Chimera Investment Corp (CIM) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation Third 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, Lori. And thank you, everyone, for participating in Chimera's Third 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 statement disclaimer in our earnings release in addition to our quarterly and annual filing.

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 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 this information.

I will now turn the conference over to our President and Chief Executive Officer, Matthew Lambiase.

Good morning, and welcome to Chimera Investment Corporation's Third Quarter 2017 Earnings Call. Joining me on the call this morning, I have Mohit Marria, Chimera's Chief Investment Officer; Rob Colligan, our Chief Financial Officer; Choudhary Yarlagadda, our Chief Operating Officer; and Vic Falvo, Chimera's Head of Capital Markets.

I want to start today's earnings call by welcoming Teresa Bazemore to Chimera's Board of Directors. Teresa, was formally a President of Radian Guaranty and brings with her a wealth of experience in residential mortgage finance. Before Radian, she was -- she held executive positions at Nexstar Financial, Bank of America Mortgage and PNC Mortgage Corp. Ms. Bazemore is currently a member of the Board of Directors of the Federal Home Loan Bank of Pittsburgh and has previously served on the Economic Advisory Council of the Philadelphia Federal Reserve Bank and the Board of Directors of the Mortgage Bankers Association.

Both Chimera's management and its Independent Directors are excited to add someone of Teresa's expertise and experience to our board. And we look forward to her input in the years ahead.

This quarter, Chimera continued to expand upon our seasoned mortgage loan strategy. We purchased and securitized $783 million of loan, and after quarter-end, we issued a $512 million rated securitization, our first since 2012. This -- transaction was rated by both Fitch and DBRS with AAA ratings assigned to the most senior tranche.

This is a positive development as it avails additional opportunity for Chimera to reach a broader investor base for our securitized debt strategy. Mohit will explain the economics of these transactions later in this earnings call.

We continue to see good liquidity in the financing market for our nonagency mortgage securities. And this quarter, we arranged a $356 million non-mark-to-market 2-year secured term financing for unrated legacy bonds in our portfolio. This is the first non-mark-to-market financing that the company has executed outside of securitization, and it underscores increasing liquidity in the financing markets available to Chimera.

The underlying fundamentals of the residential housing market remain positive. Home prices have been increasing nationally. And there's persistent low inventory in the starter home segment of the housing market. This is important for Chimera because the average outstanding balance on our loan portfolio is just $90,000. And increasing home values in the segment means we have more collateral and potentially better performance for our mortgages. Over time, this should translate into lower loss assumptions, help holster prices on our credit asset.

We continue to believe the seasoned low loan balance mortgage loans offer the best value in the fixed income market. In addition to positive housing fundamentals, this segment offers benefits from a supply and demand imbalance. The overall size of the nonagency market is less than half the size it was before the credit prices. And investors' demand for attractive risk-adjusted spread product in this low interest rate environment remains very high.

With positive economic housing performance and fewer bonds available for investors, we see liquidity remaining strong and the positive signs for evaluation continuing until new supply offsets the strong investor demand, which we think, at this point, may be years away.

These trends have been very good for our portfolio. This quarter, Chimera's book value increased by 2.3%, and year-to-date book value increased by 6.6%. Total economic return, taking into account common stock dividend and change in book value, was 5.3% for the third quarter, and it's been 16.1% for the first 9 months of 2017.

Chimera now has a $21 billion balance sheet with 79% of our capital allocated to residential mortgage credit assets. In the current fixed income market, both attractive yield opportunities and high-quality assets are scarce. Our strategy of securitizing season mortgage loans, and creating high-quality assets for investors have been welcomed and well received by both financing counterparties and high-grade bond investors.

We have a large, unique portfolio of residential mortgage credit assets, which have become increasingly more valuable over the last year, and we remain constructive on residential mortgage credit going forward.

We continue to believe that Chimera is well positioned to generate steady income for our investors and to capture market opportunities in the increasingly volatile fixed income markets ahead.

And with that, I will now turn the call over to Mohit to review the quarterly portfolio performance.

