, all the people at Chimera. They have executed very well on the strategy and did a fine job in 2016, I think everyone is appreciative of that.

I'd also like to thank my long-term shareholders and my Board of Directors. They've stuck with us. We really have transformed the company to a better place and it's been nice -- with the encouragement. Sometimes it hasn't been the easiest, but we were in a different place and it's just -- really a lot of thanks goes out to them for sticking with us over the years. With that, I'd like to conclude the call. Thank you for participating in the Chimera 2016 fourth-quarter earnings call.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect your lines.