Chimera Investment Corporation (CIM) Q4 2016 Earnings Report, Transcript and Summary

Welcome to the Chimera Investment Corporation Fourth Quarter and Year End 2016 Conference Call and Webcast. At this time, all lines are in a listen only mode. [Operator Instructions] It is now my pleasure to turn the floor over to Emily Mohr of Investor Relations. Please go ahead.

Thank you, Kristine. And thank you everyone for participating in Chimera's fourth quarter and year end 2016 earnings conference call. Before we begin, I'd like to review the Safe Harbor statements. During this call, we'll be making forward looking statements which are predictions, projections or other statements about future event. These statements are based on current expectations and assumptions that are subject to risk and uncertainties which are outlined in the risk factor section in our most recent annual and quarterly SEC filing. Actual events and results may differ materially from these forward looking statements. We encourage you to read the forward-looking statement disclaimer in our earnings release in addition to our quarterly and annual 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 content time sensitive information that is accurate only as of the day 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 Matthew Lambiase.

Thank you, Emily. Good morning and welcome to the fourth quarter 2016 Chimera Investment Corporation's earnings call. Joining me on the call this morning I have Mohit Marria, our Chief Investment Officer; Rob Colligan, our CFO; Choudhary Yarlagadda, our Chief Operating Officer and Vic Falvo, the Head of our Capital Marketing. I'll make a few brief comments, Mohit will then discuss the changes in the portfolio and Rob will review our financial results. Afterwards we'll open up the call for questions. We witnessed high vitality in the fourth quarter of 2016 as the 10 year US Treasury increased in yield over 85 basis points and the Federal Reserve increased short-term interest rate. In this very difficult bond market, Chimera's portfolio held up well and produced the positive total return for the period. Residential mortgage credit bond which comprised the majority of our holdings did not suffer the same negative price movement as agency mortgage backed securities or US Treasury did in the sell off. We believe that our asset mix and lower recourse leverage should help us to continue produce solid returns even if we see more volatility in the future. Overall, 2016 was a good year for Chimera. It was our first full calendar year operating as an independent internally managed company. Over the year, Chimera shares posted a 46% cumulative total return, and since internalization in August of 2015, the company had a 60% cumulative total return. Over the last 19 months we've had a number of successes that have added value for our shareholders. We were able to internalize the management function without paying a breakup fee and lowered the operating expense of the company. We strengthened our operating systems by implementing new state-of-the-art third party accounting and portfolio management. We added experienced new employees in accounting legal and technology to round out our team. We repurchased $250 million of Chimera shares at a discount to its book value at an average price of $13.94. We recovered $95 million for our shareholders which resulted in special dividend. We diversified our capital structure and issued $145 million, 8% cumulative preferred stock. Our first preferred issue which was accretive to the common shareholder. We executed a noble securitization with Freddie Mac which enabled them to sell credit mix to Chimera in a structure never been done before. And most importantly, our portfolio team successfully purchased and securitized over $5 billion of season performing low loan balance mortgages in three separate transactions, which enables us to grow our earnings and raise our dividend in the fourth quarter of 2016. Looking forward, we feel good about our portfolio and believe that the recovering housing market makes legacy residential mortgage credit one of the most attractive options for income investors. Our portfolio of over 90,000 low loan balance mortgages is truly unique. And we believe it is well positioned to continue to produce high relative income for our investors. Our confidence is evidenced by our Board of Directors announcing last night that Chimera expects to pay a $0.50 dividend for each of the four quarter of 2017. We hope this is a minimum as our investment team is continuously looking for new and accretive investment opportunities with the goal to be able to grow earnings and increase our dividend in the future. Now I'll turn the call over to Mohit to discuss the changes in the portfolio over the period.

