Chimera Investment Corp (CIM) 2017 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation Second Quarter 2017 Conference Call and Webcast. (Operator Instructions)

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

Thank you, Crystal. And thank you everyone for participating in Chimera's Second Quarter 2017 Earnings Conference Call. Before we begin, I'd like to review the safe harbor statement.

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 filing. 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 reconciliation to the most comparable GAAP measure. 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. I will now turn the conference over to our President and Chief Executive Officer, Matthew Lambiase.

Thank you, Emily. Good morning, and welcome to the second quarter 2017 earnings call. Joining me on the call this morning, I have Mohit Marria, our CIO; Rob Colligan, our CFO; Choudhary Yarlagadda, our COO; and Victor Falvo, the Head of our Capital Market. I'll make a few brief comments, then Mohit and Rob will review the quarter and then we'll open up the call for questions.

Chimera posted solid income and book value results for the second quarter. Since the presidential election in November, interest rates and LIBOR rates have risen significantly. Through this period, we continue to produce an attractive risk-adjusted return on equity, while operating in some of the lowest recourse leverage in the sector.

Chimera closed the second quarter at 1.7: 1 recourse leverage, which we believe to be appropriate in light of the Federal Reserve raising short-term interest rates and the discussions surrounding the unwind of its Agency mortgage portfolio.

In the current challenging fixed income market, we believe Chimera is well positioned to continue to earn our strong dividend, while operating with defensive leverage. We have plenty of dry powder to invest and would be comfortable increasing our leverage when market conditions clarify and when quality investment opportunities become available.

As an internally managed company, we are mindful of maintaining a consistently high return on equity, rather than just growing our assets under management. The $470 million in preferred equity capital that we raised in the previous 2 quarters has allowed us to meaningfully increase the size of our loan portfolio, which was beneficial this quarter. And we're still in the process of deploying the remainder of that capital into additional loan packages.

Our portfolio team continues to express the opinion that the best investment in the mortgage credit space is in low loan balance seasoned loans. This quarter, Chimera closed on $377 million pool of loans and expects to close on another $1.4 billion of similar loans into the third quarter.

As a long-term investor and risk container of mortgage credit, finding the right investments takes time. It's important to use discretion to find the right asset, rather than just rush to invest capital in any one quarter. The $12.4 billion portfolio of seasoned low loan balanced mortgages that we had assembled has had slower prepayments and experienced better credit performance metrics than what we expected when we originally purchased them.

Our loan portfolio is unique and in my opinion, it would be very difficult to recreate. We consolidate on our balance sheet over 138,000 loans with an average coupon of 7%, and an average balance of just less than $90,000. These loans, on average have been outstanding for over 10 years.

The prepayment REITs have been low on the portfolio due to the relatively high refinancing cost for these borrowers and a general lack of credit available to them. We expect our securitized interest in this portfolio to have roughly a 7-year average life at current prepayment speed, which means that the earnings power of this portfolio will be driving our dividend for years to come.

Chimera's book value was up over 2% this quarter and over 4% in 2017, reflecting the strong investor demand for mortgage credit and the type of assets we hold in our portfolio. This strong book value performance coupled with Chimera's high dividend has generated economic return, measured to the change in book value plus dividends in excess of 10% for the first 6 months of 2017.

As the housing market fundamentals continue to improve with the decline in unemployment rates and increases in home values, we see investors' expectations of future cash flows becoming more positive. We think that this positive trend will, most likely, continue as the housing market improves and could be a catalyst for higher prices on our portfolio in the future.

In summary, this is a challenging fixed income market to navigate and prudent leverage is the best course. We are comfortable earning our dividend at current leverage ratio and retain the option to increase leverage should the opportunities present themselves. We're bullish on low loan balance season mortgages and continue to have success finding assets to add to our portfolio. We remain optimistic that mortgage credit should continue to outperform and produce some of the best risk-adjusted returns in the fixed income market as the U.S. economy gets better and investors adjust their expectations on loan performance. So with that, I'll turn the call over to Mohit to discuss the mortgage market in the quarter.

