Chimera Investment Corp (CIM) 2022 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Chimera Investment Third Quarter 2022 Earnings Conference Call. (Operator Instructions) At this time, it is my pleasure to turn the floor over to your host, Victor Falvo, Head of Capital Markets. Sir, the floor is yours.

Thank you, operator, and thank you, everyone, for participating in Chimera's Third Quarter 2022 Earnings Conference Call. Before we begin, I'd like to review the safe harbor statements. During this call, we will be making forward-looking statements which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties which are outlined in the Risk Factors section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statement disclaimer in our earnings release in addition to our quarterly and annual filings.

During the call today, we will also discuss non-GAAP financial measures. Please refer to our SEC filings and 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 CEO and Chief Investment Officer, Mohit Marria.

Good morning, and welcome to the Third Quarter 2022 Earnings Call for Chimera Investment Corporation. Joining me on the call today are Choudhary Yarlagadda, our President and Chief Operating Officer; Subra Viswanathan, our Chief Financial Officer; and Vic Falvo, our Head of Capital Markets. After my remarks, Subra will review the financial results, and then we will open the call for questions.

Before we begin, I would like to congratulate all the Chimera employees and members of our Board of Directors, past and present, as we celebrate our 15th anniversary as a New York Stock Exchange listed company. I'm very proud of the team we have built and very much appreciate all their contributions to the company. While elevated market volatility in the third quarter has led to higher rates and wider spreads, putting further pressure on our book value, we believe this has created several opportunities for Chimera on both sides of the balance sheet.

In particular, to the end of October, we've been able to increase our cash position, increase the amount of non-mark-to-market financing and either added or committed to add new investments to our portfolio. It has been a busy period for us, which I will discuss in more detail in a moment. But first, let me describe the overall market and how that translates to our portfolio and expectations. The capital markets have been volatile this year, buffeted by global conflicts, high inflation, a rapidly rising interest rate environment and a weakening U.S. economy. Inflation, which Federal Reserve officials have believed to be transitory in nature last year has turned out to be persistent with the consumer price index reaching 8.3% on a year-over-year basis in September.

As a result, the Federal Reserve raised interest rates 75 basis points at each of their July and September meetings, bringing total tightening of short-term interest rates to 300 basis points over the first 9 months of this year. The magnitude and velocity of the Fed tightening has put downward price pressure on all fixed income products, including treasuries, corporate bonds and mortgage-backed securities. Higher rates across the capital markets have flowed through to the consumer with a rate of 30-year conforming mortgages rising to 7.04% at quarter end versus 3.18% 1 year ago. Higher mortgage rates have substantially slowed down new home purchases and eliminated refinance activity. As reported in September, sales of existing homes declined for 8 consecutive months to the lowest level in the past decade. As a result, we believe this year's mortgage rate shock to the consumer will have an impact towards slowing down the economy and ultimately lead to lower rates as many consumers will have less disposable income to spend.

Chimera's portfolio of residential mortgage credit is unique and differentiated amongst our peers. It is well seasoned and has experienced many interest rates and economic cycles. We have approximately $1.2 billion of non-agency RMBS and which is largely comprised of opportunistic purchases made after the previous housing crisis. This portfolio has provided double-digit returns for a long period of time for our portfolio, and we expect it to continue into the foreseeable future. And since 2014, we have amassed an $11.8 billion portfolio of residential mortgage loans with substantially different characteristics then available through typical mortgage banking channels used by banks and traditional mortgage-backed security investors.

Our loan portfolio consists of 115,000 loans with an average loan balance of $102,000. The loans are an average 15-year season and an average loan to value at origination was 83%. Importantly, 88% of our loans were originated in 2007 or earlier, which means homeowners have been making mortgage payments on their homes for 15 years or more. And the portfolio is geographically diverse with only 3 states having geographic concentrations above 5%. Overall, this portfolio is different. The small loan size equates to low monthly mortgage payments. The age of the loans has afforded many of the homeowners a reasonably long period of time to capture home price appreciation and/or mortgage amortization and there is a long and demonstrated history of monthly mortgage payments paid by the homeowner. All of these factors are very important features when evaluating a mortgage borrowers paying ability.

