Chimera Investment Corporation (CIM) Q4 2015 Earnings Report, Transcript and Summary

Good morning. And welcome to the Fourth Quarter 2015 Earnings Call for Chimera Investment Corporation. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Any forward-looking statements made during today’s call 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. 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. Participants on this morning’s call include, Matthew Lambiase, President and Chief Executive Officer; Rob Colligan, Chief Financial Officer; Mohit Marria, Chief Investment Officer; Choudhary Yarlagadda, Chief Operating Officer; and Bill Dyer, Head of Underwriting. Please note this event is being recorded. I will now turn the conference call over to Matthew Lambiase.

Thank you, Laura. Good morning. And welcome to Chimera Investment Corporation’s fourth quarter 2015 earnings call. I will make a few brief comments this morning, then Mohit Marria; our CIO will discuss in the changes in the portfolio, followed by Rob Colligan, our CFO, who will review the financial results for the period. And afterward, we will open up the call for questions. I would like to start this morning by reviewing some of the important steps we took in 2015 to better position Chimera to create long-term shareholder value. One key step was the successful internalizing of our management function, which we completed on schedule at the end of 2015. Now Chimera owns its technology and trading systems. All personnel are directly employed by the company itself and managements compensation is thrived to the performance of the company. We believe that internally managed REITs increase long-term shareholder value by aligning the interests of management and shareholders more closely. We continually monitor our cost structure to find efficiencies in order to maximize performance and income, while operating at one of the lowest expense ratios in the mortgage REIT sector. As a result, we believe this traditional corporate structure is superior and it should trade at a premium over other externally managed REITs. An example of our shareholder friendly approach is the $250 million share repurchase program we announced along with internalization in August of 2015. In the fourth quarter, Chimera completed the remaining $19 million in purchases available under that authorization. In total, we repurchased 8.7% of our outstanding shares in 2015. We continue to believe that our shares represented an attractive use of our capital, given our book value per share, our high dividend yield and our strong investment portfolio. Tuesday evening our Board of Directors authorized an additional $100 million for repurchase of Chimera’s common stock by increasing the share repurchase authorization to $350 million. The board also declared a first quarter dividend of $0.48 per common share and guided to expect the dividend of $0.48 per common share for each quarter 2016. It would represent the total dividend payment of $1.92 per common share for the calendar year of 2016. The continued strong performance of our portfolio and our streamlined cost structure help enable us to continue to support this level of dividend throughout the year. In total, we’ve returned $1.2 billion to our shareholders in the past two years through a combination of taxable dividends, special dividends and share repurchase. Chimera paid shareholders taxable dividends of $370 million in 2014 and $379 million in 2015. In addition, we paid shareholders $205 million special dividend in 2014. And as I mentioned earlier, we repurchased $0.25 billion of our shares in 2015. With the quality and durability of our portfolio, the increased shareholder share repurchase authorization and the annual dividend guidance, we’re utilizing multiple levers to increase shareholder value. In a world where negative interest rates are becoming the norm, we believe Chimera’s attractive income payments and capital returns set us apart from other financial companies. At the current stock, Chimera’s portfolio is generating income to support the 15% dividend yield. Looking ahead into 2016; we believe we’re well-positioned to continue to create high income and increase shareholder value, even though persistent volatility in the markets present a headwind for most other financial companies. Despite the Federal Reserve's action in December to raise interest rates, the yield on the 10 year treasury have fallen by 45 basis points since the beginning of the year and credit spreads have widened. The market dislocation is helping us to find more attractive opportunities to invest in mortgage credits. In this turbulent market its important for investors to understand that the fundamentals of our mortgage credit portfolio remains positive. Loan-to-value metrics are improving because house prices are stable to increasing nationally and principal amortization payments continue to reduce the outstanding mortgage debt. Furthermore the credit of our older mortgage pools are improving as the weakest loans have been liquidated and delinquency rates continue to decline. Chimera has a large portfolio of securities and loans, which are performing well. And we expect this will allow the company to keep producing a durable high dividend well into the future. Before I pass the call over to Mohit, I’d just like to say that we believe Chimera’s stock remains undervalued and attractive. Our investment portfolio has produced attractive returns for shareholders over the past several years and the characteristics that generated this performance continue to remain in place today. We believe that Chimera’s portfolio of unique mortgage assets, management’s demonstrated ability to find investment opportunities and our internally managed corporate structure position us well to continue to create long-term shareholder value. And we’re optimistic that over time, the equity market will recognize our commitment to our shareholders and start to value our company more favorably. And with that, I'll turn it over to Mohit to discuss the portfolio in the quarter.