Thank you, Matt, and good morning, everyone.

Q3 was similar to the first 2 quarters of the year with both equity and fixed income markets continuing their strong performance. Treasury rates changed modestly over the quarter with short-term interest rates being -- ebbing higher, [much as] longer-term rates causing yield curve to flatten.

Strong investor demands for fixed income assets continue to leave credit spreads tighter, helping to drive the increase in our portfolio's net asset value. Chimera's agency pass-through portfolio was marginally lower this quarter by $60 million as we remain cautious on agencies with a flatter yield curve and ahead of the potential unwinding over the Federal Reserve's $1.8 trillion agency portfolio.

In Agency investment, we currently favor the [restraint] profile and more certain cash flow characteristics of Agency CMBS and added $400 million to our portfolio this quarter. This segment of our portfolio has grown to $1.8 billion, representing approximately 42% of our agency investments.

We continue to like and deploy our capital in seasoned mortgage credit opportunities. This quarter, Chimera bought and securitized $783 million seasoned performing low loan balance residential mortgages. The weighted average coupon of the portfolio was 6.46%, and the weighted average loan age was 143 months. This pool of loans had a average loan balance of $89,000. Chimera retained 156 million subordinate bonds as an investment and expects to generate low to mid-double-digit levered returns.

This securitization closed at the end of August and was unrated. After quarter-end, in October, we completed our first rated RPL transaction with loans resettled on in Q3 totaling $512 million.

This deal, CIM 2017-7, was rated by Fitch and DBRS and had AAA ratings on the senior-most rated tranches by both rating agencies. Rated bonds provide Chimera access to a broader range of investors for our securitizations affording us more opportunities in the future to structure deals best suited to the individual loan packages. CIM 2017-7 had a 5.08% weighted average coupon, weighted average loan age of 137 months and a $144,000 average loan balance. The return profile for this investment looks very similar to Chimera's other recent securitizations.

Also after quarter-end, we refinanced $1.3 billion of outstanding bonds, including the final Springleaf deals: Springleaf 13-2A and Springleaf 13-3A as well as our first Springleaf relever CSMC 2014-CIM1 and CIM 2016-5. We'll provide more complete information and economics for (inaudible) of transactions on our next earnings call.

As of the end of Q3, Chimera's acquired over 146,000 loans for a total unpaid principal balance of $13 billion. The aggregate portfolio has a weighted average loan balance of $89,000, 6.97% weighted average coupon and 143 months weighted average loan age. Improving housing fundamentals will continue to benefit our residential credit portfolio. The 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 the financial results.

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

GAAP book value at the end of the third quarter was $16.92 per share, and our economic return on GAAP book value was 5.3%, based on a quarterly change in book value in the third quarter dividend per common share. GAAP net income for the third quarter was $130 million, up from $106 million last quarter. On a core basis, net income for the third quarter was $116 million or $0.62 per share, up from $112 million or $0.60 per share last quarter. Securitization deal expenses were $3 million in the third quarter compared to $1 million in the second quarter.

Net interest income for the third quarter was $156 million, up from $151 million last quarter. The increase in net interest income relates, primarily to the increase in Chimera's loan portfolio, partially offset by higher financing costs as LIBOR has increased.

The yield on average interest earning assets was 6.3% compared to 6.2% last quarter. Our average cost of funds was 3.6% compared to 3.5% last quarter, and our net interest spread was 2.7%, unchanged from last quarter.

Total leverage for the third quarter was 4.6:1, while recourse leverage ended the quarter at 1.8:1. Our net interest return on equity was 16.9% for the quarter, up from 16.6% last quarter. And our return on average equity was 15.4% for the quarter, up from 13% last quarter. Expenses for the third quarter, excluding servicing fees and deal expenses, were $12 million, in line with the second quarter.

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

(Operator Instructions) Your first question comes from the line of Bose George of KBW.

It's Eric on for Bose. Can you tell us the yield leverage levels and expected ROEs on incremental purchases that you made during the quarter, including the securitization that you completed, I guess, after quarter-end?