Our seasoned reperforming portfolio is the cornerstone of our business and we believe our portfolio of seasoned reperforming loans will continue to outperform the market. We believe market conditions with higher interest rates and wider mortgage spreads presents new accretive investment opportunities. Since the beginning of the year, we have been scaling into new investments. We believe our patience and investment discipline throughout this year will benefit our shareholders over the long term.

Now I will take you through our recent activity. During the third quarter of 2022, we committed to purchase $687 million of residential mortgage loans, $211 million of this total settled in October. We expect to close $476 million loans into a long-term non-mark-to-market structure, which we anticipate will generate double-digit returns. Due to the delay in settlement, we expect to see the full benefit of these loans in 2023. We Additionally, we purchased and settled on $66 million of business purpose loans during the third quarter of 2022. As we have mentioned in the past, we like the loan characteristics associated with business purpose loans. They have short duration and provide good spread income for the portfolio. In total, we committed to purchase $753 million loans in the third quarter.

As of the end of the quarter, 96% of our capital was allocated to residential credit assets. Securitizations remain the primary source of financing of our loans.

In September, we sponsored CIM 2022-R3. Our rated securitization of seasoned reperforming residential mortgage loans with a principal balance of $370 million. Securities issued by CIM 2022-R3 with an aggregate balance of approximately $284 million were sold in a private placement to institutional investors. These senior securities represented approximately 77% of the capital structure. We retained subordinated notes and certain interest-only securities with an aggregate balance of approximately $86 million. We also retained an option to call the securitized mortgage loans at any time beginning in September of 2027. Our average cost of debt for this securitization is 5.80%. As of the end of the quarter, securitized debt represented 72% of our total financing with an average cost of 2.7% and 98% of our securitized debt is fixed rate. Largely because of securitization this quarter, we reduced our overall recourse financing by $328 million. On the remaining 28% of our financing we have kept a portion of our secured credit financing in either non or limited mark-to-market facilities.

This quarter, we extended a maturing $489 million non-mark-to-market facility by an additional 29 months to February of 2025. We continue to believe these facilities are valuable components of our liability structure. The third quarter experienced a significant increase in interest rate volatility. Given the market outlook for higher rates for an extended period, we entered a $500 million 2-year and a $385 million 5-year interest rate swap. These swaps complement the $1 billion swaption we entered in Q2 so that we may partially hedge our borrowing cost over a longer period. We expect to manage our derivative hedge position in conjunction with our asset and liability framework. In total, during the third quarter, we entered into $885 million pay-fixed interest rate swaps.

And post quarter end, we ended October with approximately $350 million of cash on our balance sheet, entered an additional $1.1 billion of pay-fixed interest rate swaps. Entered a new 2-year non-mark-to-market secured financing facility for $250 million to finance retained securities from our securitizations and sponsored $145 million CIM 2022-NR1 with existing loans from our warehouse. These transactions have further strengthened Chimera's liability and liquidity position since quarter end. Throughout 2022, we have managed our balance sheet to lock in long-term funding while seeking opportunities to have higher-yielding mortgage assets to our portfolio. We have maintained a lower recourse leverage and stuck to our discipline of carrying non or limited mark-to-market financing for many of our subordinate credit assets.

And while markets have been challenging since the beginning of the year, we have closed or committed to acquire $1.6 billion of loans, completed 5 securitizations totaling $1.6 billion, repurchased $50 million of our common stock, entered nearly $3 billion hedge transactions to protect against further increases in interest rates and expect to add new credit financing partners bringing on non and limited mark-to-market facilities to nearly 50% of secured financing. We believe our credit portfolio is strong, and we'll continue to outperform other mortgage assets in the marketplace. Chimera is a strong believer in securitization. It provides us with stable, nonrecourse long-term financing. We have taken many steps to bolster our balance sheet so that we can weather the current economic storm. We believe we are well positioned to take advantage of the new market opportunities and that our patient and investment discipline will benefit our shareholders over the long term.

