Chimera Investment Corporation (CIM) Q4 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation’s Fourth Quarter and Full-Year 2019 Earnings Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speakers’ 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 Relation. Please go ahead.

Thank you, Maria, 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 Factors section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statement disclaimer in our earnings release in addition to our quarterly and annual filings.During the call today, we 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.

Good morning and welcome to the fourth quarter 2019 earnings call for Chimera Investment Corporation. Joining me on the call this morning are Mohit Marria, our Chief Investment Officer, Rob Colligan, our Chief Financial Officer; Choudhary Yarlagadda, our Chief Operating Officer; Vic Falvo, Chimera's Head of Capital Markets.I'll make some brief comments, then, Mohit will discuss the changes in the portfolio. Rob will then review our financial results, and afterwards, we'll open up the call for questions.Before we get started, I'd like to point out that $0.07 of our core earnings in the fourth quarter came from one-time gains on securities that were called away from our portfolio. The gain was a result of legacy non-agency bonds that we won at a discount, getting called away from us at par and from prepayment penalties that we received on Ginnie Mae commercial loans.Non-agency mortgage-backed securities have clean up calls, which can be exercised when the upstanding loan collateralization in a securitization falls below a certain threshold. As our portfolio of legacy non-agency bonds gets older, the underlying deal factors get lower and it becomes more likely that these cleanup calls will occur.Cleanup calls, however, can also create one-time losses when interest-only bonds or IOs get redeemed sooner than originally expected. Given the low interest rate environment and the strong market for residential mortgage loans, I would expect to see one-time gains or losses in the quarters ahead, and we will highlight them in our earnings announcements going forward.In the fourth quarter, Chimera posted a total economic return of 1.7%, and we had a 14.1% total economic return for the full year of 2019. I'm very pleased with these results as we successfully managed our portfolio through a very difficult market, taking advantage of improving conditions now and adding to our portfolio.As I've discussed on previous earnings calls, repo rates for much of 2019 were elevated while other interest rates fell. In the fourth quarter, we finally started seeing our repo funding costs decline and to begin to reflect the Federal Reserve rate cuts. The yield curve also steepened in the period, which helped us slow our prepayment expectations and reduce our amortization costs.Lower funding costs and slower amortization contributed to the increase in our net interest margin for the period. Looking ahead, we anticipate the Fed will be on hold, and that our funding costs should remain relatively stable at these lower rates. As interest rates fell in 2018, prepayment rates on agency mortgage-backed securities increased, we were successful in redeploying these agency pay-downs and some sales into new investments in residential credit.In the fourth quarter, we added $1 billion in seasoned reperforming loans to our portfolio, bringing our total loan purchases for the full year of 2019 to $2.3 billion. We have a well-established history of issuing more mortgage securitization and the demand for the bonds from our securitization remains strong. In the fourth quarter, we completed five securitizations totaling $1.8 billion. And for the full year, we completed 10 securitizations. Selling senior notes from our load securitizations enabled us to lock in term financing and create high-yielding, long-term investments for our portfolio. The sound underlying fundamentals of the U.S. economy such as low unemployment, attractive mortgage rates, and a lack of housing supply makes us believe that residential mortgage credit should continue to perform well.As we look to the New Year, we feel good about our portfolio. The investment team continues to source new loans for purchase, Chimera’s existing loan securitizations continue to perform well, and funding costs are lower and stable.Beginning in 2020, we will adopt new CECL or current expected credit loss accounting rules, which will reduce some of the yields on our legacy non-agency bonds. However, this is a relatively small part of our balance sheet, and we do not feel that these accounting changes will hamper our ability to pay an attractive dividend. Accordingly, last night, the Board of Directors announced the first quarter dividend of $0.50 per common share, and that it expects to pay $2 in common dividends for the full year of 2020. This is the fourth consecutive year that Chimera has announced its intention to pay $2 in annual dividends, which I think underscores the quality of the portfolio and the stability of the cash flows that we create for securitization. I continue to believe that our balance sheet is well-positioned to benefit from the strong U.S. economy, and we're all optimistic of our prospects for the year ahead.And with that, I'll turn it over to Mohit to talk about portfolio.

