Chimera Investment Corp (CIM) 2018 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation Third Quarter 2018 Earnings 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, Holly, and thank you, everyone, for participating in Chimera's Third Quarter 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 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.

Thank you, Emily. Welcome to the Third Quarter 2018 Chimera Investment Corporation Earnings Call. Joining me on the call this morning are Mohit Marria, our CIO; Rob Colligan, our CFO; Choudhary Yarlagadda, our Chief Operating Officer; and Victor Falvo, Chimera's Head of Capital Markets. I'll make some brief comments, and then Mohit will review the activity in our portfolio and Rob will then go over the financial results. Afterward, we'll open up the call for questions.

Chimera posted solid returns for the third quarter considering the volatility in the fixed income markets. In the period, 10-year Treasury bonds sold off 20 basis points, closing the quarter at its highest yield since the middle of 2011. The Federal Reserve increased short-term federal funds target rate for the eighth time in the last 3 years and continue to pare down its holdings of U.S. treasuries and mortgage-backed securities adding over $100 billion of additional supply to the market in the quarter. We believe the Fed will likely continue to raise the fed funds target rate, perhaps, one more time this year and several times next year in an effort to cool down the expanding economy in order to stave off inflation.

Accordingly, the housing market is starting to show signs of moderation as mortgage rates have also hit their highest levels in 7 years. Due to higher rates, refinancing activities dropped off and homebuilder confidence has trended lower. While residential mortgage credit prices have remained well bid to date, we think these macro trends have the potential to impact prices in the future. It's our opinion that we're most likely to see more volatility in the fixed income markets as the Fed continues to increase short-term interest rates.

History has shown us that the end of Fed tightening cycles can often create market dislocations and opportunities for those who are prepared. We took the opportunity late in the third quarter to raise additional capital issuing $260 million of preferred shares. The Series C shares have a fixed coupon of 7.75% for the first 7 years, after which the coupon adjusts quarterly at 474 basis points over 3 months LIBOR. Since the fourth quarter of 2016, we've raised over $700 million in capital through preferred shares, which has helped us diversify our capital structure, lower our cost of capital while being accretive to our common shareholders. The additional capital should be beneficial for our portfolio should we see a widening of credit spreads in the future.

In the near term, we plan to initially invest the new capital in Agency mortgage-backed securities. Agency mortgage-backed securities have had a sharp decline in price over the last year, which has, in our opinion, made them significantly more attractive from both prepayment and interest rate risk perspectives. For example, Fannie Mae 30-year, 4% coupon pass-throughs had a price of over 105% a year ago. Today, the same securities trade around at par. The prepayment speed assumptions on these securities will be cut in half over the period as well. With 5 points lower in dollar price and slower prepayments assumptions than a year ago, we believe this is a better entry point.

The current market also allows us to hedge using longer duration interest rate swaps because the flat yield curve prices longer-duration swaps at approximately the same cost of shorter-duration swaps. Longer-duration swaps should provide more protection if rates fell off and the yield curve steepen. And it's our belief that longer-hedged Agency mortgage-backed securities currently offers one of the best risk-adjusted return profiles in the entire fixed income market.

Agency pass-throughs have the added benefit of being highly liquid and can be a source of funds should new credit opportunities present themselves. In the past, Chimera's portfolio team have successfully sold Agency mortgage-backed securities to invest in more attractive mortgage credit.

So to sum it up Chimera has the capital and liquidity to be opportunistic should the bond markets become volatile and create opportunities in credit. And should the equity markets become volatile, we also have the liquidity and desire to repurchase our shares as well.

While we remain cautious in the current market, our investors should understand that as our results show this quarter, Chimera is well positioned to continue to earn a strong dividend and deliver a meaningful total return to our shareholders in the quarters ahead.

And with that, I'll turn it over to Mohit to talk about our portfolio in the quarter.

Thank you, Matt. The U.S. economy continue to show significant strength in the third quarter and with somewhat more hawkish Fed commentary, consumer confidence at the highs and record low unemployment, the Federal Reserve continue to march higher in rates. We continue to believe that the Fed is on the path to higher rates. However, with escalating trade tensions and slowing global growth, the path of rate hikes may be slower.

Post quarter end, volatility has increased with both U.S. and international equities struggling to maintain their gains for the year. In addition, credit spreads have also widened to start the fourth quarter. Given the backdrop of equities and credit spreads, Treasury yields initially continue to inch higher approaching 3.3% on 10-year Treasury but retracing back to 3.1%. The strong economy remains beneficial to the performance overseas of mortgage loan portfolio. Loan performance has been steady and continues to perform better than the assumptions initially made at investment.