Thank you, Matt, and good morning, everyone. I will briefly review macroeconomic factors and then go over the investment activity for the quarter. During the second quarter both equity and fixed income markets continue their strong performance as volatility continue to ebb lower. Since the start of the year, 10-year treasury yields have rallied 14 basis points, ending the quarter at 2.3%, while the yield curve has flattened 33 basis points. The Federal Reserve at their June meeting raised rates and communicated that they plan to begin selling their MBS and treasury holdings later in 2017. But this as a backdrop, option adjusted spreads on Agency MBS were slightly wider during the quarter. Our residential credit, CMBS and corporate bonds continue to tighten. Dollar rates remain low by historical standards, we remain cautious on leverage. We believe lower inflation expectations and growth projections will limit future rate increases by the Federal Reserve and like many other market participants, we do not expect any meaningful increases in bond yields.

Chimera's Agency portfolio was marginally lower this quarter by $104 million and our Agency CMBS portfolio was down a modest $27 million. We remain cautious on agencies with a flatter yield curve and ahead of the potential unwinding of Federal Reserves $1.8 trillion Agency portfolio.

We continue to like and deploy our capital in mortgage credit. This quarter, Chimera bought and securitized $377 million seasoned performing low loan balance residential mortgages. The weighted average coupon on the portfolio was 5.43%, and the weighted average loan age was 137 months. This package of loans had a weighted average loan balance of $125,000. The securitization closed at the end of May.

In the second quarter, we also committed to purchase $620 million of similar mortgages with the [WAC] and (inaudible) of 5.10% and 132 months, respectively. These loans have not yet settled, though we expect to close the securitization in Q3.

Subsequent to quarter end in July, we identified and expect to acquire and securitize an additional $825 million loans, bringing our expected securitization to be approximately $1.4 billion. We will discuss these securitizations on future earnings calls.

New issue non-agency MBS supply remains limited. Housing fundamentals continue to be strong with the S&P CoreLogic Case-Shiller indices, recently reporting 5.6% annual home price gains. These factors have benefited and helped increase Chimera's book value by more than 4% year-to date. Much of the increase has been generated by strong investor demand for mortgage credit assets as they exhibit attractive risk-adjusted investment returns relative to other fixed income investments.

Our securitized loan portfolio continues to experience moderate prepay rates and investors in non-agency securities continue to refine their modeling inputs to reflect the positive characteristics of the underlying loans, resulting in tighter spreads and higher prices.

We believe our loan portfolio and securitizations are poised to perform better than our purchased assumptions and offer us the ability to further optimize our financing cost. With Chimera's continued strong credit performance and our currently low recourse leverage, we have ample ability to increase our portfolio when attractive investment opportunities are available.

I will now turn the call over to Rob, to review our financial results.

Thanks, Mohit. I'll review Chimera's financial highlights for the second quarter. GAAP book value at the end of the second quarter was $16.54 per share and our economic return on GAAP book value was 5.2%, based on the quarterly change in book value in the second quarter dividend per common share. GAAP net income for the second quarter was $106 million compared to $158 million last quarter.

On a core basis, net income for the second quarter was $112 million or $0.60 per share, up from $96 million or $0.51 per share last quarter. Securitization deal expenses were $1.3 million in the second quarter compared to $11.4 million, incurred in the first quarter.

Net interest income for the second quarter was $151 million, up from $141 million last quarter. The increase in net interest income relates primarily to the increase in Chimera's loan portfolio, partially offset by a higher financing cost as LIBOR has increased.

The yield on average interest earning assets was 6.2% compared to 6.5% last quarter. Our average cost of funds was 3.5%, in line with last quarter, and our net interest spread was 2.7% compared to 3% last quarter. Total leverage for the second quarter was 4.5:1, while recourse leverage ended the quarter at 1.7:1.

Our net interest return on equity was 16.6% for the quarter, up from 16.5% last quarter. And our return on average equity was 13% for the quarter compared to 20% last quarter. Expenses for the second quarter, excluding servicing fees and deal expenses were $12 million, up slightly from the first quarter. For the remainder of 2017, we expect these expenses to be $12 million to $13 million per quarter. This concludes our remarks and we'll now open the call for questions.

(Operator Instructions) And your first question comes from the line of Bose George with KBW.

Eric on for Bose. I'm hoping we can get a little bit more detail on the prepay rates on the low loan balances pools. Specifically, how are they compared to the rates on Agency specified pools out with low loan balance protection? And then if you can just remind us or give us a rough idea of how sensitive the yield? Do you expect to capture on those loans is to pick up in CPR in a given quarter?