Thank you, Matt. It was another interesting quarter for both fixed income and equity markets. The unexpected results of the election marked a major stock market rally and a sizeable sell off in the Treasury bond market. As Matt said, during the quarter 10 years Treasury yield increased by approximately 85 basis points and the curves deepen roughly 42 basis points. Given the large move in treasury yields, agency mortgage spread widened. However, mortgage credit spreads tighten somewhat as a result of the risk on mindset following the election results, which positively benefited our credit strategy and overall performance. At the peak, the legacy mortgage market was approximately $1.3 trillion. At the end of calendar year 2015, the estimated amount of outstanding securities was $630 billion. And as 2016 came to a close the market has further shrunk to approximately $550 billion. Chimera in her first major portfolio innovation of few years back created a large portfolio of Re-Remic from legacy mortgage bond. The securities we created for investment continue to generate attractive return for the portfolio. And the senior security still has acted as a buffer to our portfolio from the pay downs that have occurred. At year end, we had nearly $2 billion Re-Remic outstanding, representing 61% of our original $3.2 billion of investment of consolidated Re-Remic. Consistent with the improvement in housing market, these securities continue to perform well in both delinquencies and prepayment. And continue to generate mid high-teen yields for our portfolio. Mortgage loan securitization is not new to Chimera. Unlike most investors in legacy mortgage bond, Chimera can utilize its securitization and loan credit analysis that bringing us to capitalize on the opportunity to purchase new seasoned mortgage loans. We have securitized over $10.5 billion loans in our history. In each of these deals, Chimera owns the subordinate position and has never sold out of the retained subordinate investment. So when this new risk retention regulation came into effect, Chimera was prepare to assume a leadership position. Inclusive of the $5.8 billion loan securitization completed in 2016, Chimera now has nearly $8.9 billion in loan securitization outstanding while retaining $1.8 billion. Additional details of the outstanding consolidated loan securitizations can be found on page 5 of the quarterly supplement. This quarter we closed on $185 million in securitization, CIM 2016-FRE1 which was Freddie Mac pilot program, enabling Chimera to generate similar returns those achieved in the $5 billion securitization earlier in 2016. Some of the detail -- deal highlights are as follows. The loans were 133-1 seasons re-performing with an average LTV of 7. Freddie Mac provides term senior financing at a financing rate of 2.35%. Chimera retains just over $70 million as subordinate holding, lost a just deal of low to mid-teens. Although the deal size have not overly impactful to the portfolio, it is important for us to innovate and establish a potential new source of supply with the GSE. In addition, we refinanced Springleaf 2013-1 resulting in new issue of CIM 2016-4 and CIM 2016-5. Though we did not materially reduce our capital commitment, we were able to reduce our financing cost on our investments from 4.07% to 3.5%, saving us over 55 basis points. We have now re-securitized five of the seven original Springleaf deal and have Springleaf 2013-2 and 2013-3 remaining. Details are currently callable and we continue to value every meaningful opportunity. Subsequent to year end but not reflected this quarter, in January we closed on CIM 2017-1, which is a new loan securitization totaling $525 million. The loans have economic or substantially similar to those should in CIM 2016-1, 2 and 3. Also in January, we acquired approximately $330 million of seasoned performing mortgage loans which we intend to securitize in the near future. We will provide more details on these transactions on our first quarter 2017 earnings call. As we look forward in 2017, we remain committed supplying capital to areas of our business of high return and driving earnings power while also maintaining a disciplined approach to risk management and protecting book value. And with that I'll turn the call over to Rob.

Thanks, Mohit. I'll now review financial highlights for the fourth quarter of 2016. GAAP book value at year end was $15.87 per share and our total return on GAAP book value was 1.2% based on the quarterly change in book value and fourth quarter dividend. GAAP net income for the fourth quarter was $219 million, up from $173 million last quarter. On a core basis, net income for the fourth quarter was $121 million or $0.65 per share compared to $129 million or $0.68 per share last quarter. Deal expenses for the fourth quarter were approximately $4 million, or $0.02 per share. Net interest income for the fourth quarter was $154 million compared to $156 million last quarter. The yield on average interest earnings assets was 6.9% compared to 6.5% last quarter. Our average cost to funds was 3.4%, up from 2.9% last quarter and our net interest spread was 3.5% compared to 3.6% last quarter. Our total leverage for the quarter was 4.1 to 1, down from 4.4 to 1 last quarter while recourse leverage ended the quarter at 1.8 to 1. Our net interest return on equity was 19.5% for the quarter compared to 20.2% last quarter and our return on average equity 28.8% for the quarter, up from 23% last quarter. Expenses for the fourth quarter excluding servicing fees and deal expenses were $12 million. For 2017, we expect expenses again excluding servicing fees and deal expenses to be $12 million to $13 million per quarter which is lower than most companies in our sector. And we continue to deliver cost savings discussed during Chimera's internalization of management in the third quarter of 2015. That concludes our remarks. And we'll now open the call for questions.

