Chimera Investment Corporation (CIM) Q3 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation Third Quarter 2020 Earnings Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Emily Mohr of Investor Relations. Please go ahead.

Thank you, Laurie. And thank you, everyone, for participating in Chimera's third quarter earnings conference call. Before we begin, I'd like to review the safe harbor statement. 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 and our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. I 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 third quarter 2020 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 COO; and Vic Falvo, the Head of our Capital Market. I'll make some brief comments, then Mohit will discuss the changes in the portfolio, and Rob will review our financial results. Afterward, we'll open up the call for questions. Chimera continues to work remotely, and I'm happy to report that the team is safe and our remote work environments have been successful. Over the past 6 months, we've taken many steps to strengthen our balance sheet, protect our desirable credit assets and stabilize the earnings stream of our portfolio. These steps included selling agency mortgage-backed securities, selectively selling agency CMBS, negotiating new non-mark-to-market financing arrangements and lowering the company's overall recourse leverage. The actions taken over the period enabled us to participate in the market recovery of asset prices from the depressed levels that we experienced in March. For the quarter, Chimera's book value appreciated 12% to $11.91 per share. We generated $0.33 of core earnings, and we paid $0.30 in common dividend, resulting in nearly 15% economic return for the period. The rebound in residential mortgage prices this quarter can be attributed to a very strong housing market, which has been boosted by a generational lull in U.S. interest rates. The COVID-19 pandemic has had a dramatic effect on the housing in the United States. The market for single-family homes is thriving as many families are fleeing cities for more spacious quarters in the suburban and rural areas of the country. Families across America are seeking additional living space for home offices, home classrooms and safe outdoor environments. Accordingly, the Stanford Institute for Economic Policy Research, 42% of the U.S. labor force is currently working full time from home. Demand for single-family homes is booming. The rate of existing home sales rose in September to 6.5 million homes, the highest level since 2006. And the available inventory of existing home sales has decreased nearly 20% from the previous year to 1.5 million homes. At the current pace of home sales, all-in inventory currently on the market could be sold in less than 3 months. Much of this housing demand is driven by record-low borrowing rates orchestrated by the Federal Reserve. Since March, the Federal Reserve has increased its balance sheet by 75% to over $7 trillion, helping to provide low interest rates and ample liquidity to the mortgage market. The average rate for 30-year mortgages was recently reported at 2.8%, the lowest rate on record, which dates back to 1971. Additionally, fiscal stimulus from the federal government for COVID-19 relief has added over $3 trillion into the economy and has helped many mortgage borrowers through this difficult economic period. Both political parties in Washington are currently discussing additional fiscal stimulus packages, which, if enacted, we believe, will help continue to support troubled borrowers and be constructive for both the housing and the mortgage market. A robust housing market, paired with low mortgage rates and the government support, provide a very strong pace for owning residential mortgage credit. As of quarter end, nearly 90% of Chimera's investment portfolio was allocated to mortgage credit. The mortgage securitization market has also returned to near pre-pandemic level, and in some cases better as a result of lower interest rates and comparable advance rates. This quarter, Chimera completed 3 securitizations while committing to purchase $640 million of mortgage loans. Due to the improving housing fundamentals and better credit conditions, investor demand for highly rated senior mortgage securities is very strong. Chimera is a frequent issuer of these securities, which enables us to secure long-term, non-mark-to-market financing for our credit portfolio assets. Our investment team continues to find opportunities and is successful adding to our portfolio for future securitizations. The housing market is one of the few bright spots in the U.S. economy, and higher housing prices can contribute to better mortgage credit fundamentals. In a world of low investment returns, having a high-yielding portfolio with a favorable credit profile is an enviable position to be in. We believe that Chimera's portfolio is well positioned to take advantage of these positive trends and to continue to produce strong dividend income for our shareholders in the quarters ahead. And I'll now turn the call over to Mohit to discuss the portfolio.