Thanks Matt, and good morning everyone. I will briefly review macroeconomic factors and then go over the investment activity for the quarter. It was another volatile quarter for the fixed-income markets. After approximately seven years of zero interest rate policy, the Federal Reserve commenced for their fed tightening of 25 basis points in December. Higher rates and constrained deal balance sheets during the quarter are part of the spread widening across agency MBS, non-agency MBS and CMBS. A combination of slower global economic growth, lower commodity prices and adverse currency moves are likely to negatively impact US economic growth. Against this backdrop the Federal Reserve's ability to continue to raise rates have been materially reduced. More favorable interest rate outlook and wider spreads on new investments improves the portfolios long-term potential. Though we tend to view our portfolio over long period, the market move during the period produced a lower book value in the fourth quarter. Our credit metrics remain unchanged and the relevance of credit portfolio continues to perform well. Housing fundamentals remained strong as home prices, delinquency rates and household formation are all showing improvements. These strengthening fundamentals continue to bode well for our season non-agency portfolio. Given these strong fundamentals and wider spreads, we continue to evaluate new non-agency mortgage investment for incremental return on the portfolio. In the fourth quarter, Chimera successfully called 750 million of Springleaf 2012-3A and issued 750 million of CIM 2015-AG. With the execution of the call, Chimera was able to reduce the financing cost by over 100 basis points. We have three remaining Springleaf deals we could potentially call in 2016, but given the challenging new issue environment we will evaluate the economics of these deals as we get closer to the call dates. As discussed on prior calls, the vast majority of the equity Chimera had committed to the Springleaf loans was within the first four deals. In addition, we were able to successfully rebalance the portion of our agency portfolio in the fourth quarter. With the lower for longer scenario, we executed a down in coupon swap to reduce the potential for faster prepayments. In addition to rebalancing the Agency’s portfolio, we continue to deploy capital in Agency CMBS, growing the portfolio 100 million in the fourth quarter. This sector saw some pretty dramatic spread widening in the quarter, which put some near-term pressure on book value, but we feel these securities continue to offer a better convexity profile than the Agency RMBS securities do to the prepayment protection they offer. The portfolio has grown to over $550 million at the year-end 2015. With asset prices reflecting increased risk premiums, low leverage in our existing portfolio, Chimera remains in a good position to generate attractive risk adjusted returns for its investors. With that I will turn the call over to Rob who will discuss the financial results for the quarter.

Thanks, Mohit. I will now review selective financial highlights for the fourth quarter. GAAP book value ended the quarter at $15.70 per share and economic book value ended the quarter at $14.65 per share. While both economic and GAAP book values are down 4% this quarter on a total return basis accounting for the dividend, economic and GAAP book value were down 1% this quarter. For the year, economic return was positive 4% and GAAP book value was positive 0.4%. GAAP net income for the fourth quarter was $115 million, up from a loss of $48 million last quarter. On a core basis, net income for the fourth quarter was $100 million or $0.53 per share, down from $108 million or $0.54 per share last quarter. We updated our definition of core to remove gains and losses on interest rate features to recognize that changes in futures can be volatile and not always reflective of a run rate income. The updated definition is also more consistent with our peers. Specifically this quarter, we removed $9 million of gains, which otherwise would have made core income higher by $0.05 compared to last quarter where we recognized a loss of $9 million. A full reconciliation for the current and all comparative periods is included in the press release. Fourth quarter net interest income was $137 million, down from $144 million last quarter. The rebalancing of our agency portfolio and amortization updates led to a onetime increase in amortization expense of $4 million and we don't expect to occur in future quarters. We expect future amortization to be in line with market trends for CPRs. This amortization update also had an impact on our spreads. The yield on average interest earning assets was 5.8%, down slightly from 6% last quarter and our average cost of funds was 2.6% consistent with last quarter. The net interest spread was 3.2%, down from 3.4% last quarter. Although it’s a challenging quarter to manage interest rate risk, our net interest return on equity was very consistent at 15% unchanged from last quarter and was 15.7% for the year, up from 14.1% in 2014. For the year, return on average equity was 11.6%, down from 17% in 2014. During the fourth quarter, we purchased 1.4 million shares for $19 million from our initial authorization of $250 million. In aggregate, we purchased 17.9 million shares with an average price of $13.94. Our block purchase from Annaly was traded at $14.05 and the open market purchases averaged $13.83 per share. As discussed, we’ve extended the plan by $100 million to $350 million. Expenses are generally in line with last quarter and include $3 million of non-recurring costs related to the securitization of Springleaf loan collateral into the CIM 2015-4AG deal. Prior to the internalization and continuing into the fourth quarter, the combination of management fees, transition expenses and other G&A, were running at approximately $15 million per quarter. This expense run rate excludes servicing fees and deal expenses for securitizations. As discussed last quarter, we still expect G&A expenses excluding one-time securitization costs and servicing fees to run approximately $13 million to $14 million per quarter in 2016. That concludes our remarks and we’ll now open the call for questions.