[Operator Instructions] Our first question comes from Bose George with KBW.

Thanks. Good morning. It is Eric on for Bose. Now that we are almost a decade beyond the financial crisis, do you think Chimera are any more less sensitive to changes in housing prices versus pre prices? And do you think there might be other perhaps more germane factors that have emerged over the last few years which may impact the credit profile of low to middle income borrowers, which you think might be getting overlooked right now?

Well, it's really interesting question. I would say that the big difference right now that you are seeing in housing valuation and especially in the housing values of the properties that we finance in our portfolio is that with an average portfolio of 90 somewhat thousand loans less than a $100,000 balance. You are talking about probably $125,000 home values. And those homes haven't been over built in this market. So and you are seeing kind of steady price appreciation in that market. And I think it's been pretty solid and the other thing that you are not seeing really is the kind of excessive lending. So the price gains that we are seeing I think are sustainable. And actually I don't think there is a lot of supply in that market. So I think if anything the housing prices there can actually appreciate with inflation in the marketplace. And I don't think it's a bubble at all especially what we are -- the home values that we have in our product that we are funding.

Yes. And the only place we do see where the homeowner sensitive to the level of rate in HPA is on the prime jumbo size, we've seen new originations stuff or stuff that we originate in 2012 paying a lot faster than the loans that Matt just alluded to which is why we shifted our focus in 2014 to season performing low loan balance storage.

Right. That's helpful answer. For the Re-Remic bond that you list on slide 6, what's your approximate assumption for the average remaining life of those securities?

So the senior bonds which is $350 million outstanding from the original $3 billion. I would say the average life is anywhere between two to three years. The subordinate bonds of $1.9 billion probably have an average life between six to seven years based on again performances that we've seen over the last eight years.

Go ahead I am sorry, Matt.

No, I think when we look at CPRs on the Re-Remic portfolio in general that's been coming in relatively slow right. So you would think with that's been nine or so CPR,

That's right I think the weighted average CPR bringing some Re-Remic portfolio between 8 to 10 CPR, yes, based on seasonal.

Got it. I was just going to say so modeling this out we can expect that yield that you are booking to continue for the foreseeable future.

Yes, absolutely.

Our next question comes from Brock Vandervliet with Nomura.

Hi, guys. Good morning. If you could just kind of talk generally about sourcing new, tapping new sources of credit, any details on where this $330 million that you purchased came from and just more broadly Springleaf has been great for you but what do you -- what general opportunities you are focused on here in 2017?

Right. Well, I mean the good news is that so far this quarter, the first quarter of 2017 the company has about -- we've completed one $500 million transaction and we probably have another one that will be $300 million. So the good news for everyone is that we are able to find I think investments that we like. And are going to be accretive to the earning stream of the company. So I know there is always a risk but you said can you find assets, and to the point that Mohit made in his comments is that we've done a deal with Freddie Mac which is a very interesting risk transfer structure that they have never done before. No one has ever done it before and I think it was success for us and I think it was success for them. And I think that also could be a very large source of assets for us to securitize in the future. I think Freddie Mac and Fannie Mae are looking for different ways to shed risk on their balance sheet. And they have been very creative and I think that they have frankly a lot of risks that we would -- I know that we would put on our balance sheet if we got the right financing in the right terms for it. And I think if you talk to them, you are talking about billions maybe tens of billions of dollars of assets that could come out in the couple of years.

Okay. Great. And just as a follow up, could you talk about how you are thinking about the dividend? You obviously took it up in the fourth quarter, your earnings continue to beat us and the rest of the --

Well, I mean I think -- listen, we want to raise the dividend with ideally the idea is to find more good assets and grow our earnings is job number one here. But I think being cautious is important. We are in very volatile market. And I take Janet Yellen at her work and she says that she might raise rates three times this year which means higher fund across for us. And I really don't want to be in a situation where I cut the dividend. So I want to see what happens with the Fed, I want to see what happens with the market. And I want to go in a thoughtful fashion rather than just bringing up the dividend. And I think but if we get to the end of the year, we are able to grow our balance sheet and grow our earnings assets, absolutely, that's we would love to raise the dividend.

Our next question comes from Doug Harter with Credit Suisse.

Thanks. First a point of clarification, securitization that you said you did in the first quarter. Was that on newly acquired assets or assets that were already on your balance sheet?

Those were newly acquired assets. The $500 -- the CIM 2017-1 was newly acquired $500 million. That's right.