We continue to execute upon our call strategy, optimizing our outstanding securitized loan liabilities. This quarter, we called CIM 2015-3AG and refinanced loan collateral into CIM 2018-R5. The deal size was $380 million, and we issued $256 million of securitized debt at a yield of 3.8%. We're able to reduce our financing cost by 104 basis points while maintaining a similar advance rate, the retained level of loss-adjusted yield of mid-high single digits.

Late in the third quarter, we also issued $408 million CIM 2018-INB1. This is Chimera's first securitization of investor-based residential mortgage loans. The yield on loans in this deal were eligible for purchase by both Fannie Mae and Freddie Mac. These loans are unlike our seasoned low loan balance portfolio. They are newly originated and have weighted average mortgage rate of 5.9%, a weighted average balance of $279,000, the average credit score was 763 and had a 32% debt to income ratio. These loans were on average 3 months season with a weighted average loan to value of 68%. And no loans exceeded 80% loan-to-value at the origination. We retained $40 million investment in this deal that will have loss-adjusted yield of mid-high single digits.

Subsequent to quarter end in October, we called our fourth and remaining deal eligible for call in 2018. CIM 2015-4AG was refinanced into $478 million CIM 2018-R6. We will discuss this deal in more detail on our fourth quarter earnings call.

As Matt mentioned, the backup and interest rates, we currently find Agency mortgage-backed securities to provide an attractive risk-adjusted return for our portfolio. This quarter, we added $2.5 billion to our Agency portfolio consisting of $1.9 billion in Fannie Mae 4s, $341 million in Fannie Mae 5s, and $235 million of Agency CMBS. As we continue to try to protect book value, we have added $1.34 billion in swap hedges, mostly with longer tenures to take advantage of the shape of the yield curve. Our total Agency portfolio now comprised of $2.5 billion Agency CMBS, $6.7 billion residential Agency pass-throughs with coupons ranging from 3.5% to 5% and the total Agency portfolio is now at $9.3 billion.

Given the strong price performance of mortgage credit in 2018 led to rising interest rates, we've been very disciplined and selective in our approach to mortgage credit investments, and we're successful in finding value and securitizing the investor loans. The backup in interest rates, coupled with the Federal Reserve reducing the size of its portfolio leading to lighter mortgage spread is helping to create new opportunities for Agency mortgage investments.

Since we raised the capital d late in the third quarter, as of September 30, the capital has not yet fully been deployed. As we continue to put new capital to work, Agency mortgage investments provide good spread income for Chimera, while representing a large pool of liquidity in our investment portfolio should we see attractive long-term residential mortgage credit investment opportunities.

I will now turn the call over to Rob to discuss the third quarter financial results.

Thanks, Mohit. I'll review the financial highlights for the third quarter of 2018. GAAP book value at the end of the third quarter was $17.2 per share. Our economic return on GAAP book value was 3% and 10% for the first 9 months of the year based on the increases in GAAP book value and dividends per common share.

GAAP net income for the third quarter was $147 million compared to $109 million last quarter. On a core basis, net income for the third quarter was $112 million or $0.60 per share up from $110 million or $0.59 per share last quarter. Economic net interest income, which includes the impact of our interest rate swaps, was $148 million, up from $147 million last quarter. Interest income is up versus prior quarter as a result of the increase in our agency portfolio.

For the third quarter, the yield on average interest-earning assets was 5.8%, our average cost of funds was 3.6% and our net interest spread was 2.2%. Total leverage for the third quarter was 5.1:1, while recourse leverage ended the quarter at 2.8:1.

Our economic net interest return on equity was 16%. Our GAAP return on average equity was 17% for the quarter.

Expenses for the third quarter, excluding servicing fees and deal expenses were $14.3 million. Expenses are up from last year as a result of equity compensation expenses that are down from last quarter, primarily due to lower legal expenses.

That concludes our remarks. I will now turn the call back to the operator for questions and answers.

(Operator Instructions) Our first question is going to come from the line of Jason Arnold, RBC.

Just looking at your Agency wise in detail, you focused in on the 4% coupons and obviously took down your basis nicely on what you commented on Agency prices. Can you talk about your focus on those coupons? And then maybe add a little extra context on your rate outlook and kind of how you see things going out? I know you said more hikes kind of coming, path might be slower. But maybe just again a little added context will be helpful?