[Operator Instructions] And our first question will come from Doug Harter of Credit Suisse. Please go ahead.

Thanks. You guys talked about monitoring the economics of whether the Springleaf deals still remain feasible to call, can you sort of walk-through what are the key variables there that we should be watching?

Sure Doug. This is Mohit. I said in my opening remarks, we did call a deal in Q4, which was the 2012 3A deal. And the main thing we sort of evaluated is what the advanced rate improvement would be along with the financing improvements. As I mentioned, new issue environment seems challenging given what people are expecting on senior execution, so that’s going to play a role into how we see the deals being called in Q4. If the demand for the seniors isn’t there, we’ll remain – structures intact, and as market conditions improve, we’ll exercise the calls at that point in time.

And then just also your – the comment that you had made around most of the economics being in the first four deals. Can I – can you just flush it out and remind us how many you’ve already called up those for?

Yes. Back in 2014 when we acquired the Springleaf portfolio, there was a total of seven deals, three which were callable in 2015, one that was callable in 2014. And the equity we had committed to the investment was north of 700 million and the first four deals that have been called have effectively – that’s 90% of the equity we had committed to the trade. So, the last three deals, we have 10% of the equity commitment, so it’s not that larger investment for us.

Great. And then just, is there anything Mohit that you guys are looking at as far as investment opportunities given the spread widening away from the Springleaf deals?

Sure. I mean, we've discussed this in past calls as well, the loan space particularly in the re-performing loans look attractive. Again, given the pressure on the new issue space, execution on the seniors being wider that will put some pressure on loans to trade down as well, but also on the legacy subside, given the spread widening that's occurred, assets have been – looked the most attractive they’ve looked in the last 12 to 18 months where you could get mid-teens levered returns even in that space. I mean, we expect that some of that to come out in Q4 and some of it did, and we continue to see that trend coming out in Q1. We’ve been able to pick up some attractive assets in the legacy side that generate mid-teens ROEs.

Thanks Mohit.

The next question comes from Joel Houck of Wells Fargo.

Good morning. Could you talk a little bit about the – we saw the non-agency senior yield drop several hundred basis points in the prior two quarters. What was driving that, is that more accounting or technical issues or something else driving that yield lower this quarter – for the fourth quarter?

Hey Joel, this is Mohit. I’ll take up that and Rob could chime in as well. On the last deal that we did, we retained some of the seniors of the latest deal, which was obviously a lower yielding asset for us given the environment that we were in. That put some pressure on, we retained about 105 million of the senior notes of the last securitization, but for the most part, nothing else [indiscernible] on the senior space.

The only other piece obviously, senior stayed down over time, so we’re replacing in some cases a little bit lower yielding asset versus the legacy which are a little bit higher, but I wouldn’t say there is anything else.

Okay. And the next one I have if the – can you maybe put a little color on what type of commercial assets that you're buying and how we should think about the returns on that sector?

