Chimera Investment Corp (CIM) 2018 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Chimera Investment Corporation Fourth Quarter and Full Year 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, Nicole, and thank you, everyone, for participating in Chimera's fourth quarter and full year 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 Fourth Quarter 2018 Chimera Investment Earnings Call. Joining me on the call this morning are Mohit Marria, our CIO; Rob Colligan, our CFO; Choudhary Yarlagadda, our COO; and Victor Falvo, Chimera's Head of Capital Markets. I'll make some brief comments, then Mohit will review the activity for our portfolio and Rob will go over the financial results. Afterward, we'll open up the call for questions.

The fourth quarter was one of the most volatile periods in recent memory due to fears related to Brexit, Italy's monetary problems, China/U. S. trade tariffs and aluminum government -- U.S. government shutdown as well as some economic data, which seem to imply the U.S. economy's growth is starting to slow. The market's final kick in the shins occurred on December 19, when the Federal Reserve increased the federal funds rate for the fourth time in 2018 by 25 basis points.

These factors helped send investors into a risk-off mode, driving the S&P 500 down 9.2% in December. It was the first worst December for U.S. equities since the Great Depression. Like equities, the fixed income markets also experienced great volatility in the fourth quarter. 10-year U.S. Treasury notes hit a 7-year high of 3.24% in November, then rallied significantly to close the quarter at 2.68% yield.

The surprising reversal in Treasury yields in the relatively short period left most fixed income -- left most of the fixed income market struggling to keep up and most sectors underperformed the price action of treasuries. Chimera's portfolio was not immune to the market dislocation in the fourth quarter. As most know, mortgage-backed securities did not perform well and markets experienced high volatility due to the embedded prepayment options on mortgage.

As rates rallied into the close of 2018, we witnessed spreads on Agency mortgage-backed securities widen versus comparable yield duration U.S. treasuries and interest rate swaps. Additionally, Chimera's Agency CMBS portfolio experienced increased spread volatility due to the impending and ultimate partial closing of the U.S. government.

The uncertainty of the government shutdown relating to how the FBJ would handle construction loan draws, cause Ginnie Mae CLC yield spreads to further widen in the fourth quarter. As you'd expect, a longer duration of these assets experienced more price volatility than residential Agency MBS pass-throughs. While we're not happy with the price action in the quarter, we think the current market represents a buying opportunity and we are actively looking ahead to our Agency CMBS portfolio.

Although this was a tough quarter for Chimera's book value, we believe our asset mix and risk profile will continue to deliver solid returns for our investors. This market volatility has impacted asset and liability pricing in the short term, these price movements have had no impact on our high-yielding non-Agency portfolio. Both our non-Agency and loan portfolios remain strong and continue to perform better than our projections made at initial investment.

For the full year of 2018, Chimera had many achievements. Despite a difficult fourth quarter market environment, Chimera generated a positive 6.2% total economic return for the full year of 2018. Chimera successfully raised $260 million Series C Preferred, and subsequent to calendar year-end, we raised another $200 million Series D Preferred stock. All preferred shares carry dividend rates below our common stock.

Chimera completed 9 securitizations in 2018, of which, 4 represented successful resecuritizations of previous Chimera deals. Loan securitizations continue to be a key differentiator for Chimera amongst our peers and produces good consistent stream of core earnings for our portfolio.

Chimera has increased its holdings of Agency securities, serving our shareholders by generating good spread income, while also providing the added benefit of liquidity for our investment portfolio. Last night, our Board of Directors declared the first quarter 2019 dividend of $0.50 per share, and consistent with the past, our Board announced an intent to pay $2 common dividend for the full year of 2019.

As I stated on previous earnings calls, the end of tightening cycles can bring periods of high volatility. And we believe this will continue until the Federal Reserve sets a clear direction and the global political risks get sorted out. Our balance sheet continues to generate consistent core earnings and remain flexible to adapt to the market conditions.

Chimera's high-yielding credit portfolio and large liquid Agency portfolio puts us in a strong position to continue to generate good dividend income for our shareholders.