Thank you, Matt.2019 was a volatile year in the fixed income markets. 10-year treasury notes began 219, yielding 2.68% and fell to a low 1.46% in early September, before rising again in the fourth quarter to end the year at 1.92%. The short end of the yield curve was also quite volatile. Two-year treasury notes began the year yielding 2.49% and fell to a low of 1.39% before closing 2019 at 1.57%.The two 10-year U.S. treasury yield curve was about 15 basis points steeper year-over-year, and the Federal Reserve cut overnight funding rates 3 times for a total of 75 basis points. For much of the year, repo rates were much stickier, have taken a longer time to fall. In recognition of the September, the Federal Reserve began adding liquidity to the repo markets.At year-end, Chimera’s average cost of repo borrowing from agency securities was 2.1%, down from 2.28% at the end of the third quarter, and down 45 basis points from 2.55% for the same period in 2018. As there are staggering maturities in the repo financing, rate movements are not immediate, take time to improve. Based upon current repo rates so far in 2020, we're constructive on further cost improvements for our agency financing. This year's large drop in interest rate carried over to the mortgage markets and U.S. homeowners rushed to refinance their mortgages, causing elevated prepayment rates on agency mortgage pass-throughs. Through a combination of sales and paydown, Chimera’s agency pass-through ended the year at $6.1 billion, down from $9 billion at the end of 2018.As we have stated in past earnings calls, we view the liquidity offered in agency securities not only as a source of spread income but also as a source of capital to redeploy into mortgage credit assets when attractive investment opportunities are available. We diligently reinvested these agency paydowns into reperforming residential mortgage loans.For Q4, we settled down about $1 billion in mortgage loan and a total of $2.3 billion in seasoned reperforming loans for all of 2019. Many of these loans have been securitized. And as of year-end, we are carrying $1.2 billion in our loan warehouse, most of which is being held with intent for future securitization.Chimera had a very active fourth quarter in securitizations. We closed five transactions totaling $1.8 billion in underlying loans. Four were reperforming loan deals and one was Prime Jumbo loan deal.Form our warehouse, we securitized $464 million reperforming loans in CIM 2019-R2. This deal was rated by Moody's and DBRS. The loan collateral had a weighted average coupon of 4.6%, and the weighted average loan age of 152 months. The average loan size for the R2 deal was 136,000 with an average FICO 644. Chimera sold 358 million bonds, providing a 2.6% cost-of-debt. We continued with our securitized loan portfolio optimization and called CIM 2016-4. The loans were then relevered into $343 million CIM 2019-R3. The deal was unrated and had a weighted average coupon of 6.8% and a weighted average loan age of 161 months.The average loan size of the R3 deal was 72,000 with a FICO of 661. Chimera sold 291 million bonds, providing a 2.6% cost-of-debt. The previous securitization had debt cost of 4.9%. So, through optimization afforded by our call strategy, we saved approximately 225 basis points in refinancing with CIM 2019-R3.The R3 deal was the second time relevered from our 2014 Springleaf purchase. Our ability to relever these loans has benefited our portfolio of further reinforcing the proof-of-concept of Chimera's optimization and call strategy. CIM 2019 R4 and R5 were also issued from existing reperforming loans in our warehouse. CIM 2019-R4 was a 321 million non-rated yield. The underlying loans had a weighted average coupon of a 6.2% with a weighted average loan age of 158 months. The average loan size on the R4 was 159,000 with the FICO of 621. Chimera sold 257 million bonds with the debt cost of 2.8%. And we also securitized 315 million loans in CIM 2019-R5. This deal was also rated by Moody's and DBRS.The R5 had a weighted average coupon of 5.4% with the weighted average loan age of 152 months. The average balance of the loans was 168,000 at a FICO of 661. Chimera sold 252 million bonds with the debt cost of 2.8%.And lastly, for securitization this quarter, Chimera did a second prime jumbo deal of the year. We issued 338 million CIM 2019-J2. The deal with new collateral only two months old and had a weighted average coupon of 4.1%. The average loan size for the J2 was 766,000 with the FICO of 766. The loans had an average LTV of 70%. The prime jumbo deal is not consolidated on our balance sheet.2019 was a very strong year for our portfolio. It was a combination of securitization, portfolio optimization and capital allocation strategies, we successfully navigated 2019’s market volatility and drop in interest rates. Our agency pass-throughs provide a liquid source of capital for loan purchases, our agency CMBS portfolio performed as expected, and Chimera’s mortgage credit financing strategy through securitization has enabled us to lock in longer term financing and more consistent spreading income for our portfolio.Market demand for fixed income spread product remains strong in 2020. Notes issued from CIM shelf have performed well for investors and the CIM shelf is recognized as a consistent issuer for senior mortgage-backed securities. We have loans available in our warehouse for different types of securitizations and we have in excess of 5 billion of existing CIM securitizations that have called it in the calendar year 2020. As always, we will monitor the CIM deals. And as they near their call dates, we will evaluate economic potential for portfolio improvement through our optimization and call strategy.I will now turn the call over to Rob to review the financial results.