Hi, Jason. This is Matt, and I'll just say that the agencies where we're buying are pretty much plain-vanilla pass-throughs, not a lot of pay-ups on them, I mean we're buying maybe some shorter recently originated paper. And it is liquid as you can get, because that's really the -- what we want to have in the Agency portfolio is liquidity, because we think as the markets progress here and if we get more volatility, we'll be able to take down this position kind of like what we did earlier in like say 2014, when we pared paid down the Agency position to go after some large pools of mortgage credit.

So we're hedging ourselves longer duration than I think we've done in the past. We have put on a lot of 10-year swaps against the newer agencies that we purchased. And I think the idea here is at least the internal house view is that the 10-year Treasury should be, I think, a little bit higher over the next course of the year as the Fed keeps raising rates, and I think that's why you put on longer duration hedges. And if that happens, if rates back up and the yield curve steepens, I think we'll be in a pretty decent position with the way we're hedging ourselves at the moment, and Mohit can talk about the actual pool.

And Jason as Matt alluded to, given the premium on the coupon stack, very little of the mortgage universe, I think maybe 5% to 7% is actually re-financeable at the moment. Spec pool pay-ups haven't come down in sympathy with where rates are and prepayment outlooks are going into, so they're seasonally adjusted months. So to the extent spec pool's pay-ups come down a bit, we can tell you to maybe alter the portfolio, but given Fannie 4s are trading right around par, prepayments aren't that big a concern for us right here, we kind of monetized the absolute yield levels and lock in the healthy spread for the Agency portfolio.

Okay. Great color. And then I guess, just one follow-up on kind of that opportunistic potential deployment of capital. Is there like a segment of the loan side or the credit side that you'd say, hey, if that particular market came down in value because of market dislocation, we'd be all over that? Or is there just more kind of a price-based-approach when it happens, if it's cheap, and we like it, we'll go after it? Maybe just some added color there too, please.

Sure. I mean, this year, we've done a mix of RPL loans, we've done some prime jumbo loans. And as stated in the opening remarks, we've done our first investor deal. We're open to looking at all of the loan opportunities out there. So I think pricing has been the biggest issue in sort of finding attractive assets. If any of those become more attractive with the uptick in volatility, we would take advantage and deploy capital in any one of those spaces.

Our next question will come from the line of Trevor Cranston, JMP Securities.

A little bit of a follow-up to the one of the previous questions about the Agency portfolio. It sounds like you are hedging quite a bit of the duration on those bonds, but you also mentioned in the prepared remarks that spreads have widened in October in particular. Can you comment or provide an estimate on how your book value has performed so far in the fourth quarter?

Hey, Trevor, this Mohit. So post quarter-end, as you mentioned, rates have -- had initially sort of sold off approaching 3.30%, sort of ratcheted back to 3.10%, and we were around 3.12% to 3.15% this morning. Book values and spreads have widened on top of that. I think we expect book value through the October to be down roughly about 1% currently based on the hedges we have.

Got it. Okay. That's helpful. And then a second question on new investment opportunities, particularly on the credit side. So you talked about the investment loans that you guys have securitized. Are there any other opportunities in the more newly originated loan space that you guys are seeing? And can you also maybe sort of compare the returns that you guys think are available like within the investor loan securitization versus what you're seeing in the Agency market today?

Sure. So let me talk about the loan space, first. I think the RPL space still offers an attractive opportunity set to the extent prices come down to where they were 18 months ago. I think the supply is there. I think we've -- year-to-date, we've had over $30 billion of RPL loans come out, whether it would be from the GSEs and/or private investors. I think even in the fourth quarter, we're going to see north of $10 billion of supply coming out of that space. And again, if prices soften a little bit here, I think that would be helpful for us to sort of start potentially buying some more loans there.

On the new issues side, I mean we played on the prime jumbo side with the deal in Q2, that's our first investor deal here in Q3. We're also looking at non-QM, all those opportunity sets, especially in the non-QM side, they're a little bit smaller than the RPL space to aggregate what deal size could require anywhere between 1 to 3 months. So the volumes haven't picked up there in size. We think the opportunities on the investor side could be a lot greater. I think as that box continues to widen, we could have a meaningful amount of originations there that could lead to decent securitization and the economics on what we retain would be attractive. If you compare the levered returns on doing a loan securitization and term financing versus acquiring agencies, I would say on a levered basis, they're similar returns. Keep in mind that the leverage that you would use on your credit investments are going to be significantly lower than the leverage you would use on the Agency portfolio.