I'll now turn the call over to Mohit to discuss the portfolio activity in the period.

Thank you, Matt. The fourth quarter of 2018 did indeed represent a period of increased interest rate and spread volatility in the fixed income market.

Interest rates initially rose in the quarter, but rallied dramatically in December, leading to a significant spread widening across fixed income products. The Federal Reserve raised short-term interest rate for the fourth time in 2018, which was our ninth time since the beginning of this cycle of monetary tightening. As you move into 2019, the Federal Reserve has taken a slightly more dovish stance and Chairman Powell has recently stated the case for raising rates has weakened somewhat.

We believe that they will remain data dependent in their approach to Fed policy and anticipate one rate hike for 2019. December stock market volatility caused a flight to safety amongst many investors, leading to strong price performance in U.S. Treasury bonds.

This sharp movement in rates and spreads, while somewhat painful for existing positions and year-end book value, it provides a good backdrop for future investments and can lead to good opportunities as we look ahead into 2019.

It is important to note that the changes in book value over the past quarter is a direct result of these sharp interest rate changes, Fed movements and their impact on hedge positions. And the fourth quarter decline in book value was not a result of unexpected credit losses in the portfolio.

Lastly, the repo markets operated as business as usual in the fourth quarter with the uptick in price volatility. Chimera's securitized loan and non-Agency securities continue to perform well in our portfolio.

While still maintaining a strong conviction in future credit performance for season's small balance loans, we were able to purchase 2 separate loan packages on the fourth quarter totaling roughly $328 million with a combined profile of $68,000 average loan balance, a 5.8% weighted average coupon and nearly 10 years of seasoning.

The age, coupon and loan size of these purchases have many of the same characteristics of loans firmly held in our portfolio. And we expect prepayments, defaults and severity profiles of these 2 purchases to be comparable to Chimera's existing $13 billion seasoned low loan balance portfolio. These recent purchases are currently being financed on our warehouse lines at accretive rates to our portfolio. We will continue to monitor the fixed income markets for opportunities to securitize these loans and lock in long-term spread income for the portfolio.

The portfolio team continues to be active, optimizing our previously securitized debt liability. During the fourth quarter, Chimera called $460 million of CIM 2015-4AG and refinanced into $478 million of CIM 2018-R6 by selling $335 million in senior debt with a coupon of 3.36%, reducing our financing cost by over 100 basis points.

In late September, Chimera raised $260 million in capital by issuing Series C, 7.75% fixed-to-floating rate preferred stock. Most of this new capital was deployed into Agency pass-throughs in October and spreads on those securities begin to light.

In total, we deployed, on a hedged basis, $2.4 billion in newly originated Fannie Mae 4% securities and $366 million in Agency CMBS. Chimera's Agency portfolio now stands at $11.9 billion current phase and consists of $9 billion of residential Agency pass-throughs and $2.9 billion of Agency CMBS.

Agency investments now represent 45% of Chimera's total assets. This is our highest percentage of agencies since the first quarter of 2016 and early to mid-2014 period. Chimera, as a hybrid REIT, has a long history of shifting its portfolio amongst Agency and credit investments as we see changes in relative value and long-term residential credit investment opportunity.

In 2014, Chimera used the Agency portfolio as a source of liquidity to make the long-term investment in our Springleaf portfolio. And over time, we optimize our initial investment to 2 full cycles of securitizations. In 2016, Chimera again used the Agency portfolio as liquidity to purchase large blocks of low loan balance seasoned performing whole loans.

The 2,000 securitizations become callable and potential refinance and optimization opportunities beginning mid-2020. The hybrid model provides great flexibilities for maximizing market opportunities in asset allocation, liability management and successful capital raises like Chimera's 4 separate preferred stock issuances.

Our portfolio team continues to believe that leveraged Agency MBS represent good value and provide both good spread income and increased liquidity for our investment portfolio. We continue to seek our Agency CMBS for long-term investments and actively look for credit investment opportunities to add to our portfolio. We believe we are well positioned with complementary balance of Agency and credit investments as we head into 2019.