Sure. Eric, this is Mohit. So -- the expected yields on loans that we've acquired in third quarter and heading into the fourth quarter probably range anywhere between mid-4s to high 4s, depending on the credit profile of the loan pool. And through securitization, we were able to get an advance rate anywhere between 75% to 80%, which you could pay finance right around swaps plus 100. So all-in cost of debt is probably just inside 3%. So your levered returns on a cash basis are probably mid-high single digits, probably around 7 -- potentially 8% and with some recourse levering generating mid-teens type of levered returns.

Got it. That's really helpful. And is there a funding benefit that you guys expect to capture from having the one deal that you did rate. And then, I assume that the plan is to rate more deals as they come through and if there's a funding benefit that you expect to capture there.

Yes, having the ratings definitely opens up, as Matt said on the -- his opening remarks, the investor base, in addition to the tighter execution. AAAs on rated securitizations have tightened in to anywhere between 70 to 75 per swaps where nonrated (inaudible) just mentioned is around 100 swaps and ebbing tighter. So there's definitely a pickup there. But your advance rates on AAAs range anywhere from 55% up to 80%, depending on, again, the [cloudo] profile. I think we're having done one rated securitization now. I go in forward as you review our loan packages that we have on balance sheet as well as new stuff we're looking to acquire. We have a better understanding of what the rating agents are looking for to optimize the advance rates on our structures going forward and optimize the financing costs.

Yes. And I think that just -- at that point, we are seeing just a tremendous amount of liquidity in the bond market for unrated deals as well as rated deals. And we have -- we see the spreads compressing both on the rated transactions and on the unrated transactions. And there's a certain amount of ease in terms of selling unrated securitizations versus the rated securitizations. And the rated securitizations, extra cost's involved. So it becomes -- the spreads on rated bonds are much tighter, but they also have other costs to go with it. And I think, as time progresses, there'll be times when we want to do rated deals or unrated deals, depending on where spreads are. But it -- certainly, we have -- with the last deal, we certainly opened up to a whole new range of investors in our securitizations.

Yes, yes. One more from me, if you don't mind. What's the initial credit reserve that you guys took on the NPL securitization you completed?

We didn't complete any NPL securitization.

Sorry, the one that you guys did post-quarter-end? Sorry...

That's another rated RPL securitization, similar to the ones we've done. I mean, as far as reserves, I don't think we take reserves this...

Overall, we use fair value accounting for that. So we don't have a reserve concept for those deals.

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

This is actually Sam Choe filling in. You guys had a good quarter in terms of adding loans this quarter. So just wanted your thoughts on what you're seeing in terms of the pipeline going forward?

Sam, this is Mohit, again. As far as flows, loan activity has definitely picked up heading into quarter 4. We're still seeing loans that are being shut by the GSCs. There's loan packages out for sale from mid-tier banks as well as some private equity funds. So I -- as far as supply growth, there's ample supply heading into Q4. And I think that's a result of sort of the tighter execution people are getting on their loan packages. But that's being offset by pretty good execution on the securitization side for companies like us. So I think there's no shortage of loans to look at.

Yes, it seems to us that the loan market is probably the most vibrant part of the fixed income market for the -- in structured financed. And CUSIP trading, you're seeing less and less actual bonds trade. But we are seeing loans and loan packages come out, and we've had no problem today finding things that we want to invest in.

Got it. And my other question was how do you see leverage trending throughout the year and into 2018?

Well, I would say that we're very comfortable with our leverage right now. Recourse leverage was ticked up it -- ticked up a little bit to 1.8 in this quarter. And that really gives us a great ability to increase our leverage when we see good investment opportunities come down the pike. And I think we have a lot of room on our balance sheet to grow earnings, and it's really just about adding assets, credit assets, loan packages that fit kind of what we want to invest in. And we're really not looking to add agencies or take on extreme amount of interest rate risk in this market. We like the credit portfolio that we've developed. And really, we're in a great spot right now. We have a lot of opportunity, a lot of ways to increase our balance sheet without raising equity and without taking a lot of interest rate risk. And I would say that, I think you've seen modest uptick in leverage going through next year but nothing crazy.