Our next question will come from the line of Bose George, KBW.

It's Eric on for Bose. Just to follow-up on book value. I mean, I know you guys mentioned that credit spreads had widened a bit. I mean, can you just give us a general sensitivity for your book value as it relates to mortgage spreads, I guess, somewhat generically or generally, I mean, just kind of what we can observe for the legacy market and the CRT market, I mean, how can we sort of triangulate those spreads and relate them to your -- to the spreads in your portfolio, and of course, book value?

Eric, this is Mohit again. So the spread widening on the credit assets has been more concentrated on new origination CRT-like product. I think sort of month-to-date, CRTs are anywhere between 15 to 20 basis points wider. I think the legacy assets have more technical bend to them, and I don't think those have widened out as significantly as CRTs have. I think the performance there continues to warrant adjustments in what your losses at the yields are going to be. So I think those may have wind out maybe 2 to 5 basis points, nothing as meaningful as on the CRT side. I think spreads on new issue would be prime jumbo loans. Some of the rated RPL transactions have also wind out, I would say, again to the tune of 5 to 10 basis points there as well.

And how that relates to our portfolio? We don't have any CRTs currently. So I would say, our legacy portfolio is maybe a basis point or 2 wider if that much. I think if you looked at the latest submit that came out in October, performance continues to improve defaults running lower, the delinquency pipelines are cleaning up, severities are lower. So I think those are all positives to our portfolio. And the same thing applies to the sort of the loan portfolio that we've built. The vast majority of our $12-plus billion of loans are over a 130 months seasoned. And given the favorable housing condition for legacy assets, I think that's also producing better-than-expected performance on our loan portfolio. I think some of the softness that Matt referred to on the housing numbers are our newer organization stuff and that the collateral that we're focused on whether it would be prime jumbo and/or investors, the credit metrics we spoke about give us plenty of comfort and the credit event on those type of loans.

Great. That's great detail. And then on the financing side, I mean, what percentage of your securitized at this point is fixed and what percentage is floating? And what's the weighted average margin over, I assume it's 1-month LIBOR for your floating rate debt?

Yes. The spread ranges anywhere from L plus 175 to L plus 200 on the floating rate secured debt portion. I want to say, we still have -- 50% of our securitized debt is still floating rate. But as you're aware, all the deals have a 3-year call option embedded in them, which I think, our last floating rate deal that we've done was 2017. So in 2021, that is up for call to the extent we need to relever and adjust that to a fixed rate debt.

So everything that you guys have pretty much called has been put into a fixed-rate coupon, and where -- I mean, if -- where are fixed rate?

Everything in Q3.

Yes, yes, got that. And where are fixed-rate coupons sort of trending like for -- if we were to model out sort of the securitization pipeline that we assume for the portfolio, let's just say, next year, I mean, where can we expect that coupon to be?

Sure. I mean, some of that is going to be driven by where all-in rates are. But I think if you look at rate of securitization, it's the top of the capital stack, it's probably trading anywhere between swaps plus 70 to 80. So that puts you just under 4% currently, and on an non-rated side, you're probably looking at a coupon of 4.125% to 4.25% a quarter.

And I just like to add to that. When it comes to us issuing debt, we prefer fixed. But if somebody has got a good bid or senior bonds in their floaters, and we can do an off balance sheet swap, I mean -- I'm -- my thinking is to get the best rate for my shareholders. So we will do floating rate deals if it makes more economic sense than fixed. And I don't want to give anybody the impression that we don't. We're looking at the economics of each individual transaction.

That's correct. I mean, we have the ability, as Matt just stated, to put on our hedges to change that floating rate exposure to fixed rate outside of the deal as well.

(Operator Instructions) Our next question will come from the line of Doug Harter, Crédit Suisse.

This is actually Josh Bolton on for Doug. Given the current preference for agencies and expectations for additional volatility in spread widening, can you talk about realistically how big we could see the portfolio allocation to agencies become? And then also in that context, how are you thinking about leverage when thinking about capacity and ability to take advantage of additional spread widening?

Hey, Josh, this is more Mohit again. I mean, I think to the extent the Agency portfolio continues to look compelling, I mean, we could grow that to deploy the capital that we raised in Q3. We could use that to reinvest the pay-downs we're experiencing both on the Agency portfolio as well as the non-Agency portfolio. So I mean, I think, that the back up that you just laid out was spread widening, pick-up in volatility. It could be a good time to take advantage of that going into Q4. But we hope that spread widening is not limited to just the Agency product, and it also reflects on the credit products as we just had on the prior question. The CRT market has widened out 20 to 25 basis points. Hopefully, that carries down to the rest of the spread product as well, and we could deploy capital there on a go-forward basis as well.