Sure. This is Mohit again. Again, as discussed in prior calls, we’re focusing primarily in the multifamily Ginnie space. A lot of our assets there are credit focused, government backed, we’re funding construction loans, whether it be Section 8 housing, hospitals, et cetera. Like all other CMBS products the Agency CMBS space wasn’t immune to the spread wide in Q4, but again, over the long run we still feel these assets will be accretive and the returns, levered returns we’re seeing here are also in the mid-teens with all the same benefits of the agency paths we build from the financing side.

That’s right. The Ginnie Mae, we’re not worried about getting our money back in the Ginnie Mae loans, the commercials, and this had been really just the spread widening in that part of the market, especially toward year-end that really they underperformed residential mortgage-backed securities. And I would say that we’re actively trying to buy more of that paper in this marketplace at the lighter spreads. We like it, we think it's a great value in the marketplace.

Okay great. And then lastly, on the hedge book, we noticed that there was more hedges in the 5 to 10 year range and lessened to 0 to 3, and also you extended maturity for the repose a bit, actually shifted down. But on the hedge question is that just a function of the agency composition or is there something more explicit about a rate view and that moved your hedges out in Tanner?

It’s a combination of both Joel, as we mentioned we did do a coupon swap, so we added a little more duration to the portfolio going for 4s to 3.5. So we've put some more swaps on in the belly of the curve. And from a trading standpoint, also we thought that seemed cheap and we put it on obviously the curves flattened a little bit post year-end. But we were comfortable with the hedges we have on in the place versus the agency bucked at the moment.

Alright. Thank you very much guys.

Thank you.

The next question comes from Bose George of KBW.

Good morning. Actually just a follow-up on the Agency CMBS, is the preference for Ginnie and Fannie and Freddie, is there a yield pick-up there?

I mean, on the Ginnie side, we’re funding construction loans, so it becomes the Ginnie poo, once all the commitments are in. On the Fannie side, they don't have the same program where you could originate these loans, so there is definitely a yield pick to be within the construction loan space.

And it also offers us prepayment lockout, especially during the construction period. And there is prepay lockout for all these loans for a certain duration of time.

Okay. Great. Makes sense, thanks. And then, can you walk through the drivers of the changes in book value this quarter?

Sure. I mean obviously the portfolio is broken into three categories the agency pass we can discuss up first and that's the easiest. Obviously rates sold out as Matt said in his opening comments and that some pressure lot and the basis lined a little bit in the quarter as well, so that put pressure on the agency side. Agency CMBS as we just discussed moved wider in spread, relative to what happened in the credit side in the Agency CMBS space. So that too and given the longer duration each of those assets, given most of those are eight to ten year duration that also had more adverse effect on book value. And then on the resi side, let me reiterate, the performance, the credit performance of the portfolio remains flat to whatever prior quarters have been performing better than we expected, but it was not immune to those spread widening that occurred within all sort of credit sectors, you know high yield et cetera, but it’s not a reflection of the credit performance, just more of the market conditions in Q4.

Okay, that’s helpful. Thank you.

And the next question comes from Brock Vandervliet of Nomura Securities.

Hi good morning. Thanks for taking the question. Just filling up on that last one; always tricky to observe the changes in some of these markets would you say the CMBX, which is relatively observable is a good proxy for what you experienced in non-Agency CMBS?

I wouldn't say it’s one for one co-relation, given that the loans that we have in the CMBS space are government guaranteed. I would take a percentage of what happened in CMBX to interpolate the impact on the book value of our Agency CMBS.

I wouldn’t do it one one-for-one.

Okay and can you comment at all on how that may have trended year-to-date and certainly the CMBX has widened significantly?

I mean, Q4 as I mentioned we saw a dramatic spread widening in the construction loan space and then in the Agency CMBS sector as a whole continuous – continuing issuance from the Freddie K program, again lack of dealer balance sheets to commit to those positions just put some pressure on spreads and that wind out obviously pretty significantly. And given the long duration nature of that, just multiply the effect on the book value here in Q4, but again we’re optimally we still like the sector. We’ve added 100 million in Q4 at the wider spreads and are continuing to grow the book in Q1 here.