Your next question comes from the line of Trevor Cranston of JMP Securities.

So looking at the results. Obviously, we can see what the trend has been this year in terms of core EPS versus the dividend that's been paid. Can you guys maybe talk about and give us an estimate on how you think the trend has been in, in terms of the dividend versus your estimated taxable income thus far in the year?

Sure, Trevor. This is Rob. So we look at the dividend and our run rate. At the beginning of the year, as you know, we've set the dividend or are preannouncing giving guidance. So usually, at the beginning of each year, we take look at our run rate and get a sense of where we're trending. We don't turn the portfolio over a lot, so we do have a decent insight. This year, we've had a number of rate increases that's -- some may be predicted, others may not. But we do a lot of analytics around the portfolio and run rates. Once we get comfortable with that, then we set the dividend. But I can tell you this year, the dividend is covered with taxable earnings or we expect it to be very close to where the dividend is. Core versus taxable. There are some timing items and other adjustments that don't exactly correlate core to taxable. But probably importantly, we feel [that the] dividend is covered with taxable earnings.

And then another question on the non-mark-to-market funding facility that you guys were able to put in place. Just wanted to clarify. Is that -- are you guys able to pledge -- retain positions from your new securitizations that you're doing on that facility? Or is that strictly for the legacy CUSIP bonds that you own? And then also I was just curious if there's any sort of differences in that facility in terms of fees that have to be paid or a difference in the rate versus more traditional repo?

Trevor, this is Mohit. As far as the -- as far as what we've been able to do, that was based off of legacy CUSIPs, but we're also exploring opportunities to potentially finance the back ends of securitizations that we hold as well. And we're vetting that option out currently. Given that it's a non-mark-to-market facility and longer-term; financing, the rates are probably higher than where recourse lending would take place in the markets but not significantly higher where the non-mark-to-market and the longer tenor is definitely something that's attractive to us and gives us more certainty on the financing side.

(Operator Instructions) Your next question comes from the line of Lee Cooperman of Omega Advisors.

I have a series of questions that are by and large interrelated. But before I ask them, I just got to give you a shoutout. I think you guys have done an excellent job in working for the shareholders. You intelligently bought back stock when it was very cheap. And you did a very good job of managing the enterprise, so I congratulate you. So my questions are interrelated. In the last 5 quarters, I think our average core earning's about $0.61 a share. In this current quarter, we had $0.62. Do you look at the current $0.62 as sustainable, number one. Number two, I think you kind of referenced this a little bit. Is the balance sheet fully deployed? Was it more leveraging opportunities that you could enhance sustainable recurring earnings? Three, do you feel comfortable that the 15% ROE that you're generating roughly now is sustainable? And I guess, fourth, will lead you to the logical question about the attitude towards the dividend. With the stock trading at a premium to GAAP book value, I'd assume repurchase is not something you're actively considering. At what point would you consider the dividend? And lastly, if I said to you a year from today, the Fed funds rate would be 2%, how would that affect our business? How matched are we?

Thank you, Lee. I would say just ticking down here that our earnings -- I feel pretty good, I mean, you have to tell me what goes on with the Federal Reserve and where interest rates go. And there's a lot of components that go into our earnings stream. But I would say the way the portfolio was constructed and the way it's currently performing, I feel very comfortable around that $0.60 -- the core earnings for the foreseeable future. So I think we feel pretty good about that. We feel good about how the way the assets are performing. And the nice thing about the portfolio that we have is it has not had very fast prepayments on it. So we're seeing a pretty large portfolio of credit assets that are prepaying at moderate speeds that have high coupons for a number of reasons. But that's very good for a stable earnings of the company. And I think we feel very good about the portfolio going forward. I think the 15% ROE is also -- we're going to be -- and I don't like to hang my half -- self out there too much, but I feel pretty good about our ability to generate a very high ROE going forward in the next year. Now again, there's a lot of things that could happen in the marketplace. And we're looking very closely whether Powell gets in as the Fed chairman and where short-term interest rates go, but I think, the way where we're currently positioned, we feel very comfortable that we're going to be able to produce this type of return profile at least for the foreseeable future for the next couple of quarters, definitely. I would say that when it comes to dividend, yes, we are producing a high core earnings. And it is something that we model out and we showed to the board and we discussed with the board in the first quarter, generally, when we're making announcements for our dividend for the first quarter. And the company, as you know, Lee, has been very good about looking out and projecting out what our earnings are going to be for the year and making a dividend announcement and -- no, usually the first dividend announcement of the year we'll give guidance for the rest of the year. And certainly, the earnings have been stronger, and we've been able to grow the portfolio this year. So I think that'll all be taking into consideration in the first quarter.