Thanks, Mohit.I’ll review Chimera’s financial highlights for the fourth quarter and full year 2019.GAAP book value at the end of the fourth quarter was $16.15 per share and our economic return on GAAP book value was 1.7%, based on the quarterly change in book value in the fourth quarter dividend per common share. Our economic return for the year was 14.1%.GAAP net income for the fourth quarter was $112 million or $0.60 per share and $341 million to $1.82 for the year. On a core basis, net income for the fourth quarter was $120 million or $0.64 per share, and $421 million, or $2.25 per share for the year.We had approximately $0.07 of income in the fourth quarter that was derived from securities, primarily held at a discount and were called during the quarter. While it may occur from time to time, we don't expect this level of income every quarter and in some quarters we could have a loss related to interest-only securities that are called. We will provide details on this income whenever it becomes material to quarterly earnings.Economic net interest income for the fourth quarter was $164 million, and it was $597 million for the year. For the fourth quarter, the yield on average interest earning assets was 5.5%. Our average cost of funds was 3.1% and our net interest spread was 2.4%. Total leverage for the fourth quarter was 5.5 to 1, while our recourse leverage ended the quarter at 3.4 to 1. For the quarter, our economic net interest return on equity was 15.3% and our GAAP return on average equity was 10.6%. Expenses for the fourth quarter, excluding servicing fees and transaction expenses were $18 million, down slightly from last quarter.That concludes our remarks. And we'll now open the call for questions.

Thank you. [Operator Instruction] Our first question comes from the line of Doug Harter of Credit Suisse.

Thanks. Just hoping you could give us a little more detail on the -- on that pipeline of potential callable deals. I guess, just, how we should think about the pacing of that over the course of the year? And if the relative cost of funds saving -- how the relative cost of -- potential cost of funds savings would compare to kind of what you were able to accomplish in the fourth quarter?

As mentioned in the opening remarks, we have eight deals that are callable in 2020, totaling about $5 billion of UPB in terms of loans. The securitized debt issued against those is just over $3 billion. And I think, based on what we were able to achieve in Q4 and the strong bid for the market in Q1 at least, and we’ll see if it carries forward for the remainder of the year, via cost savings on that debt, new issued debt of over 150 basis points. So, a pretty strong savings on that issuance, potentially.

Great. And then, I guess, you were able to buy kind of legacy loans and also jumbo loans in the fourth quarter. I guess, as you look out at kind of the relative attractiveness of those two potential asset classes, I guess, how do they -- how do they compare today, kind of where do you see the opportunity for incremental capital deployment?

