Chimera Investment Corporation (CIM) Q4 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation Fourth Quarter and Full-year 2018 Earnings 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, Nicole, and thank you everyone for participating in Chimera's fourth quarter and full-year earnings conference call. Before we begin, I'd like to review the Safe Harbor statements. During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties, which are outlined in the Risk Factor section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statement disclaimer in our earnings release in addition to our quarterly and annual filings. During the call today, we may also discuss non-GAAP financial measures. Please refer to our SEC filings and earnings supplement for reconciliation to the most comparable GAAP measures. Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information. I will now turn the conference over to our President and Chief Executive Officer, Matthew Lambiase.

Thank you, Emily. Welcome to the fourth quarter 2018 Chimera Investment earnings call. Joining me on the call this morning are Mohit Marria, our CIO; Rob Colligan, our CFO; Choudhary Yarlagadda, our COO; and Victor Falvo, Chimera's Head of Capital Markets. I'll make some brief comments, then Mohit will review the activity for our portfolio, and Rob will go over the financial results. Afterward, we will open up the call for questions. The fourth quarter was one of the most volatile periods in recent memory, due to fears related to Brexit, Italy's monetary problems, China-U.S. trade tariffs, and U.S. government shutdown, as well as some economic data which seem to imply the U.S. economy's growth starting to slow. Our markets final kick in the shins occurred on December 19 when the Federal Reserve increased the federal funds rate for the fourth time in 2018 by 25 basis points. These factors helped send investors into a risk off-mode driving the S&P 500 down 9.2% in December. It was the first worst December for U.S. equities since the great depression. Like equities, the fixed income markets also experienced great volatility in the fourth quarter. Ten year U.S. Treasury notes hit a seven-year high of 3.24% in November, then, rallied significantly to close the quarter at a 2.68% yield. The surprising reversal in treasury yields in the relatively short period left most of the fixed income market struggling to keep up and most sectors under-perform the price action of treasuries. Chimera's portfolio was not immune to the market dislocation in the fourth quarter. As most know, mortgage-backed securities did not perform well, and markets experienced high volatility due to the embedded prepayment options in mortgage. As rates rallied into the close of 2018, we witnessed spreads on agency mortgage-backed securities widened comparable duration U.S. treasuries and interest rate swaps. Additionally, Chimera's agency CMBS portfolio experienced increased spread volatility due to the impending and ultimate partial closing of the U.S. government. The uncertainty of the government's shutdown relating to how the FHA would handle construction loan draws caused Ginnie Mae CLC yield spreads to further widen in the fourth quarter. As you would expect, a longer duration of these assets experienced more price volatility and residential agency MBS pass-throughs. While we are not happy with the price action in the quarter, we think the current market represents a buying opportunity, and we are actively looking to add to our agency CMBS portfolio. Although this was a tough quarter for Chimera's book value, we believe our asset mix and risk profile will continue to deliver solid returns for our investors. This market volatility has impacted asset and liability pricing in the short-term, these price movements have had no impact on our high-yielding non-agency portfolio. Both our non-agency and loan portfolios remain strong and continue to perform better than our projections made at initial investment. For the full-year of 2018, Chimera had many achievements. Despite a difficult fourth quarter market environment, Chimera generated a positive 6.2% total economic return for the full-year of 2018. Chimera successfully raised $260 million Series C Preferred, and subsequent to calendar year-end we raised another $200 million Series B Preferred stock. All preferred shares carry dividend rates below our common stock. Chimera completed nine securitizations in 2018, of which, four represented successful re-securitizations of previous Chimera deal. Loan securitizations continue to be a key differentiator for Chimera amongst our peers, and produces good consistent stream of core earnings for our portfolio. Chimera has increased its holdings of agency securities, serving our shareholders by generating good spread income while also providing the added benefit of liquidity for our investment portfolio. Last night, our Board of Directors declared the first quarter 2019 dividend of $0.50 per share, and consistent with the past, our Board announced its intent to pay $2 common dividend for the full-year of 2019. As I stated on previous earnings calls, the end of tightening cycles can bring periods of high volatility, and we believe this will continue until the Federal Reserve sets a clear direction and the global political risks get sorted out. Our balance sheet continues to generate consistent core earnings, and remains flexible to adapt to the market condition. Chimera's high-yielding credit portfolio and large liquid agency portfolio puts us in a strong position to continue to generate good dividend income for our shareholders. I will now turn the call over to Mohit to discuss the portfolio activity in the period.