Thank you, Matt. The 10-year treasury ended the quarter with a yield of 68 basis points, down from 1.92% at the start of 2020. The overall magnitude of this rate movement has generated price appreciation in 10-year treasury notes of approximately 10 points since the beginning of the year. Our agency CMBS investments over the last 5 years have primarily been Ginnie Mae project loans. These securities carry government guarantees, and due to explicit prepayment lockout and penalties, the Ginnie Mae permanent loan certificates are longer-duration assets. The price performance of these assets has greatly benefited as treasury rates have fallen. During the third quarter, we acted on the strong price performance and selectively sold $659 million securities from our agency CMBS portfolio. With the sale, we harvested approximately $65 million in gain and plan to reallocate capital into mortgage credit. The objective of the reallocation is long-term optimization of the portfolio income for the benefit of our shareholders. We continue to monitor our agency CMBS holdings relative to their market values and their explicit call protection to maintain a right-sized and optimal portfolio of our agency CMBS. Our remaining agency CMBS holdings at quarter end was $1.8 billion, comprising 10% of Chimera's total investment portfolio. The new issue market for securitized products remained strong in the third quarter, and spreads on certain parts of the capital structure have approached pre-COVID-19 levels. Tighter spreads and low absolute interest rates create compelling opportunities for frequent and well-recognized issuers like Chimera to meet investor demand for securities. For the third quarter, Chimera closed 3 securitized transactions totaling a little over $1 billion. The senior note from all 3 deals carried investment-grade ratings. In July, we issued CIM 2020-R5 with $338 million loans from our existing loan warehouse. The underlying loans in the deal had a weighted average coupon of 4.98% and a weighted average loan age of 149 months. The average loan size in the R5 transaction was $152,000 and had an average LTV of 70%. The average FICO score for the borrowers was 678. We sold $257 million senior securities from this deal and retained $81 million in subordinated notes and interest-only securities. Our cost of investment-grade debt for CIM 2020-R5 was 2.05% with a 76% advance rate. Separately, in 2 transactions, we securitized pools of prime jumbo mortgage loans and a pool of agency-eligible investor mortgage loans. CIM 2020-J1 was our first prime jumbo securitization for 2020. The deal had $362 million loans with a weighted average coupon of 3.76% and a weighted average loan age of 6 months. The average loan size was $732,000 and had an average FICO of 766 and an average LTV of 67%. CIM 2020-INV1 was our first agency-eligible investor loan securitization for 2020. This deal size was $335 million with a weighted average coupon of 4.31%. It had an average loan size of $332,000. The loans had an average FICO of 765 with an average LTV of 64%. The J1 and the INV1 securitizations are not consolidated on our balance sheet. We invested $22 million in these transactions for our non-agency RMBS portfolio. During the third quarter, we committed to purchasing over $400 million of seasoned reperforming loans. And post quarter end, we securitized the loans into CIM 2020-R6. Strong investor demand for senior notes enabled us to move quickly from purchase to securitization. The deal priced on October 30 and is expected to close in early November. We will report the details of this transaction on our fourth quarter 2020 earnings call. We continue to invest in residential business purpose loans. These loans, commonly referred to as fix and flip, provide an attractive, high-yielding, short-duration assets for our portfolio. The market for these loans continues to expand and is well supported by a positive housing market and repeat business purpose borrowers. For the year, we successfully purchased approximately $135 million in business purpose loans and ended the quarter with approximately $210 million on the balance sheet. The average coupon on this portfolio was 8.57% with a weighted average LTV of 80%. Our investment portfolio is well positioned as we approach year-end. The market trends in single-family housing are positive, and the securitization market is strong. At quarter end, we had $412 million loans on our mortgage warehouse for potential future securitizations and have ample liquidity to and opportunistically acquire new pools of loans. On the liabilities side of our balance sheet, we have taken steps this year to lower the impact of mark-to-market risk on our secured financing. Recourse leverage is materially lower on the year and currently stands at 1.3x capital. We have ample liquidity to make new investments. And as part of our call optimization strategy, we actively monitor our outstanding securitizations for optimizing our long-term debt structures. And as of September 30, Chimera has $5.8 billion of outstanding securitized debt in 16 separate deals that is either currently callable or will be callable through the end of 2021. I will now turn the call over to Rob to review the financial results.

Thanks, Mohit, and good morning. I'll review Chimera's financial highlights for the third quarter. GAAP book value at the end of the third quarter was $11.91. And GAAP net income for the third quarter was $349 million or $1.32 per share. On a core basis, net income for the third quarter was $80 million or $0.33 per share. Economic net interest income for the third quarter was $125 million. For the third quarter, the yield on average interest-earning assets was 6%. Our average cost of funds was 3.5%, and our net interest spread was 2.5%. Total leverage for the third quarter was 3.7:1, while recourse leverage ended the quarter at 1.3:1. Expenses for the third quarter, excluding servicing fees and transaction expenses, were $17 million, in line with last quarter. We continue to closely monitor liquidity and have approximately $1 billion in cash and unencumbered assets as we look for new investments and financing options to support our portfolio and to optimize investment returns. That concludes our remarks, and we'll now open the call for questions.

[Operator Instructions] Our first question comes from the line of Doug Harter of Crédit Suisse.

Just to start off with an easy one, if you can just tell us what the outcome of the election will be. Back to Chimera, can you just talk about the returns, how they look on jumbo versus investment property versus reperforming, and kind of the amount of capital you can deploy, kind of per dollar of loan that you buy into each of those?

