Chimera Investment Corporation (CIM) Q1 2017 Earnings Report, Transcript and Summary

Welcome to the Chimera Investment Corporation First Quarter 2017 Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] It is now my pleasure to turn the floor over to Emily Mohr of Investor Relations. Please go ahead.

Thank you, Glory. And thank you everyone for participating in Chimera's first quarter 2017 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 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 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. Please go ahead.

Thank you, Emily. Good morning and welcome to the first quarter 2017 Chimera Investment Corp. 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 Victor Falvo, the Head of our Capital Markets. I'll make some brief comments, and then Mohit will discuss the portfolio activity, and afterward Rob will review our financial results for the period. We'll open up the call for questions afterwards. Chimera had a very busy first quarter. This quarter, we purchased and securitized $4.1 billion of seasoned performing residential loans and issued $325 million of Series B preferred stock. $3.2 billion of the loans purchased occurred near the end of the quarter, while the preferred stock was issued mid-period. The timing and expenses related to those transactions produced some noisy financial results for the quarter. Our reported core income does not capture the full run rate of these new investments and also as we’ve discussed on earlier earnings calls securitization deal costs are taken up front, and they reduce core income in the period that we execute the deals. We expect our core income to increase in the second quarter when the full run rate of the new assets is realized. In order to expand our balance sheet and acquire these new loans, Chimera raised additional permanent capital issuing a new Series D preferred stock. In February, we lost a $75 million deal and due to strong investor demand, we successfully grew the preferred stock deal and raised $325 million in new capital. This capital raise enabled us to purchase the new loans and we continue to deploy new capital to grow our balance sheet. The preferred stock is accretive to our common shareholders. With the transaction this quarter, Chimera now consolidates over $12 billion seasoned small balance residential loan by the balance sheet. In our opinion, the size and the scale of this portfolio would be very difficult to recreate and this portfolio differentiates Chimera from its competitors. We now have over 140,000 loans with an average coupon of 7%, and an average balance of just $90,000. These loans are on average 11 years old. To date, we witness moderate prepayments and better credit performance than our purchase assumptions on this portfolio. And we continue to believe that small balance, residential loans offer one of the most attractive investment options in the fixed income market. During the quarter, our investment team successfully executed four non-rated securitizations to finance the new loan acquisitions. Chimera has proven itself once again to be a leader in risk retention securitizations. There are 15 securitizations financing our $12 billion small balance residential loan portfolio making us one of the largest participants in the new issued mortgage market. When we sponsor securitizations, we have the ability to create higher yielding investments for our portfolio rather than just simply purchasing bonds in the secondary market. The bonds that we retain are generally locked out from prepayments, which allows our higher yielding investments to be outstanding for longer periods of time, which is a true benefit in the low interest rate environment. Chimera also retains the optional right to call and refinance the securitizations, which gives us a pipeline of investment options for the future. The ability to acquire differentiated mortgage assets and finance them through securitization is our core business. And this strategy affords us the ability to produce relatively high income for our investors, while allowing us to operate at lower recourse leverage than our competitors. We continue to operate with defensive recourse leverage, which gives us dry powder to be opportunistic if asset is cheaper in the future. Looking forward, we believe that we ended the first quarter in a much stronger place than where we started it. We feel good about our portfolio and we believe we're well positioned to continue to produce high relative income for our investors in the quarters ahead. Now with that, I will turn it over to Mohit to discuss the changes in the portfolio in the market.