Thank you, Matt. The fourth quarter of 2018 did indeed represent a period of increased interest rate and spread volatility in the fixed income market. Interest rates initially rose in the quarter, but rallied dramatically in December, leading to significant spread widening across fixed income products. The Federal Reserve raised short-term interest rate for the fourth time in 2018, which was the ninth time since the beginning of this cycle of monetary tightening. As we move into 2019, the Federal Reserve has taken a slightly more dovish stance and Chairman Paul [ph] has recently stated the case for raising rates has weakened somewhat. We believe the Fed will remain data-dependent in their approach to the Fed policy and anticipate one rate hike for 2019. December's stock market volatility caused the flight to safety amongst many investors leading to strong price performance in U.S. treasury bonds. This sharp movement in rates and spreads, while somewhat painful for existing positions and year-end book value, it provides a good backdrop for future investments and can lead to good opportunities as we look ahead into 2019. It is important to note that the changes in book value over the past quarter is a direct result of these sharp interest rate changes, spread movements, and their impact on hedge positions, and the fourth quarter decline in book value was not a result of unexpected credit losses in the portfolio. Lastly, the repo markets operated as business as usual in the fourth quarter with the uptick in price volatility. Chimera securitized loan and non-agency securities continue to perform well in our portfolio, while still maintaining a strong conviction in future credit performance for seasoned small balance loans. We were able to purchase two separate loan packages in the fourth quarter, totaling roughly $328 million with a combined profile of $68,000 average loan balance, a 5.8% weighted average coupon, and nearly 10-years of seasoning. The age, coupon, and loan size of these purchases have many of the same characteristics of loans currently held in our portfolio. And we expect prepayments, defaults, and severity profile of these two purchases to be comparable to Chimera's existing $13 billion seasoned low loan balance portfolio. These recent purchases are currently being financed on our warehouse lines at accretive rates to our portfolio. We will continue to monitor the fixed income markets for opportunities to securitize these loans and lock-in long-term spread income for the portfolio. Portfolio team continues to be active optimizing our previously securitized debt liability. During the fourth quarter, Chimera called $460 million of CIM 2015-4AG, and refinanced into $478 million of CIM 2018-R6, by selling $335 million in senior debt for the coupon of 3.36%, reducing our financing costs by over 100 basis points. In late September, Chimera raised $260 million in capital by issuing Series C 7.75% fixed to floating rate preferred stock. Most of this new capital was deployed into agency pass-throughs in October as spreads on those securities began to widen. In total, we deployed on a hedged basis, $2.4 billion in newly-originated Fannie Mae 4% securities, and $366 million in agency CMBS. Chimera's agency portfolio now stands at $11.9 billion current phase, and consist of $9 billion of residential agency pass-throughs, and $2.9 billion of agency CMBS. Agency investments now represent 45% of Chimera total assets. This is our highest percentage of agencies since the first quarter of 2016 and early to mid 2014 period. Chimera has a hybrid REIT, has a long history of shifting its portfolio amongst agency and credit investment as we see changes in relative value and long-term residential credit investment opportunity. In 2014, Chimera used the agency portfolio as a source of liquidity to make the long-term investment in their spring lease portfolio, and over time, we optimized our initial investments through two full cycles of securitization. In 2016, Chimera again used the agency portfolio as liquidity to purchase large lots of low loan balance seasoned performing whole loans. The 2000 securitizations become callable and potential refinance and optimization opportunities beginning mid 2020. The hybrid model provides rate flexibility for maximizing market opportunities and asset allocation, liability management, and successful capital raises like Chimera's four separate preferred stock issuances. Our portfolio team continues to believe that leveraged agency MBS represent good value and provide both good spread income and increased liquidity for our investment portfolio. We continue to seek our agency CMBS for long-term investments and actively look for credit investment opportunities to add to our portfolio. We believe we are well-positioned with complementary balance of agency and credit investment as we head into 2019. I will now turn the call over to Rob to review the financial results.