Sure. Again, I mean, I think we've said on numerous earnings calls that we still find the season reperforming loan space very attractive, still given where we could finance -- term finance our debt, the back end equity pieces have double digit returns. The convexity profile is a lot better than new issue origination, seeing what happened in 2019, as rates rallied significantly, prepayments both on the agency portfolio picked up significantly, and we've seen some of that on the new issue prime jumbo and investor deals as well.So, we still like the RPL space. We still think there's ample supply coming from the GSEs and some money center banks. But having said that, we're always evaluating and we want to do new issue business as well. And if the jumbo and industry space looks attractive and the levered returns are accretive, deploy capital there as well.Of the 10 securitizations we did in 2019, 5 were on newly originated collateral and 5 were on seasoned reperforming deals, but with a balance of almost 50-50 and even on UPB basis, and we're hoping some more success in 2020.

Thank you, Mohit.

Our next question comes from the line of Eric Hagen of KBW.

Hey, guys. Good morning. Thanks for the CECL disclosure. I know that it will reduce your forward yields. And I realize that the impact is relatively minor. But, is there also a reserve charge that gets reflected in your book value at the time that CECL became active or is the only impact the forward yield adjustment?

The only impact for us is the forward yield adjustment. I'm sure you're looking at a lot of the banks and maybe some other companies that do have some credit reserve, like a day one credit reserve, but because most of our securities that are impacted, which you are right the small corner of our balance sheet that's impacted, most of them are at -- have an unrealized gain. There's no requirement for us to put up any reserves.

And then, just the legacy loan -- low balance loan trade has obviously worked out really well for you guys. Just how big do you think the legacy low balance market is at this point? Or I think, a better question is just how active do you think the trading from other asset managers is going to be in that market going forward?

Yes. We've been able to successfully aggregate a large portfolio of low loan balance. If you look at some of the stats mentioned on the securitization sum this year, the balances are significantly higher than the $85,000 to $90,000 that we were able to aggregate in both, in ‘14 and in ‘16. The average balance of what we're acquiring now ranges anywhere from 150,000 to 285,000. I think more of the RPL stuffs that are coming out of the GSE is reflective of that. So, yes, it's still low loan balance, relatively jumbo production is, but -- and the convexity profile remains similar on a $250,000 loan as it is on a $85,000 loan, given the sort of seasoned reperforming nature of them.

Okay. Thanks for that. I'm just trying to gauge how big the market is or how big the -- how active the turnover is in that market? I think, you just responded to Doug's question that a lot of it's coming from banks and the GSEs. But, can you quantify how much -- how big that market is at this point or how…

If we adjust the GSEs alone between alone between Fannie and Freddie, probably still have north of $1 billion -- $100 billion of seasoned reperforming loans that they need to tear down. And that's assuming no new loans enter the reperforming space, something that’s a fall, but they have to work through. So, if the portfolio remains static, I think it's still north of $100 billion that they would need to dispose off.

Okay. And then, one more for me. I mean, a fairly good chunk of your dividend was characterized last year as a return of capital as opposed to ordinary dividend. Is that simply a timing difference between recognizing positive marks on subordinated securities as they pull the par, and the taxable impact is just occurring later in time? And I realize book-to-tax reconciliations can sometimes be a little complicated. I just want to get a sense for what drives that characterization for you guys?

Sure. The other piece of color, there is always timing differences between GAAP and tax. But, we did have some losses on our hedges that are taken upfront for GAAP, obviously removed from core, but are taken over time for tax. And that's one of the bigger drivers of the core to tax difference this year.

Yes. And I would just add that the tax numbers, one moment in time, it's a very complicated, like to your point, it’s very complicated calculation. And I don't think it gives a lot of meaning to the business. I think, you'd have to look at it over a very long period of time, and I'm not sure what you would learn from it. It's -- I would just take it for the not for a forward looking measure.