Yes. And I just like to add to that too is that, we've been running our company with very low recourse leverage for a very long period of time. So when you get into an environment like this when agencies are, in our opinion, much more attractive than credit, it gives us the flexibility on our balance sheet to go after those opportunities. So we have a lot of room ahead of us should we see good opportunity there.

Our next question will come from the line of Stephen Laws, Raymond James.

A couple of things have been hit on already, but I wanted to ask about the Agency CMBS. I know it looks like it's now above 10% the commercial portion of the portfolio. I know there is some attractiveness there with the prepayment protection and ability to hedge those assets. So can you talk about the pipeline there, how big can that get? I know it's only limited supply, but maybe some color on that asset would be great.

Sure. Hey, Stephen. This is Mohit again. As you stated the sort of the opportunity set there is limited, I think, on an annual basis, originations range anywhere between $12 billion to $18 billion. We've had a pretty successful year so far in adding product there. We did see some spread widening there in Q3 and took advantage of it and grew that portfolio north of $500 million. And as you stated, I mean, the portfolio started in 2014 and we're up to a little over $2.2 billion. To the extent we could increase that number, we would like to, like it does offer a better convexity pickup to the Agency product currently. It has similar financing and liquidity as pass-throughs do. So to the extent we can continue to grow that, we're focused on doing so.

Great. Are there any assets out there that you look at? I know you touched on the whole loans and RPLs and different opportunities there. Is there any asset class you don't have in your portfolio now that you think is starting to look attractive, you are spending more time on?

Again I think we are looking at all opportunities available on the residential mortgage side, whether it would be QM, single-family rental, non-QM, investor loans, RPLs, and I think it's one of our -- we could harvest the most cash flow from the investments we're making, is going to ultimately be put into the portfolio.

Great. And then, I guess, one final kind of larger macro picture. You touched on the Fed in your prepared remarks and kind of where rates are going with the economy, and I think unemployment is at multi-decade lows and they said FEMA is very focused on fighting off inflation here. So where do you think we are in the residential credit cycle? I know underwriting standards have been pretty conservative here since the crisis compared to older loans. But how do you think about that with rates continuing moving higher, unemployment potentially moving the other way, how does that impact your investment decision as you think about residential credit performance going forward?

Well, I think we're still very constructive on residential mortgage performance. Obviously, more people working, housing prices doing better, I think, is just going to be very good for delinquency and very good for mortgages in general. I think looking at originations, I think, the credit boxes that the originators are making loans in are still very tight, and I think that's good for actually mortgage-backed securities going forward too for their performance. I think the big issue is really duration in the marketplace, and how, like Mohit said, a lot of the mortgages in Agency market are 3.5% and 4% coupons and they are not refinanceable now, so we're seeing refinancing activity dry up and that market slowing down pretty dramatically. So it's that lack of supply of new stuff coming into the market being met with the supply of the Fed coming out of their portfolio. It's going to teeter-totter back and forth and you're going to have some opportunities there, I think, in the Agency market. But we're very constructive. I think the Fed, is right now at -- in a very tough spot going into December. I think if I was Powell, I'd probably pause here and see what happens to the economy and pick it up again maybe in March. But if they keep pressing this and they keep raising rates here and the market looks a little skittish, there is a chance that you could see some significant volatility in credit. That's what we're preparing for at least.

Our next question comes from Bose George, KBW.

I think I got on the investor property deal, a coupon of 5.9%, but did you say what the loss adjusted yield was on that?

The coupon is actually 5.09%, not 5.9%.

5.09% okay. Sorry, about that.

And the loss adjusted yields on our investment are going to be mid-high single digits.

Got it. And where are you guys sourcing those from?

We're working with a bank, money center bank that's sourcing the collateral and we're just in agreement on a package of debt -- on pricing works for both parties.

And it's a flow agreement? I mean, as they make more loans, you guys are the only source that are prepared to buy them?

No, I think it has to work for both parties to the extent we can agree on a price, we can do a transaction, but it's not a full agreement.

I'll now turn the call back over to Matt Lambiase for closing comments.

Well, thank you for joining us on the third quarter 2018 Chimera Investment Corporation earnings call, and we look forward to speaking to you in the New Year for the fourth quarter results.

Once again, we'd like to thank you for participating on today's conference call. You may now disconnect.