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

Thanks, Mohit. I'll review Chimera's financial highlights for the fourth quarter and full year of 2018. GAAP book value at the end of the fourth quarter was $15.90 per share, and our economic loss on GAAP book value is 3.7%, based on the quarterly change in book value and the fourth quarter dividend per common share.

Our economic return for the year was 6.2%. GAAP net loss for the fourth quarter was $117 million compared to $147 million of net income last quarter. For the year, GAAP net income was $368 million compared to $491 million last year. On a core basis, net income for the fourth quarter was $109 million or $0.58 per share, down slightly from last quarter. Securitization deal expenses were $4 million in the fourth quarter compared to $1 million incurred in the third quarter.

For the year, core net income was $440 million, consistent with core income earned in 2017. Economic net interest income for the fourth quarter was $154 million, up from $148 million last quarter. The increase in net interest income relates primarily to the increase in Chimera's Agency portfolio, partially offset by higher financing costs.

For the year, economic net interest income was $593 million, up from $589 million last year. For the fourth quarter, the yield on average interest-earning assets was 5.7%, our average cost of funds was 3.6% and our net interest spread was 2.1%. Total leverage for the fourth quarter was 6.1:1, while recourse leverage ended the quarter at 3.8:1.

For the year, our economic net interest return on equity was 16% and our GAAP return on average equity was 11%.

Expenses for the fourth quarter, excluding servicing fees and deal expenses, were $16 million, up from the third quarter related primarily to increased equity-based compensation and increased legal and diligence costs related to loan pool acquisitions. This concludes our remarks.

And we'll now open the call for questions.

(Operator Instructions) The first question comes from the line of Trevor Cranston with JMP Securities.

First question, you guys talked a bit about the spread widening across most asset classes, obviously, but particularly, the Agency sector. Can you expand a little bit on how you're thinking about the opportunity in terms of deploying capital, in terms of Agency CMBS versus Agency RMBS? And also, maybe, add a little bit of color in terms of which particular sector of the Agency CMBS market you're looking at as a value?

Trevor, this is Mohit. So as we stated on the opening remarks, Agency spreads, all fixed income spreads were wider materially in Q4. And Agency residential pass-throughs run are between 5 to 15 basis points depending on what part of the coupons that you played in. And on the Agency CMBS side, those spreads gapped out materially as we headed into December with the looming government shutdown and spreads were about 30 to 40 basis points wider than where they ended in Q3. Now as we look at the investable landscape 2019, to the extent, we can buy more Agency CMBS we would definitely find those to be more attractive currently. And our focus there has been on the construction loan size, Ginnie Mae project loans. The levered returns there are based on the spread widening that took place in Q4 produced mid-teens levered returns, but given, again, the pending government shutdown, which is now reopened, those have been very limited there. So the volumes haven't picked up. But on the Agency side, obviously, there is a lot more flow there. And I think levered returns there are also in the low mid-teens. And all of the Agency CMBS that we buy is government guaranteed. So it's Ginnie Mae FHA backed.

Got you. Okay, that's helpful. In terms of credit, obviously, credit spreads widened also. Have you guys seen any sort of increased opportunities to add outside the whole loan space? Are you seeing anything being more attractive within the CRT or the legacy non-Agency market?

On the legacy side, again, I think spreads have widened, but the leverage returns there don't look that compelling. I think real money is a better bid. Financing rates, although improved significantly over the course of 2018, advanced rates and spreads relative to LIBOR don't get you to double-digit returns currently. On the CRT side, there has been significant widening that took place that is starting to look attractive, but again, we haven't really played in that space given some of the technical as a result of spread widening, continuing issuance from the GSEs and the like to sort of widen those spreads out even further. What's does look attractive to us is on the new issued funds, some of the securitizations that are currently being priced. Spreads are widened significantly on both the rated on non-rated securitizations. Rated stuff is trading around 125 swaps, which was as tight as low 50s at the start of 2018. And the nonrated senior bonds are trading anywhere between 155 to 165, and those have gotten as tight as 90 area earlier in the year, so those parts of the capital stack do look attractive to us.