Sure, Eric. This is Mohit. As far the speeds we're experiencing on the portfolio, I think the average has been around 8 to 9 CPR. Now that compares to on the Agency side that you asked -- of course, I don't even know if there's $12 billion of 7% WAC coupons available out there. But I would expect the speeds on sub-100k loan balance on the Agency side with those type of WACs to be probably in the mid- to high teens. If you just compare it to where current production 3.5s and 4s are, I would say even 85k max loans there probably trade around 6 to 7 CPR assumptions. And those have pay ups of probably north of 2 to 3 points on those coupons. So our portfolio is holding up pretty well given the WAC, and as Matt mentioned on the opening remarks, the limited credit availability for these borrowers. As far as the sensitivities to yields, I mean, we've held these assets in some cases now for 3 years. I mean, a slight uptick doesn't really impact us that much. We do own the bonds, the collateral at a discount, so it'll actually be accretive from that sense, but we don't see any reason for speeds to really pick up here.

Got it. Well, that's very helpful, Mohit. The $21.5 million that you show us, which moved out of credit reserve during the quarter. Can you get more specific about were in the portfolio that was taken from?

Sure, that's in the non-agency portfolio. And that's just from improvement on expected cash flow.

Where is specifically in the non-agency portfolio though?

You know what, we'll have to come back to you on that. I'm not sure we disclosed that level of detail. But we'll take a look at the Q that will come out later this week.

Your next question comes from the line of Douglas Harter with Crédit Suisse.

Can you talk about the yields you're seeing on the $1.4 billion of loans you purchased this quarter? And how that compares to what's in the portfolio?

Hey Doug, this is Mohit again. As I mentioned in my opening remarks, we'll discuss the securitizations in more detail on Q3's earnings call. But I would expect the yields on a levered basis to be somewhat what we've acquired loans at and securitizations at in the past, even with tighter spreads in overall basis, given how the markets rallied in (inaudible) finance. The leverage available through securitization has also improved with tighter executions there, which will help support the yields we've -- we will get on the equity pieces we will hold.

Got it. That makes sense. And then on the existing structures, can you talk about how -- I guess sort of pay down and how those -- how the leverage kind of works on that? And whether you're able to kind of maintain -- kind of what you're doing to sort of maintain that leverage over time as structures pay down?

Sure. As we've mentioned on prior calls, most of our deals have either 3 or 4-year calls built-in from the time they were issued. We acquired the Springleaf portfolio in August of 2014, and have subsequently delevered 5 of those deals. 3 years in, our first deal that we relevered was in October of 2014 and it becomes releverable starting this October, as the market presents that opportunity. And heading into 2018 and '19, we will have 3 deals next year as well as a couple of deals in 2019 to relever. The way the deals are structured, all the principal payments are used to pay down senior bonds. So if you look at the 2014 deal, I think that senior bonds delevered to almost 60% of original balance. And again, based on market conditions we should be able to relever it come Q4. But again, it's subject to what we think the execution is and if economics makes sense.

Got it. So if the economics makes sense, that could be an opportunity for you to have sort of incremental capital to be able to buy additional pools kind of with your existing capital base?

That's right.

Your next question comes from the line of the Trevor Cranston from JMP Security (sic) [JMP Securities].

A follow-up question on Mohit, the comment you made about better execution on the securitizations. Can you elaborate a little bit on that in terms of what you saw in the May deal? And what you're expecting for 3Q in terms of the improvement in execution is in the availability of more leverage or on a tighter spreads you're able to sell-up on that or both?

Yes, absolutely. The deal that we executed in May, we altered the structure slightly. As we have found lack of assets to buy, we only sold the top 20% of the collateral, and we retained the rest. And with the expectations of both investing dollars as well as spreads tighten further, we could opportunistically sell down the road. But on securitizations that we see going forward, just based on other deals in the marketplace, senior bonds have executed the tightest 70 basis points or 70 to swaps on 3, 4-year assets. So if you look at that relative to the start of the year, those new issued spreads were probably around 100-ish over to swaps. So the new issue market has tightened quite significantly and the rating Agency and the investor base themselves have gotten more comfortable with higher advanced rates overall.