I mean, I just think you put in context with the rest of the market, you know Bloomberg had an article saying $7 trillion worth of sovereigns are trading at negative yields across the globe and here we are, we have long Ginnie Mae paper that's trading 20 basis points or so wider, it’s a buying opportunity for us we think in the marketplace, and we've been trying to buy more of it.

I understand, so no comment on year-to-date performance?

It’s been weaker too.

Yeah, I mean I think, again, the typical January effect that you see most year was not exhibited this year obviously, volatility remains elevated and spreads are continuously under pressure here. Even year-to-date, I think, I mean I would say maybe the spreads are about 10 basis points to 15 basis points wider since the start of the year, but stabilizing. I think Freddie has announced given some – they could continuously issue, they’ve given a more programmatic approach to how they’re going to issue, which should clam investor fears about supply and that should lead to hopefully flattening or tightening the spreads going into the end of Q1 and for the remainder of the year.

Okay. And separately Rob, if you could just review again the expense dynamics going forward, that will be helpful?

Sure. So, we expect next year or this year, 2016, our quarterly expenses will be $13 million to $14 million per quarter, whereas last year we were running closer to $15 million a quarter. So we do expect some drop off. Obviously, for the third and fourth quarter this year, we got a mix of partially internally managed, partially externally managed, as well as transitional expenses. Through now, our transition is nearly complete, 99%. So I don’t think you’ll see a big drag or continued transition-related expenses, all those exercises are pretty much done at this point. So I think you’ll start to see the expenses from Q4 to Q1 trend down a little bit, and I think we’re comfortable at $13 million to $14 million a quarter for 2016.

Okay, great. Very helpful. Thanks.

The next question is from Steve DeLaney of JMP Securities.

Hi, good morning, and thanks for taking the question. I guess for starters, Mohit, could you comment generally on the bag that you – sort of the range of dollar price changes on the legacy RMBS that you observed in Q4 2015 and maybe also year-to-date here in Q1 2016?

Sure, Steve. In 2014, I would say prices across all legacy q subs were flat, even the first half of 2015 they were flat to slightly up. Obviously as we headed into the back half of the year, summer – spreads started widening out. Again – and sort of using it as subprime, I'd say more investment grade and below investment grade. Investment grade prices in the second half of 2015 were maybe down 1 to 2 points, again that was sponsored by real money that still had investment need, so I think that held in pretty well. The non-investment grade portfolio obviously saw more dramatic widening. And I would say depending on where on a dollar price basis you were, that could be anywhere from 3 to 10 points lower, and most of our portfolio is non-rated sort of lower in the capital stack. So I think that's why you saw a slightly decrease in book value versus others for Q4 for us.

Right. And then, how are you seeing things so for this year? I assume spreads are wider, so some continued price pressure?

Yeah, I mean, again Q1 has started out as Q4 ended, so I think there is still obviously elevated volatility prices continue to be challenged. And I would say they’re down probably another 1 to 2 points across the board, and in the non-rated below investment grade space.

Okay. That’s helpful and pretty much in line with the assumptions that we’ve made. I guess anytime we see volatility in prices, it kind of leads in the actual collateral, it leads us back to – wondering how the banks are viewing this and the lenders. I was just curious if you’re hearing any changes from your counterparties as far as terms, whether it be share types or pricing on some of the legacy collateral in the repo market, how that is evolving?

No, actually I would say Steve that we're not seeing any real pushback or any significant price changing in the repo counterparties at all. In fact we've been – having more people call us looking to finance non-agency positions. So I think from that point of view, the street is that are set up in a strange way to do financing rather than trading. I think the banks and the dealers now have to hold more capital against the positions that they hold in inventory and then there is the health pricing, I think there is going to be a lot less dealers doing portfolio health for their own balance sheet and trading the assets, and a lot more than we’re looking to the financing books to actually make money in the space. And we've been having a lot of new people come to us looking to set up credit lines with us. So it's kind of an interesting dynamic as these new bank capital rules get kind of the codified here and people start thinking about how they want to operate their businesses. I think we’re going to see less liquidity with the dealers making markets with their own balance sheet than more of a matching service, and I think they’re going to be looking to put a lot more paper on repo, especially the non-agency paper because it's such a – the high margin product for them frankly.