Of course, just wanted to get a sense for what drove that characterization. So, thank you. Thanks for the comments, guys.

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

I think, you have mentioned in the prepared comments that you benefited in the fourth quarter from slower prepay speeds on the agency book. And it looks like the yield on the agencies picked up a decent amount this quarter. Could you provide some color on how you're thinking about that going forward with the rally in rates we've seen so far in 1Q? How much you think speeds may pick up in 1Q and going forward, especially relative to kind of how fast they got during the fall of last year. Thanks.

This is Mohit again. Speeds slowed down just due to seasonal factors right now. But, as the market has rallied in the 30 basis points from year-end through today, we do -- with spring approaching we think speeds will pick back up. I don't think they get back to the same level that we saw in the fall September, October from the lows hit in August. But, we do think speeds will pick up from where we are here in Jan and Feb marginally.

Then, the second question, the income that was generated this quarter from the legacy securities, which are called, and I guess some of it was also penalty income on the CMBS. Could you provide any additional color in terms of -- especially the legacy securities book in terms of how much of that you estimate is currently callable, just so we can sort of get a sense on how much of those gains might be coming through in the future? Thanks.

Sure. It's hard to estimate the exact timing of that type of income. You have certain deals where you don't expect them to be called than they are, and other ones where they'll have a bond with a very low factor and you expect it could be called at any time and it isn't. What I can say, a fair amount of our non-agency portfolio is in that category, the older legacy items. But, I can say, we have way more discount or positive income coming than premium on IO. So, over time, we should have a very good positive impact, although it could be up or down quarter-to-quarter.

Our next question comes from the line of Kenneth Lee of RBC Capital Markets.

Hi. Thanks for taking my question. Just a quick follow-up on that last question in terms of the callable securities. I realize it's probably hard to forecast from quarter-to-quarter in terms of where they could see gains or losses. But, could you just tell us maybe under which macro assumptions or interest rate levels could you see a little bit more losses within the IOs, or conversely, more gains on the other securities, just in terms of the backdrop regardless of the actual, obviously behaviors? Thanks.

Good morning, Ken. I think, it's going to be less dependent on rates. I mean, a lot of these securities were issued in ‘05, ‘06, ‘07. So they’ve had the ability to sort of refinance if they could, and why a lot of these securities are impaired. But, as just normal amortization, these deals continue to factor down. Other deals have a 10% to 20% deal cleanup calls, which they're approaching as these deals continue to delever, which is why some of these deals have been called over the last year more meaningfully in Q4 of this past quarter. We think, there's a lot of factors that go into making something callable. Just as we look at our securitizations, there's the cost of the call where you could refinance. And given the strong bid for loans that we've also discussed over the last several quarters, that execution is helping achieve or making a lot of these legacy deals more callable.

And just one follow-up, if I may, wondering if you could just highlight some of the key drivers for the movements in the book value per share sequentially in the quarter?

Yes. On the credit side, spreads were effectively unchanged quarter-over-quarter, maybe slightly lighter. The biggest driver of the lower book value was the change in rates, the market sold off roughly about 30 basis points from September 30th to December. And that puts some pressure on book value. But year-over-year, the book value is still higher, which is sort of the bigger takeaway given the volatile markets.

Our next question comes from the line of Matthew Hallett of Nomura.

Thanks, guys. Did you give a cadence on the agency MBS portfolio? Maybe as repays come in, is that book good to continue to run down and the capital reallocated?

Yes. I mean, as we mentioned in the opening remarks, the pay-down sales we have for the year in the agency portfolio have been redeployed in our loan investments and that equity base there has grown as a loan portfolio. If we continue to see opportunities, as we’ve said on prior calls, that is resource of funding for those acquisitions.