Thank you Matt and good morning everyone. I will briefly review macroeconomic factors and then go over the investment activity for the quarter. Unlike the fourth quarter of 2016, the first quarter of 2017 experienced lower rate volatility with minimal changes in rates quarter-over-quarter. A two-year and 10-year U.S. Treasury rates each closed the quarter within 5 basis points of where they began and the yields were flattened by a little less than 10 basis points. The Federal Reserve raise showed interest rates by 25 basis points in March, though the announcement by the Fed had minimal impact as it was very much anticipated by the market. Looking forward, our expectations for interest rate is not too different then market consensus. We are expecting one, maybe two more rate hikes in 2017 followed by the Fed focusing on shrinking its balance sheet. Consistent with the treasury rate market, pricing in the agency mortgage market was little change quarter-over-quarter. Other fixed income assets, residential credits, CRT, CMBS, high yield, and investment grade corporate bonds however experience strong performance due to spread timing during the quarter. The size and coupon distribution of our residential agency portfolio was relatively unchanged on the quarter, and our agency CMBS was modestly larger 16 million as we continue to add prepayment protection to our portfolio given the uncertainty around the rates market. Residential mortgage credit continues to perform well. The universe of seasoned mortgage credit continues to shrink, while housing and homeownership fundamentals continue to experience stable to improving trends. Both S&P Case-Shiller Home Price Index and housing starts were up 5.8% and 9.2% respectively year-over-year, and US homebuilder confidence is at the highest level since 2005. With that as the backdrop, we continue to exit queued upon our risk retention securitized loan strategy. As Matt mentioned, we purchased and securitized $4.1 billion in loans this quarter in four separate transactions. We briefly discussed in our last earnings call that we securitized 526 million loans in January. We followed that up with 331 million CIM 2017-2 in Feb and 3.23 billion CIM 2017-3 and 4 in late March. The 4.1 billion loans were purchased from multiple sellers. However, the underlying characteristics were all very select [ph] and complemented our existing portfolio of seasoned small volume performing loans. Chimera retained a face amount of 640 million in the securitizations and we expect to generate mid-teen lower returns like the deals we just issued in 2016. Collectively, CIM 2017-1 through 4 have a weighted average coupon of 6.95%, a weighted average loan age of 139 months, and an average loan balance of 84,000. The combined pool of loans had a weighted average cycle core of 668, and a loan to value ratio of 89%. Like in the Agency CMBS sector, loans with low loan balances are most expensive to refinance, which helps create lower and more consistent prepayment rates for our portfolio. Chimera’s securitized loan portfolio in total is performing better than our original expectations. We continue to experience prepays in the high single digits and defaults and severities are low within our original purchase assumptions, which is consistent with a strong housing statistics talked about earlier. Despite a continued tightening and shrinking universe of residential mortgage credit product, and a relatively low level of residential mortgage-backed securitizations in the market, portfolio team has continued to source product and execute upon our risk retention strategy. With the continued improving performance in seasonal residential mortgages, and the decreased amount of outstanding RMBS securities available for purchase our CIM deals continue to meet strong investor demand affording us the ability to add high yielding assets were a long-term investment portfolio. We continued to deploy that capital raised and are optimistic that it will be fully invested in the future. I will now turn the call over to Rob to review the financial results.

Thanks Mohit. I will now review financial highlights for the quarter. GAAP book value at the end of the first quarter was $16.20 per share and our total return on GAAP book value was 5.3%, based on the quarterly change in book value and the first quarter dividend. GAAP net income for the first quarter was $158 million, compared to $219 million last quarter. On a core basis, net income for the first quarter was $96 million or $0.51 per share, compared to $121 million or $0.65 per share last quarter. Securitization deal expenses reduced core income by $0.06 in the first quarter. Also amortization related to our agency portfolio reduced income by approximately $0.06, compared to the fourth quarter. Their most recent preferred tax offerings, while successful temporarily reduced earnings by $0.01. Net interest income for the first quarter was $141 million, compared to $154 million last quarter. The decrease in net interest income relates, primarily to our agency portfolio and related slowdown and prepayment fees in the fourth quarter as the 10-year treasury rate rose dramatically post election in November. Our yield on average interest earning assets was 6.5% for the quarter, compared to 6.9% last quarter. Our average cost of funds was 3.5%, up slightly from last quarter, and our net interest spread was 3%, compared to 3.4% last quarter. Total leverage for the first quarter was 4.6:1 however recourse leverage ended the quarter at 1.7:1. Our net interest return on equity was 16% for the quarter compared to 19% last quarter and a return on average equity was 20% for the quarter, compared to 29% last quarter. Expenses for the first quarter, excluding servicing fees and deal expenses were $12 million, slightly lower than the fourth quarter. In 2017, we expect these expenses to be $12 million to $13 million per quarter. That concludes our remarks and we will now open the call for questions.