Okay. And when you say new issue, are you referring to, like, prime jumbo deals or non-QM or...

All of those. Prime jumbo, non-QM, rated RPLs, nonrated RPL transactions.

Got you. Okay. And then, I guess, last thing, we've heard some commentary that spreads have recovered somewhat since the end of the year. Can you guys give an update on how you think your book value has trended since December 31?

Sure. I mean, it has definitely shifted as we headed into January, both corporate spreads, high-yield spreads have firmed up and as a structure product mortgage spreads. And we are probably up roughly around 2% on book value since the end of the year.

Your next question comes from the line of Bose George with KBW.

I guess, just a 2-part question on your capital structure. Can you just discuss how you're thinking about the capital stack with just the mix of common versus preferred? And how you might look to change that mix going forward? The second question is just the preferred deal that you did in the early part of the year, this year, can you just discuss where that capital went? It sounds like it probably went into the CMBS stuff that you just discussed, but maybe you can just give some color on where that went and just the pro forma leverage that came out of that deal?

Sure, Eric, this is Rob. To take your questions in order, we have raised a fair amount of equity over the last few years in the 8 percentage range. We've talked about that over time as being a good source of capital for us in a way to diversify and not to lose the common holders. Listen, we try to make sure our capital backs as efficient as possible, and we will look at alternate sources, including convertible, if that make sense. And we'll see how the stack evolves over time. I think in previous calls, I talked about having 25% to 30% of our capital in preferred. We are getting closer to that. So we'll see how things go from there. As far as deployment of capital, a fair amount of the capital that was raised the second half of last year went into agencies. And Mohit can give maybe a little bit more color on that, but I would say, the majority went into Agency pass-throughs with some going into Agency CMBS. It's hard to acquire a lot of Agency CMBS at one point in time. So it's not like if we raise a lot of capital, again, just deploy all of it into the CMBS side.

And to expand -- and expand on what Rob just said, yes, even with the Q4-- Q3 raise that we did in September with investment capital in Q4, the vast majority of that did go into pass-throughs. We were able to add CMBS when available, but to just size the market on the Agency CMBS side, originations on an annual basis range anywhere from $12 billion to $18 billion. So obviously, it's a significantly smaller market to acquire assets in. And that trend hasn't really changed materially in Q1, given for the most part of January, there was a government shutdown, so originations weren't there. But again, as I mentioned earlier, the Agency residential pass-throughs don't look attractive on the levered basis.

Got it. That's really helpful. Maybe I can just press a little bit just for the leverage that came out of the preferred deal that you did in the start of the year.

Yes, it's not something that we disclose at this point. We'll probably talk about that more in the first quarter. You're talking specifically about the Series D and how [we] deployed leverage on that?

Correct, yes.

I think we'll hold off on that until Q1.

Sure. All right. The second question is just around the -- on the credit piece. The transfer out of the credit reserve during the quarter, I think, that's the first transfer out we've seen in a while. Maybe you can just give some color around what led to that? And how we should think about the impact that has on the portfolio yield going forward?

Sure. I don't think the transfer out was that dramatic. And obviously, that's dependent on performance of cash flows. So I don't see a dramatic change in the yields going forward based on that independently.

Which segment of the credit portfolio did that come out of? Or I guess, a better question would just be, historically, you guys have taken -- the accounting has been the opposite, right, you've taken a release of credit. So what has just led to the difference between this past quarter versus last string of quarters?

I wouldn't say, there was any one thing in particular. And most of those are related to our non-Agency book. I don't think there is anything particularly unusual. Those positions are older, and the performance could be potentially lumpy over time from quarter-to-quarter. But over a long period of time, I still think the yield on that portfolio will be very strong.

(Operator Instructions) Your next question comes from the line of Stephen Laws with Raymond James.