I will now turn the call over to Subra to review the financial results for the quarter.

Thank you, Mohit. I will review Chimera's financial highlights for the third quarter of 2022. GAAP book value at the end of third quarter was $7.44 per share, and our economic return on GAAP book value was negative 13% based on the quarterly change in book value and the third quarter dividend per common share. GAAP net loss for the third quarter was $205 million or $0.88 per share. On an earnings available for distribution basis, net income for the third quarter was $63 million or $0.27 per share. Our economic net interest income for the third quarter was $104 million. For the third quarter, the yield on average interest-earning assets was 5.5%.

Our average cost of funds was 3% and our net interest spread was 2.5%. Total leverage for the third quarter was 3.9:1, while recourse leverage ended the quarter at 1.1:1. For the quarter, our annualized economic net interest return on average equity was 14.8%. And our annualized GAAP return on average equity was negative 26.5%. And lastly, our third quarter expenses, excluding servicing fees and transaction expenses, were $15 million, consistent with previous quarter.

That concludes our remarks. We will now open the call for questions.

(Operator Instructions) And our first question comes from Ken Lee from RBC Capital Market.

A lot going on in terms of the financing side between the -- extending the non-mark-to-market and the rate swaps you've been entering into. Just wondering if you could talk a little bit about how you think funding costs could trend over the near term given all these changes? And importantly, how responsive would funding costs be to rising rates?

Ken, this is Mohit. That's a good question. As we enter 2022, the expectations of the Fed from where it started to where it was going to end with the magnitude of about 3 to 4 rate hikes. Obviously, as we mentioned in the opening remarks, they've gone much further. And yesterday, went an additional 75 basis points for the Fed funds rate to be at 4%. And as a result of how quickly the expectation of where the Fed is going to change, is why we started laddering into swaps and hedges to protect our financing costs over the last 2 quarters and even post quarter end.

So the mass majority of our recourse borrowings are floating rate in nature. So any adjustments in the index and the Fed fund rate translates into an increase in financing costs. But these hedges will lock in over the next 2, 3 years locked in rate with the spreads that this finance on. But from a spread perspective, in terms of the asset we're looking to finance, there are still ample cash at those spreads to finance those assets. So it's more the benchmark rate as opposed to the spread, that's a bigger concern for us.

And I appreciate -- just one follow-up, if I may. I appreciate the discussion on the RPLs and realizing that much of the resi loans are very seasoned. But I wonder if you can just talk about the potential impact of a slowing housing market and the potential home price declines in terms of resi loan valuations or non-agency valuations.

Sure. So the big differentiator for us on our loan portfolio is the vast seasoning that the portfolio has. The origination in LTV was 83%. So if you assume that 85% of the portfolio was originated prior to 2007, there's been 15 years of natural amortization, coupled with some pretty strong HPA. So we think the updated or HPI adjusted, amortized adjusted LTV on the portfolio is closer to 50%. So from a credit performance standpoint, that gives you a lot of equity to play with and if you look at the average loan balance of $102,000, the monthly mortgage payment is sub-$800 a month. And if you just compare that to the change in mortgage rate from the start of the year to now, for a $400,000 mortgage, that mortgage payment adjustment would be $900. So these borrowers have gone through different interest rate cycles, different credit events, so we think there's going to be really not a material change given the lack of housing alternatives that these borrowers have.

And our next question comes from Trevor Cranston from JMP Securities.

Can you guys talk a little bit about how the high level of volatility in the rates market has impacted your investment appetite just given the risk that there could be a big move in rates and spreads between the time period when you acquire loans and when the securitization takes place?