[Operator Instructions] Your first question comes from the line of Doug Harter of Credit Suisse.

Thanks. I was hoping if you could talk about your capital mix, how you, what type of capacity do you think you have for additional preferreds?

Well you know we raised a fair amount over the last six months between the Series A and Series B. They have been very accretive for us as Mohit and the team have found investments that are yielding in the mid-teens. The excess earnings over the preferred yield is accretive to the common holders. We have done some interesting deals that we’ve talked about and Mo has provided details, and we will continue to be opportunistic, but we haven't given out any other guidance as far as near-term capital raises and if we plan on raising more I think we would have an announcement.

Yes, I would just add to that to say that we are still working through the capital that we raised in investing, as you saw on the quarters recourse leverage numbers, they are down quarter-over-quarter and that’s just really because as we invest in the marketplace it takes us a lot longer, you know it is not just like buying agencies and going out and putting 1 billion or 2 billion on. It takes Mo and the team quite a bit longer to actually invest in the marketplace. So we're still working through that. We don't have any immediate needs for more capital. I would say, just in general with a company like ours, you are probably - just have a little bit more room for preferred’s, I would imagine, but I don't think that there is a tremendous amount of capital out there on the common base that we have.

Got it. And just on that Matt to follow-up on that, I guess how much more rooms do you have on leverage to sort of fully deploy the capital that you raised last quarter?

Yes, I think we were at 1.7 at the end of last quarter in terms of recourse leverage. I could see ourselves going back up to 2 turns of recourse leverage over and say this quarter and the third quarter. I mean if we are successful in finding investments, I think we have to take the leverage up here over time as we find good investments. The biggest issue for us is really making sure that we're finding good assets in the marketplace that we like and that fit in with the portfolio and I think I have been very happy with the team. I think they have been finding a lot of very good assets and I will tell you the way pricing is going in the market; you are seeing very strong pricing and residential mortgage credit. There is just not a lot of supply out there and I think when - I don't think about this portfolio next year, I think we will all be very happy shareholders that we were able to buy as much as we did in the first quarter and Mo has been working with the team to continue to add. And I think just the way pricing is going; it is going to be a good thing to have a lot of these assets on the book.

Great, thank you Matt.

Your next question comes from the line of Trevor Cranston of JMP Securities.

Hi, thanks, good morning. A follow-up question to the comment on the strength that you have seen in pricing on residential credit assets, can you talk about, generically if you are still seeing the same type of returns, you know with what you've bought in the first quarter and what you are looking at currently kind of versus where they were in the latter part of 2016?

Sure Trevor, this is Mohit. So on the legacy queue supplies, spreads continue to tighten, so level of returns are probably inching lower. On the loan strategy that we’ve implemented, yes there is tightening in sort of the loan space itself, but the secured debt that you are issuing is also tightening. So, your leverage return on the loan space that you are retaining, although in slightly is still attractive and double-digit to what we will end up retaining in the securitizations we have done in Q1, in any potential future securitization. The secured debt is coming quite a bit on the issued deals given the lack of bonds available for the investor immediately.

Got it. That makes sense. As a follow-up on the capital structure question, to the extent after you may be increased leverage a little bit and finished deploying your current - the raise from the first quarter, if you continue to find attractive opportunities beyond that would you guys be looking at selling down the Agency portfolio currently as an option or are you kind of happy with the way the portfolio is performing or looking to keep it roughly at the current size?

You know we look at that as our liquidity portfolio. So, we would be definitely, in my opinion we would probably look to, in the short run bringing that down a little bit. We always have to have it to meet our 40 act, and we also like to have it for liquidity. I think it is just a good shock absorber if you will on the balance sheet, but we are still working through the capital that we already raised, so we don't have anything to announce or talk about for further capital raises.