Got it. Okay, that's helpful. And then on the MBS portfolio. Can you comment at all on your view on whether or not the Wells Fargo trustee holdbacks might have any impact on the bonds you own, if they become available for call anytime in the near future?

On the Wells Fargo side, I mean, prior to what they did in June, a lot of the trustees that have been -- are being litigated against for reserving cash on a monthly basis anyway. I think as a result of the deals being called and the trust being collapsed. The Wells' expedited the amount that they retained. It didn't affect any of our holdings, necessarily. But I mean, the way we look at it is, anything that was potentially callable based again on economics from the calling party. It made delay calls that may happen in the future if the economics aren't there. As far as the impact on our future holdings, I mean, I don't think we're at the top of the capital structure. Most of the bonds were written off were subs. I don't really foresee any of our holdings being impacted, but...

Certainly, they're not new bonds that we have issued, all right?

And not any of the securitizations that we've done, will not be affected by this litigation.

Your next question comes from the line of George Bahamondes with Deutsche Bank.

You touched on the characteristics of the $620 million of loans that you identified in 2Q. Can you repeat that, I missed some of the metrics you guys were touching on during your prepared remarks?

Sure. On the $620 million that we expect to close in Q3, the weighted average coupon on that is 5.10% and it's 132 month seasoned. Similar to our other loans that we've acquired.

Your next question comes from the line of Lee Cooperman with Omega Advisors.

A couple of questions. When the board looks at setting dividend policy, does it look more a GAAP earnings or core earnings? Question 1. And question 2, you've been a lot of activity in terms of investing, it did not yet fully reflected in your core earnings. I'm wondering if you could make a comment that on a kind of a run-rate basis, the moves you've taken if you annualize them, whether our core earnings would be higher than they are presently.

Yes, Lee. This is Rob. So to just answer your first question on the board policy on the dividend. The dividend is based on taxable. So that's what drives the ultimate decision on how much we pay.

And tax will be closer to GAAP?

It depends on the year. Unfortunately, there are some nuances that create differences between GAAP and tax. You can see that more clearly at the end of the year when we report our taxable earnings. You can take a look at that versus the annual GAAP and core. So and some years are similar, other years, there are timing differences or other things that make the few metrics different.

And with regard, kindly, with regard to earnings, I would say, that one of the problems with core is that we -- as you said, we're always adding to our portfolio in order to do securitizations. We always takes these deal expenses. In the first quarter, we have $11 million worth of deal expenses come right out of core, and we're always adding to the portfolio. So we're always -- our core is always going to be reduced by that -- by those expenses. We take them up front rather than the old days, we used to just level or take them out of the yield of the portfolio over time. So there is kind of, in a way, you're realizing, I think you're being pretty conservative by taking them out up front. I think right now the company is operating at, I think, pretty low leverage, 1.7 turns of leverage. We have a lot of excess capital since raising the preferreds in last 2 quarters. The company is, I would say at the moment, slightly under levered. I think we have a higher target going forward. But I want to be extremely careful about how I deploy the capital, especially in this market. I know I -- some investors have said, you guys should just go out and buy a ton of agencies and lever up the balance sheet and get a couple extra cents a quarter. And frankly, I just think that that's not the right trade for us at the moment. I think my investors and the company a whole does a lot better when we differentiate our portfolio from the other people in the marketplace. And I think the portfolio that we have, and we keep adding to, is going to be around for a very long period of time. The securitized interest that we have or probably 7 years or maybe even longer, depending on how they prepay, and we're going to be able to produce this dividend, I think for a very long period of time in a very challenging market. And so our job right now is to acquire and continue to do what we're doing and grow the earnings sequentially. If you look at the run rate of the company, our interest income is up. And I think that's a good fact pattern, and I think when people start modeling it in and then if we can find more assets and lever up the balance sheet, you'll see core going up over time.

If could throw my two cents in. With all this advice you're getting, you guys have been terrific stewards of the shareholders' money and just go with your own instincts and your own decision. But you should be very pleased with the performance of your team.

I really am. And we look at -- total return here is about income and preserving book value. And these guys have done a great job.

At this time, there are no further questions in queue. I'll now turn the conference back to the Matt Lambiase.

Well, thank you very much for joining us on the Second Quarter 2017 Chimera Earnings Call. And look forward to speaking to you in early November.

This concludes today's conference call. You may now disconnect.