Trevor, again, a good question and one we addressed on sort of other calls as well. Like our approach is not to necessarily aggregate loans in mini bulk size that we buy bulk production and warehouse them to transfer servicing and ultimately to securitize. So the period of time from committing to a trade to funding a trade to securitization, we sort of look at it from a 60- to 90-day basis from a turnaround perspective. So we try to limit how much exposure we have to spread in rates adjusting. Now this year has been unique, given how quickly rates have moved in Q3. The 2-year it moved 130 basis points, a 5-year moved 100 basis points and the 10-year moved 90-ish basis points. So it made it a bit challenging environment on top of the amount of issuance in the new issue market. But again, we do take warehousing risk and use that as much as possible with a quick turnaround that I just mentioned.

Okay. Got it. And then in the post quarter update, you mentioned the $476 million of loans, I think you called it, they were going to be placed into a long-term non-mark-to-market structure. Can you explain exactly what that is? And why are you utilizing that versus securitization?

Sure. So as you just touched upon and as I just mentioned to the prior question, given the challenges within the new issue market currently, like we acquired these loans where we have also locked in a 5-year tenure financing arrangement, which will be on a non-mark-to-market basis achieving a similar advance rate that you would get via a securitization. So we thought this was a better outcome to produce better returns for the company.

And are structures like that something that you think could be more available in the near term if the new issue market doesn't necessarily look as attractive?

Yes. I mean I think, again, given the challenges the new issue market is facing, these structures could become more commonplace. And if and when the market returns on the securitization front, we will sort of balance that out on a go-forward basis.

Okay. Got it. And then last thing, can you provide a update on book value quarter-to-date?

Sure. I mean, again, we've had this question in the last 2 quarters. And each time you've sort of presented it. It's been very vastly different by the time quarter has ended. Since the end of the quarter, rates have moved about 30 basis points parallel across the curve. Spreads are marginally wider. I would suspect book value to be down between 2% to 3% since quarter end.

(Operator Instructions) And our next question comes from Bose George from KBW.

This is actually Mike Smyth on for Bose. My first question is, can you provide an update on your asset acquisition pipeline kind of the overall level of competition in the space. I'm wondering if any of your loan origination partners has stepped away kind of given the uptick in volatility. And then as a follow-up, can you just remind us how many loan origination partners you have? And then if any are shutting doors or facing solvency issues, just kind of given the moving rates.

Sure, Mike. As far as sourcing assets, it's not a problem. I think as we've sort of highlighted, we've been defensive trying to maintain low leverage while adding accretive assets. Since the start of the year, we acquired $1.6 billion of loans. And obviously, we've also done 5 securitizations to fund a lot of those transactions. We are going to bid loans to where the securitization exit is and/or where we can find other long-term sources of financing for those loans. We don't have a flow agreement with anybody. We buy to what makes the most economic sense from an ROE perspective for the company. So again, we have no commitment with any particular originators in terms of sourcing on a flow basis any assets. We have everybody I reckon call to sort of pick and choose the collateral that we like. So hopefully, that answers your question.

Yes, that's helpful. And then maybe just one more. Can you talk a little bit about where levered ROEs are on new investments? And then kind of how you're thinking about the balancing act between going on offense, buying back stock and maintaining a strong liquidity position?

Sure. So let me start with the ROE question. As we mentioned on the loans that are looking to settle here in Q4, the $476 million, we mentioned double-digit returns on that investment. I think the vast majority of the mortgage ecosystem can produce pretty attractive levered returns. But given the backdrop of higher rates, still impeding inflation and Fed being active, we're going to maintain a pretty disciplined approach to deploying capital. I think maintaining liquidity is the biggest focus here as we have done throughout the year. We started the year with 1.0 turns of recourse leverage. We're at 1.1 now and rates have moved to the tune of 300 to 400 basis points across the curve. But at the same time, we want to be just as in deploying accretive capital given how attractive some investments look. But on the aggregate, lever return should be in the mid-teens at least for us to sort of deploy capital and we see plenty of opportunities there as it stands now.

And there appears to be no further questions at this time. I would now like to turn it over to management for any closing remarks.

Thank you, operator, and thank you, everyone, for joining us on our call today. We look forward to speaking to you next year.

Thank you. This does conclude today's conference. We thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.