Okay, fair enough, thank you.

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

Thanks good morning, it is Eric on for Bose. Given how tight credit spreads are in the market today and especially considering the level of appreciation that has already taken place in the legacy non-Agency market, would you say there has been any meaningful change in the appetite that you're seeing from investors who participate in the loan securitizations you sold? I assume you have a good relationship with the investor base who buys bonds from your securitizations, and you know generally what drives their decision-making for buying the senior bonds out of your deals? So, what if anything, do you think would make it more difficult for you to place those bonds with investors going forward?

Honestly, Eric, this is Mohit again, I think the demand for the asset is so strong currently that we’ve actually gone rivers and creeks for more investors and bonds we have to offer, which is what is leading spreads tighter on the securitized debt side. I mean, I think a liquidity issue or some other geopolitical risk, obviously could affect the market and spreads could maintain or leak out a little bit wider, but I don't see that happening in the near future.

Yes, I am continuously amazed by how quickly will we bring a deal out and Mo starts marketing, and how quickly the senior bonds gets sold. I think there is tremendous amount of demand from depositories from insurance companies, from mutual funds. I mean it is just, there is just not - in my opinion it just doesn't seem like there is enough spread product in the market that satiate of demand that we are seeing. So, I think we are in a very good position, I think as I said before, I think that continues, I just don't see the supply coming out into the marketplace to in the near future at least in residential mortgage credit. I think the only downside would be, if the Federal Reserve starts, we really want to see what happens with the agency market maybe next year when they start not reinvesting, maybe that could widen things out a little bit here, but the technicals right now in the residential mortgage credit are very strong and I don't see them really abating.

Right, that's helpful. Thanks. I had a question on leverage too, but I think you guys touched on that fairly well. The financing on your securitizations is mostly tied to one month LIBOR, is that right? And it looks like your financing cost stays flat at like 4.4% quarter-over-quarter on that portfolio even though LIBOR was up 20 basis points, I'm just trying to reconcile that.

As Matt mentioned in his opening comments, the senior debt that we have issued receives all the principle pay downs, so our net balances there shrink by the amount of money that comes in on the loans, so the overall universe of our balances on the secured debt is also lower, which is why the yields are not that meaningfully different given that the balances are smaller quarter-over-quarter.

Okay.

Even with LIBOR having gone up like you said 20, 25 basis points in Q1.

Got it. All right thanks.

Your next question comes from the line of Joel Houck of Wells Fargo.

Thanks. Just a follow-up on the Agency equity allocation, how [indiscernible] can that go and still be 40 act [ph] compliant? Like what’s the floor on that?

Surely, Joel this is Rob. You know I think we have said in the past we can take it down to 2 billion to 3 billion and still pass our [indiscernible]. So, I don't think much has changed in that in space. So I think that’s where we be more comfortable, plus as Matt said earlier we will probably want about that amount and the way for general liquidity purposes.

Okay good. And on that non-Agency repo it looks like there has been a consistent theme of shortening duration on the repo, can you talk about that a little bit, you used to run 80 to 90, now it’s running kind of 20 to 30 days.

Surely Joel this is Mohit again. So the reason we sort of kept the Agency repo short is to take advantage of opportunities that present themselves in the residential credit space to the extent we need to potentially sell some agencies to fund some of those purchases. In addition to that the rate outlook by the feds go potentially two or three rate hikes, some people lenders are building on that. So, we are being cognizant of how much we think of that is actually going to happen, so we're keeping repo short of just another management tool to manage expenses.

So there will be a way of saying you think the forward curve might be ahead of itself, so you don't want to overpay for longer date of repo?

That is right.

And then… thank you. You guys, the Agency yields dropped from 4.1 to 3 is there like a catch up back or something on?