So if I said to you -- you asked if I had a view of interest rates. So if I said to you the Fed funds rate a year from today was 2%, and the 10-year government was close to 3%, how do you think that would affect our business?

I'm going to throw [Mo] under the bus on that one.

Yes, Lee, so as far as the Fed funds going up to 2%, I mean, we've had brief Fed hikes, as Rob mentioned, this year, and the income -- and the way the portfolio has been positioned has been well absorbed. I mean, core income, as you mentioned, been around $0.51 for the last 5 quarters and $0.62, currently. We think the portfolio is protected with the hedges we have on. The way the portfolio is been constructed to handle a potential 3 or 4 more rate hikes, I mean, it'll have some impact on income. I think it'll -- may decrease income by 10%. But I don't think that's meaningful, based on assets we could add if that does happen. The other metric that we have that could be pushed a little bit tighter is the financing cost. They have come in quite significantly since last year in the demand of asset from depositories to put nonagency credit on and finance it. Spreads there have gone in from 250 in some cases down to 150. And I think if the Fed was to tighten a little bit more, I think those counterparties would still want to have exposure to those assets and may refine what they're looking for on a spread basis. So I think that could be offset by some of that as well.

Lee, this is Rob. Let me just add in. And thanks for your questions and comments. Though we've been pretty conservative, obviously Matt mentioned that leverage is low. It gives us some opportunities to move the portfolio around to make sure earnings are steady and stable for the investors. But I do want to mention, too, frankly, we've averaged out, as you said the $0.61 a share over the last 5 quarters. But we may have certain quarters given deal expenses or other items where maybe we could end up in the low to mid-50s because they have a bunch of deals in 1 particular quarter. And then earnings may be a fair amount higher if we don't have any deals in a particular quarter. So I don't want people to get locked into expecting an exact number every single quarter. There'll obviously be some variability. But over the long period of time, it's a nice way we framed that we've averaged to nice solid earnings.

I guess -- as I say, we'll get the answer basically in January, I guess. Because we've been averaging say core earnings of something -- a touch over $0.60, and we're paying a dividend of $0.50. Do you want to retain that $0.10? Or do you want to retain a little bit less and give more money to shareholders. But I'm happy to have myself in your hands because you guys have done an excellent job..

I'm on your side, Lee.

I know that. Look you guys are doing a terrific job.

And listen, we think the portfolio is really a tremendous portfolio to provide value to our shareholders for a long period of time. It's really of the unique large portfolio. You couldn't put this together. It's a very -- I think we have a very unique proposition to the marketplace that's going to produce very high income for our shareholders going in the future. We're very bullish on the prospects of our earnings ability going forward. And we like the portfolio we've put together. And we're just -- we think we're in the right place in a very tough market. And we're not -- and we're really not out there trying to raise money to go after interest rate risk here. And I'm not sure what the upside of that is. And I think, we'd just continue with the credit as the market gets better for housing and as there's less and less bonds available in the marketplace, we're in a very good position.

I'll now turn the call to Matthew Lambiase for any additional or closing remarks.

Well, we look forward to talking to you in the first quarter of 2018. And thank you very much for participating in our 2017 third quarter earnings call for Chimera.

Thank you for participating in today's conference call. You may now disconnect.