Thanks, Mohit. I will review Chimera's financial highlights for the fourth quarter and full-year of 2018, GAAP book value at the end of the fourth quarter was $15.90 per share, and our economic loss on GAAP book value was 3.7%, based on a quarterly change in book value and the fourth quarter dividend per common share. Our economic return for the year was 6.2%. GAAP net loss for the fourth quarter was $117 million, compared to $147 million of net income last quarter. For the year, GAAP net income was $368 million compared to $491 million last year. On a core basis, net income for the fourth quarter was $109 million or $0.58 per share, down slightly from last quarter. Securitization deal expenses were $4 million in the fourth quarter compared to $1 million incurred in the third quarter. For the year, core net income was $440 million consistent with core income earned in 2017. Economic net interest income for the fourth quarter was $154 million, up from $148 million last quarter. The increase in net interest income relates primarily to the increase in Chimera's agency portfolio partially offset by higher financing costs. For the year, economic net interest income was $593 million, up from $589 million last year. For the fourth quarter the yield on average interest earning assets was 5.7%. Our average cost of funds was 3.6%, and our net interest spread was 2.1%. Total leverage for the fourth quarter was 6.1 to 1, while recourse leverage ended the quarter at 3.8 to 1. For the year, our economic net interest return on equity was 16%, and our GAAP return on average equity was 11%. Expenses for the fourth quarter excluding servicing fees and deal expenses were $16 million, up from the third quarter related primarily to increased equity-based compensation and the increased legal and diligence cost related to loan pool acquisitions. This concludes our remarks, and we'll now open the call for questions.

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

Hi, thanks. Good morning. First question, you guys talked a bit about the spread widening across most asset classes obviously, but particularly the agency sector. Could you expand a little bit on how you're thinking about the opportunity in terms of deploying capital, in terms of agency CMBS versus agency RMBS, and also maybe add a little bit of color in terms of which particular sector of the agency CMBS market you're looking at is a value? Thanks.

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

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

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

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

All of those, the prime jumbo, non-QM, rated RPLs, non-rated RPL transactions.

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

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

Okay, perfect. That's helpful. Thank you.

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

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

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

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

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

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

Correct, yes.

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

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

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

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

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

Got it, great. Thanks for the color, guys. Appreciate it.

[Operator Instructions] Your next question comes from the line of Steven Laws with Raymond James.

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

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

Okay, thanks for that color. And I guess more from the macro side, I think a lot of the portfolio questions have been asked. But certainly the interest rate outlook from here is different than maybe what the market expected with it was pricing in six to 12 months ago. Has that changed your strategy at all as that rate forecast has changed, how has the impacted both what you're doing on the portfolio side as well as on the financing costs. If you maybe talked a little bit about how you've responded to that change and interest in outlook?

I'll start with the portfolio side first. I mean, most of what we own are fixed rate assets, and we've issued both floating rate liability [indiscernible] in the securitizations we've done. We had spent the better part of 2017 and '18 switching from fixed to floating given sort of the expectations of what the fed may do, it did go for a time, so we were able to lock in fixed rate liabilities on the vast majority of the '17 deals than a lot of the '18 deals. But the last securitization we did in October of '18, we did keep it as a floating rate securitization given our outlook on what the fed was going to do for the remainder of 2018 as we head into '19. On the liability side, just our repo funding, given the view on the Fed, I mean we've kept some of our agency repos shorter in duration, given this Fed mismatch between one-month and three months LIBOR. So we've brought down the days, the maturity under repo significantly over the year, given I think it was about 25 basis point difference in one-month three months funding rates currently. And as that converges based on what Paul had said in the late-Jan meeting, I think we could extend that backyard longer as the difference between the rates closes in.

Great. Thanks a lot for taking my questions, I appreciate it.

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

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

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

Great.

And on the single-family rental side, again, we're looking at that product, but the residential transition loans offer more spread currently on the levered basis.

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

So, the loan spreads have widened out with sympathy with everything else, but -- so has the securitization market for other people's issuances. So we could buy new issued product in the market that's issued by others, like I said the spreads there have lined up more materially than the loan pricing has done. So, on the rated side stuff is widened from mid-50 to close to 120 to 125, and on the non-rated side, stuff is lined from 90 to 155 in the last three to four months. I think both look attractive to us. That's where we could find product to invest in.

All right, thanks for that clarification, Mohit.

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

Well, thank you very much for joining us on our fourth quarter 2018 Chimera Investment Corporation's earnings call, and we look forward to speaking to you in May for our first quarter. Thank you.

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