A couple of questions that have already been hit on, but maybe to follow up on one earlier. Are there any asset classes out there that have become significantly more attractive that maybe aren't in the portfolio now that you're looking at? I know to previous question you commented about new issue jumbo and non-QM securitizations, but what other asset classes out there you guys looking at? Or you pretty happy with just the ones you currently target?

Stephen, this is Mohit, again. I mean, the asset mix we currently have, we're obviously very happy with and would add given the spread widening that has taken place, but as we source the landscape of investable assets, we continue to look at the non-QM space, volumes are picking up there. Our concern in the past has been around origination volumes and the ability to aggregate in size to do something meaningful with. We noticed that, that has changed in 2018, and view the same changes affecting 2019. But we could either acquire loans and/or securitizations done by others given the spread widening. We've looked at sort of some residential transition loans where, again, volumes have picked up, that could be attractive to the portfolio. So I mean, we are always searching for landscape for new opportunities that will be accretive to the portfolio.

Okay. I guess, more from the macro side [of the delta], a lot of the portfolio questions have been asked. But certainly, the interest rate outlook from here is different than maybe what the market expect in those pricing and 6, 12 months ago. Has that changed your strategy at all as that rate forecast has changed? How has that impacted? Both what you're doing in the portfolio side as well as on the financing cost, can you maybe take about -- talk a little bit about how you responded to that change and then just your outlook?

I'll start with the portfolio side first. I mean, most of what we own are fixed-rate assets and we've issued both floating rate liability and the optimizations in the securitizations we've done. We had spent a better part of 2017 and '18, switching from fixed to floating given sort of the expectation of what the Fed may do. They did go 4 times. So we were able to lock in fixed rate liabilities on the vast majority of the '17 deals and lot of the '18 deals. But the last securitization we did in October of '18, we did keep it as floating rate securitization given our outlook on what the Fed was going to do for the remainder of 2018 as we head into '19. On the liability side, just our repo funding, given the view on the Fed, I mean, we've kept some of our Agency repos shorter in duration given the spread mismatch between 1-month and 3 months LIBOR. So we bring -- we brought down the days to maturity on the repo significantly over the year given, I think it was about 25 basis point difference in 1-month, 3-month fundings rates currently. And as that converges based on what Powell had said in the late Jan meeting, I think we can extend that back out longer as the difference between the 2 rates closes in.

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

Can you just talk about how you see the attractiveness of business purpose loans, like single-family rental, fixed and flip? And whether that's an asset class that's attractive to you today?

Doug, Mohit, again. So as I just mentioned on the last question, we have started to look at the residential transition loans or fixed and flip depending on the nomenclature used. But our concern in the past has been around sort of getting volumes. We've noticed volumes have picked up. The rates that you could demand on those loans are higher than sort of the traditional 30-year fixed-rate mortgage loans. And we think those are -- offer an attractive opportunity to add to the portfolio, and we are actively looking to source more of that product in 2019. And on the single-family rental side, again, we're looking at that product, but the residential transition loans offer more spread currently on a levered basis.

Got it. And then just to clarify on your prior commentary around kind of the new issue loans, jumbo or non-QM, when you were talking about the spread widening there, is that talking about the attractiveness of MBS off of other people's issuances or the attractiveness of owning the loans outright?

No. So we -- the loan spreads have widened out in sympathy with everything else, but so has the securitization market for other people's issuances. So we could buy new issue product in the market that's issued by others. Like I said, the spreads there have widened out more materially than the loan pricing has done. So on the rated side, [stuff] is widened from mid-50 to swap to 120 to 125 and on the nonrated side, stuff is widened from 90 the 155 in the last 3 to 4 months. I think both look attractive to us. It's where we could find product to invest in.

(Operator Instructions) And with no further questions, I'll hand the call back to Mr. Matthew Lambiase for closing remarks.

Well, thank you very much for joining us on our Fourth Quarter 2018 Chimera Investment Corporation's Earnings Call. And we look forward to speaking to you in May for our first quarter. Thank you.

This does conclude today's conference call. We thank you for your participation, and ask that you please disconnect your line.