Okay. And then, with the recourse -- the leverage comes down obviously naturally as you use presumably higher leverage in that book. So, when we look at the Company's capital -- excess capital position, is that improving as the agency book runs down or is it - do you look at it sort of as a wash with redeploying at lower leverage, credit strategies. I mean, I guess, how do you look at just the excess capital position of the company today at 3.4 times economic leverage?

Matt, I think, we just view it as a lot. Right? Most of that capital is being deployed into loans and we've had a lot of success acquiring loans over 2019. We've bought over $2 billion. We're hoping for similar success in 2020. And given the pay-downs we’re achieving on the pass-throughs, that should help fund those acquisitions and keep leverage forward.

Another follow-up, just on the issue market, and I asked you last quarter, I want to ask again, new issue, you guys are active but doesn't seem like you're active in non-QM. Clearly that market’s doubling again this year. Can you give us an update on anything you're looking at that asset class?

Yes. I think, as mentioned on the last earnings call that’s the market we look at all the time, we look at where issues are coming in. As I mentioned, the convexity profile of that product is --gives us some pause, given the premiums needed to acquire those loans. Speeds have been elevated and the premium erosion is there. So, we are sort of cautious on adding that. The convexity profile of the loans we've been able to acquire over $2 billion is far superior and the levered returns on what we retain more than meeting the dividend that needs to be paid out. So, we continue to evaluate it. But, we've had a lot of success on continuing to acquire RPL loans. And on the new issue front, as we’ve mentioned, we did five newly originated collateral deals, both jumbo and investor loans, where the subs are also very attractive from a return-on-equity standpoint.

And just to reconfirming, mid-to-low teens you're saying on a net levered return?

I would say, low-to-mid teens.

Low-to-mid teens? Got it. Okay. It's pretty attractive. Okay. Then, next question, the $10 billion of 1 to 2019 repo at 12/31. I know, you give us some general numbers but where did that roll at over the last 45 days? Where did it go? Where was it? And where did it roll at?

Yes. As we mentioned, the cost of our agency funding at year-end was 2.10. And we were going to see if there was any disruption as we had at the end of 2018. But, the Fed injected a lot of liquidity, over $500 billion of cash in the market to make sure that didn't get volatile. But, as we entered Q1 of 2020, our repo rates have been pretty stable. I mean, you see where one month LIBOR is and financing is a few basis points above that. So meaningfully about where Fed fund target is, but again lower than where we ended Q4 of ‘19. So I would say, in the 1.75 to 1.80 area range.

Got it. Great. Thanks a lot. I appreciate it.

Our next question comes from the line of Lee Cooperman of Omega Family Office.

Thank you. You guys continue to execute very well. I appreciate that. Hate it for, we have followed the policy of holding a dividend flat and preferring to buy stock back whenever it's traded at or below book value, very understandable. Because of the fine job you guys have done, stock has a meaningful premium to book. Going forward, how do you intend to employ capital as it regards dividend increases, supplemental dividends or stock repurchase?

Well, I think right now, we think the balance sheet and our capital is pretty right sized, for the business opportunities that we're seeing. I think we have plenty of dry powder, if you will, in our agency book of business that we can deploy into residential credit when we see opportunities. And that's what -- I think, the team has been doing a great job of finding out those opportunities. I don't know if we would buy back stock at the prices in the market right now. And I think, if we had the excess income, I think you do a special dividend, if we had that.

You don't have any excess income now that would require a special dividend?

No. And I think going forward, if we get to a situation where you do you, we would certainly favor that of buying back stock at the current price.

Congratulations. You guys are doing a very fine job for the shareholders. Thank you.

Thank you, Lee. I appreciate that very much.

Thank you. That was our final question. I will turn the floor back over to Matthew Lambiase for any additional or closing remarks.

Well, thank you all for participating in the Chimera Investment Corporations fourth quarter 2019 earnings call. And we look forward to speaking to you later in the year with the first quarter’s earnings.

Thank you, ladies and gentlemen for joining us for today's Chimera Investment earnings conference call. You may now disconnect your lines at this time, and have a wonderful day.