Very interesting, that's very helpful and insightful. Thank you Matt. Appreciate your color guys.

Thank you.

And our next question will be from Lee Cooperman of Omega Advisors.

Thank you. A few questions if I may. In terms of economic versus GAAP book value, which one does management, the board view as being more relevant of the value of the business? And when would those numbers converge? And second and more importantly, could you discuss the outlook over time that you think that we have for the return on the shareholder investment? And let me, before I give you the chance to answer, let me tell you why I asked that question. And I’m going to read you something, I sent to another company who go nameless, but is relevant, and they are in your space “I'm looking forward to following up on our conversation. Well, I’m pretty sure you understand my view, let me summarize it in bullet point form. Wall Street created a bunch of companies in the MLP REIT of real estate mortgage REIT and BDC space that worked as long as the issued stock sold at a premium to NAV creating the ability to issue capital by new paper and grow the distribution, however once the stocks drop to levels below NAV it’s the beginning of game over. Companies that want to remain independent and not bothered by activists would have to do right by the shareholder by either earning a proper return on equity, aggressively return capital to investors. In some cases like Windsor Realty, is a company that announced intention of liquidating, they reached a conclusion that stock would never get to the underlying value of the assets, we've seen tender offers and buybacks of consequence by companies in your space, such as Chimera, Harbor, Senior Housing, Fortress, Ellington et cetera.” Not compliment, you guys are doing very fine, I’m very pleased with your performance, but I’m curious as look out over the cycle what is a reasonable return on equity to the shareholders?

Well I think, you know we've been out saying to investors that over cycle and we've been pretty consistent, and we’re actually producing it, as we think there will be – that Chimera can produce a low teens return, anywhere between say 11% to 13%, 14% return for our shareholders, and when we've been pretty consistent, but not able to do that over time. And I think you know when the stock trades at the levels that it’s been trading at, it is obviously – it’s more advantageous for us to consider buying the shares back, and I think we've been pretty aggressive doing that and advocating our shareholders best interest in doing that. I think that there is a place for private capital in the mortgage market. I think there's a lot of assets out there and a lot of borrowers that need Chimera’s capital. And I think over time, especially as these bank rules and the different regulations hamper mortgage lending and mortgage creation for certain types of borrowers, it’s more and more important for companies like Chimera and people that have certain expertise in the securitization markets to get capital to those borrowers, and I think we can do that and continue to produce a very decent return in this market. And I would just say, you know we’re entering a world where a lot of financial companies are having difficulty producing any kind of return on equity and I think Chimera is set up very well with our portfolio to continue to produce very good income for our shareholders. And if the stock market refuses to understand what we we’re doing then we'll buy back shares and protect our shareholders as best as we can.

On the question of economic versus GAAP book value and when those numbers converge, which has been more relevant to you guys?

Yeah. I think, they’re – I’m told that they’re both important. I think – actually Rob is raising his head, he wants to answer.

Yeah, you’re right. I mean, both are important, the GAAP book value is important and we think it’s also important to show economic because if we had to liquidate the book and sold all that q-subs that we own, that represents the current state lower economic value. Talking about convergence, I know, we’ve touched on this with lots of investors over the last few years. It’s interesting at year-end where only $1.05 or roughly $200 million difference in book value between economic and GAAP, so they had started to converge. And economic this year, if I go back to my comment was – economic was positive 4% this year, where our GAAP was essentially flat. So economic is moving up to GAAP and we may see continued convergence as some of the old legacy deal start to burn off.

Just help me, one last question, I apologize. I thank you for your help, but I thank you very much for your performance by the way. Assuming no defaults and that the paper that we own is money good and goes to maturity, the decline in book value rising from spread widening should result in our ability to reinvest money to higher return, which would raise that return on equity, isn’t that correct?

That is absolutely correct.

Okay. Thank you. Good luck and thank you very much for your performance.

Thank you, Lee, for your support.

Thanks Lee.

This concludes our question-and-answer session. I would like to turn the conference back over to Matthew Lambiase for any closing remarks.

I’d just like to thank everybody for participating in our call today. And we look forward to speaking to you in May with our results for the first quarter. Thank you very much.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.