Great. Thanks for that. And any sense as to the Freddie Mac transaction, any sense as to kind of when or if there could be a second transaction and how you would think about competition for your ability to acquire the subordinate pieces of that?

So I would just say in general, dealing every dealing with the Fannie Mae and Freddie Mac, that they are highly competitive situation always. They do nothing one off and even the small package that we bought and the pilot program was a competitive bid. So I think that's mitigated with the fact that they just have a tremendous amount of supply. So we should be able to find things when they do actually have a sell program on or they figure out that this is more that they want to do going forward. I really don't have a window into what they are thinking. We have been told that there might be another package this year. But we aside from that we really don't have a window into what either one of the agencies are thinking.

Got it. And then just on that Freddie Mac, obviously the financing that they provide or them buying the AAA mix that financing very cheap but I guess how do you think about given your expertise on sort of doing securitizations and your ability to get your own financing, do you think that them that's kind of level supplying field and opens it up to sort of other buyers that might not be as sophisticated as you. I guess how do you think about the pros and cons of that attractive financing?

I mean obviously for this particular transaction it was first of one its type as Matt said. So the financing was a large portion what attracted us to the loan package. Also the credit work that we did on a standalone basis. I think that does make it competitive as Matt said. I mean anything the GSEs do is in a competitive bid style. And I think it providing term financing at the time of the capital structure gives other people who may not have done securitization in the past way window into doing it. I think again at the underlying foundation of the credit work. If you are not comfortable with the credit, irrespective of the financing you can get, that's got to be the base of the their credit decision, or investment decision.

Our next question comes from [Jim Dalal] with Wasatch.

Good morning, guys. Rather than the classic congratulation on a great quarter. Just want to say, Matt, hey thanks to recapping the year 2016. I have been watching the stuff for long time. I don't recall anything like team like hitting it as well as you guys did this whole cycle. It has been a pleasure to watch. Congratulation. You listed your accomplishment for 2016; the one thing missing was issuing stock accretively. We are now in 2017 and you could probably fill in that space on your spreadsheet if you want to. I would like to hear your thoughts about that.

Well, I think our common stock yields are around 11% and firstly I am biased on this. I think my stock is always under priced. And I think there are other people in our space that trade 100 basis points or so tighter in yield. And I think that there is room for our company stock to trade in tandem with other people who do the same thing in our space. So I think selling something at 11% when it should be trading at 10% or 9% or something like that is just it's hard for me to get excited about doing. I would say that I am very happy with Vic's effort here to do preferred stock issuing. We were able to raise capital in the preferred market 8% and that is capital and it was accretive so the assets that we put on against that capital have been accretive to our common shareholder which is a good thing. And I think my job is frankly would be to figure out ways to reduce the cost of our capital, whether it have the trade, the stock trade up higher and get closer to some of our competitors or more preferred issuance. I think that make sense too.

And how much more deals of the size that you have done so far this quarter, could you do, could you onboard with your current dry powder?

Hey, Jim. This is Mohit. I mean we have the ability obviously we did $800 million so far this quarter. We have the ability to add more, obviously of the magic securitization reduces their overall investment need. So it's all subject to the credit profile that we are acquiring and what type of advanced where we could get through securitization so it's --

I think we are amply cap -- we have the ample capital at the moment to execute. So I don't think there is any approximate need but again if great opportunities come up those changes very quickly. So in this market and I'll tell you I think I have the best guys working here to find asset and they find great things for us to invest in on a regular basis. And I am constantly surprised at their creativity and their work effort.

[Operator Instructions] Our next question comes from Lee Cooperman with Omega Advisor.

Thank you very much. I think one has to say we have to give you shout out. You guys done a great job. I agree with the previous questioner where he basically praised you for the job you've done and I would like to add my praise. I'd like to also say I agree with your answers to the second observation regarding stock issuance. I think it make no sense when issuing stock when stock is under valued. So I would agree with the tone of your response. My question in the following area. I think it's clear from your actions but just want to give you the chance to state it, your priorities in the use of free cash flow, I am assuming the way you are acting now as you want to kind of more asset growth and followed by the dividend and then if the stock got down to a level where we achieve relative to underlying asset value in more meaningful way that stock repurchase would also be used. So that be question number one. Your priorities as things stand now, what are your priorities for the use of your cash flow?