Yes, so in the fourth quarter with a 10-year backing up we are a free sizable catch up, so if you look at our portfolio on the supplement we have a lot of 3.5 and 4, so for us have a yield of 4.1 and almost and 5 par even at discount on agencies, which as you know just doesn't happen, so there was a bump clearly in the fourth quarter that didn't recur in the first quarter. I don't have it exactly in front of me; I think we are closer to a 3 or 3.1 on the agency yield, which is probably a more normal run rate.

Okay and then last one…

Competitively.

That makes sense. The last one…

Just to add to, compared to our peers, if you look at our Agency portfolio versus others, I think our gross yields and spreads are just as good, if not better than anyone else.

No, I would agree. Last quarter you got rid of the economic book value, is that because the appreciation has caught up so that there is much difference between GAAP and economic anymore?

There are a few reasons for that, one is obviously the companies have some pressure on non-GAAP measures. That was one reason and the other pieces is, a lot of the deals that we are doing now are the risk retention bonds and when you look at the old disclosure we talked about bonds that we’ve retained that we can sell or otherwise liquidate, that is really no longer the case. So, those are the main two drivers of why we took that disclosure out.

Alright, thank you guys very much.

Your next question comes from the line of Steve Delaney of JMP Securities.

Hi good morning everybody, congratulations on the first quarter whole in transactions, and if I may, I just wanted to follow-up on Trevor’s question and touch on one or two other quick things on the capital structure, if I could, so you’ve had good success obviously with the retail preferreds, with the 8% coupons, I am just curious looking at some other transactions that we have seen in the capital markets in recent months, would you also consider supplementing your common equity with unsecured senior notes or possibly convertible notes in the 5 year to 7 year range and think they would come in with coupons below your 8% preferreds? Just curious, your thoughts on the corporate debt.

Yes, thank you for the question Steve. Yes, the things that have been on the table we have looked at them in the past, and I think we are always out trying to figure out the best way to optimize both sides of our balance sheet. So those are, I think some of those are very interesting transaction. My gut is that like all credit spreads they are probably, the coupons are those that are going to come into.

Yes, we have seen in everywhere, it’s hard to find yield, right? And then the last thing, obviously I am sure you guys noticed that we saw a very, one of the larger mortgage REITs rang a really good size follow-on last night, primarily with the intention of investing in Agency CMBS, so I am not going to ask you Matt if you plan to issue common shares that would be inappropriate, but I'm going to phrase it this way, if you were to consider issuing common shares, would you and the team need to see a fairly immediate investment opportunity beyond just the Agency CMBS space?

Well, I think let me just say that we raised in the last six months about $470 million worth of preferred shares, which is a lot for a company with $8 billion [ph] of expenses. And we are having have not raised go put on Agency CMBS or do anything like that, we're being very consistent and deliberate about how we go about add to our portfolio and as an internally managed company, we are in this - for the long haul, and for me - the most important thing is for me to be able to put good assets on the books that are going to be with us forever. And that’s job number one, so I don't see any real reason for us to go out and the question is to go buy agencies, I don't see that as something that I have an access to do them at all.

Obviously, we have raised the preferred and looked at the capital's back and our very thoughtful with that as a way. Obviously the preferreds are permanent whereas the converts have a five or seven year refinance risk to it. So, we thought from a evolution to the capital's like having those in place is important, with call features in them, so we do have some flexibility, but all those types of deals, preferreds, converts, senior notes I think given the way we’ve been investing they will all be accretive to the common, which is our goal as we are investors alongside with all of our institutional and retail investors.

Those comments are great and it looks like you guys have a lot of flexibility on where you can turn. So, I appreciate the answers this morning.

Thanks Steve. We are in a good spot. Thank you.

Yeah.

At this time, there are no further questions. I will now return the call to Matt Lambiase for any additional or closing remarks.

Well thank you very much for participating in our first quarter earnings call, and I just like to thank my investment team and management here. We're working to build our portfolio for the future, and I think we are on the right path, and I look forward to speaking to you next quarter.

Thank you for participating in the Chimera first quarter 2017 earnings conference call. You may now disconnect.