That's correct. I would just echo what Mohit said in his comments that the universe of the mortgage market is shrinking. And I think there is scarcity aspect to the assets that we have on our balance sheet. And I think to the fact that we can buy things today and have them on our balance sheet for -- in some cases I think some of the deals we are doing look like they could be on the balance sheet for five, seven years average life. And have that high yielding assets on our balance sheet when there is not lot more of being made, I think is a great place to be trying to grow your portfolio and trying to expand the portfolio with those types of assets. So that's the priority number one for us to get as much as of the credit that we like, in the story that we like and grow the portfolio. And certainly, yes, if the stock ever we have the ability to buyback stock. We have $100 million authorized and if the stock we are able to trade down, yes, that we would certainly contemplate buying back shares. But right now I think we've been successful and we've been proving that we can find accretive investment for our shareholders. And that's really job number one here.

Got you. The second question. I think the world we are heading into is one I call normalization that we are going to -- we had $14 trillion of sovereign debt with negative interest rates now down to $4 trillion. So I think the world we are looking at is more growth, more inflation, high corporate profits, and higher interest rate. So I said to you in three years time the Fed funds rate will be 2% and 10 year government will be 4%, would you expect this company would earn less or money than it earns today. If it says Fed funds went to 2% and the 10 year government went to 4% and took us say two years to get there.

I think I am going to throw Mohit to the bus; do you want to answer that Mohit?

Yes, I mean, Lee, I mean we do have -- I mean some of our assets mix is not just fixed rate so we do have some adjust more rate assets within the portfolio which has rates go up should help income growth. And on the flip side obviously we do some recourse leverage where we borrow money so higher fund rate should weaved into that. I mean I think it's tough to say all out equal. I think we should be flattish to maybe slightly down but obviously we are going to have reinvestments that will be invested at the higher rates. So I think there could be some interest income growth in two years from now.

Got you. And last question, as you guys intend to run the business you run it extremely well. What kind of -- what's the realistic return on equity over a year cycle that you guys think you can achieve?

I think our return on equity should be in the low double digit. I think anywhere between 11% to 13% I think is something that we proven that we can produce on a regular -- over a long period of time. And I think that's I think that make sense to us in terms of what we [Technical Difficulty] and we've been trying to manage the company and try to take less recourse leverage risk. We've been bringing down our -- we've been bringing down our leverage and I think we are running as conservatively as we can and still producing a very high dividend for our shareholders. We think about it everyday.

And we have a follow up from the line of Brock Vandervliet from Nomura.

Thank you. You've come a long way in terms of the changing balance sheet composition and the de-emphasis of agency MBS, however assuming a change in the agency MBS market perhaps driven by said shrinking its own balance sheet or some other outside dislocation, would you ever look to build that back up or strategically are you just much more focused on credit now and that's just not realistic.

I think we are always kind of opportunistic. Right now agencies are not exactly the best asset in the world. I don't think anybody is really looking at Chimera and think I want to buy it for their agency portfolio; most people know that we usually out for both pool testing and liquidity on the balance sheet. It's -- in the current market it's not something that we feel that we would want to allocate more capital to. I would say that if things where it right now we certainly have -- the one of the nice thing about operating the business the way guys have put the portfolio together is that we are operating at a low leverage ratio and you can expand the balance sheet if something gets really inexpensive. And we would definitely look at that. And we would definitely try to take an opportunity if we saw something there. But at the moment, it's not something we would allocate a lot more capital to. And I would say the same thing for other assets too in the mortgage space. We haven't really been in these cash and stocker bond or CRT bond but should they ever really trade down in a dislocated fashion, we have the ability to add them to the portfolio too. I'd like to think that we are opportunistic and nothing is 100% off the table at any time.

This concludes today's question-and-answer session. I'll now hand the program back over to Matt Lambiase for any additional or closing remarks.

Well, I just wanted really personally thank my team here and all the people at Chimera. They have executed very well on the strategy and did a fine job in 2016. And I think everyone is appreciative of that. And also like to thank my long-term shareholders and Board of Directors, they stuck with us. We really have transformed the company to I think a better place. And it's been nice, with the encouragement sometime it hasn't been the easiest but we were in a different place and it's just really lot of thanks goes out to them for sticking with us over the year. So with that I'd like to conclude the call. Thank you for participating in the Chimera 2016 fourth quarter earnings call.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect your line.