Sure. This is Mohit. I'll start in reverse. Where we see the greatest opportunity continues to be on the seasoned reperforming side. We've done 5 securitizations so far this year. And we think there's still ample supply of that coming from the GSEs, especially with what's happened this year with forbearances and deferments on the GSE portfolio. So we still think there's ample supply there to come that will create the largest opportunity. And on the securitization side, as we mentioned in our opening remarks, the securitization market is pretty strong. You're able to get term financing on -- depending on a rated or nonrated securitization, up to 80% of your capital stack plays in yields of mid-high 1s on rated to mid-2s on a nonrated basis. So the back-end equity returns are going to be high single digits on a cash basis. And at minimal leverage, you can get those to even double digits, 12% to 15%. On the jumbo side, originations are picking back up there as well. There was a lull in the second quarter with the post COVID and originations are somewhat mitigated. But there, the returns are not as attractive as on the seasoned reperforming side, but we want to be involved in the new issue origination business, so we still find it to be attractive. The returns are going to be in the mid-single digits, but there's more leverage available. And then on the agency-eligible investor loans and loans that [ don't necessarily ] get delivered to the GSEs, we think there's a larger opportunity there and an opportunity set to acquire loans in the coming months. So we think the returns there match the seasoned reperforming side. So we're pretty optimistic, and we've done one of each of those securitizations in Q3.

And then can you just talk about how is kind of the depth of the financing for the subordinate bonds today and kind of your comfort in kind of your liquidity position in case kind of we hit another kind of pocket of volatility around those financing levels?

Sure. I mean even pre-COVID, the depth of that market wasn't great and our counterparty selection was limited. We wanted to make sure the people that were financing those assets for us were involved both on the underwriting side and on the cash trading side, so just to not have market disruptions in prices as we experienced in Q1. So I think that's first and foremost. Secondly, the tenor of those financings was never on a month-to-month basis. The shortest financing we had on our credit assets was around 3 months. And in some cases, we had financings, as you recall, as long as 3 years. With what transpired in Q1, we're sort of mitigating any -- or as much as possible the mark-to-market risk on those assets. We've locked up a lot of non-mark-to-market or mark-to-market holiday financing for those credit-sensitive assets. And of the last few securitizations we've done, we're actually holding the equity pieces for cash and not putting them on recourse borrowings at the moment, just with some of the uncertainty around COVID and the elections.

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

Actually, just in terms of the level of cash and liquidity, what's a reasonable level for that as you get comfortable with deploying more capital?

This is Mohit again. I mean, I think with some -- again, some of the uncertainty we just highlighted as it relates to election outcomes, what happens with COVID, I think we're pretty confident with what we have in place in terms of liquidity, both on a cash and unencumbered basis. We're also hopeful that as a result of some increased volatility heading into year-end, that we're always hopeful for it, that creates some investment opportunities to buy some assets. As I think we have a decent mix of liquidity, we have some ability to add assets here. And as the closing comments of my prepared remarks, we were able to acquire some loans that we were -- that's right into a securitization pretty quickly. So I think that all-in cash needs would be mitigated given how strong the securitization market is for us.

Okay. That makes sense. And then last quarter, you noted that if asset prices recover, you could see book value maybe getting back into the $13 to $14 range. Is that still kind of a reasonable expectation? Just updated thoughts there.

Yes. I mean as reflected in the book value performance for Q3, we're still mindful that we think there's plenty of upside in the portfolio. We were fortunate enough to retain all the credit assets that we've taken the last decade to build out. And we think there's a liquidity issue, not a credit issue, as reflected in the overall performance of our credit assets. And more generically in the market, the concerns around forbearance and deferments have come down quite significantly from the highs in May to where we stand today.

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

Just wondering on -- in terms of the funding side, wondered if you could just share your thoughts on whether you still see potential to further extend out financing maturities.

Yes. I mean, I think separating the funding from the agency versus the credit side, our agency fundings remain short. The curve there is pretty flat between 1 month and 1 year. But you give up a lot of optionality if you want to optimize the portfolio on that side, so we prefer to keep that short to give us some flexibility. And as I stated, we did sell some of our agency CMBS positions, booked some gains, which we'll redeploy to credit-sensitive assets. On the credit side of the financing book, yes, we do prefer that to be longer. We've -- as Matt said, we've entered into some long-term arrangements there, up to 5 years in some cases. And to the extent that's available, we'll continue to use that to the extent needed, especially to match off on the deals that we have that we call and we lever.

Got you. And then in terms of just a quick follow-up, wondering if you could just share with us how you think funding costs could trend over that near term there.

So like the asset side of the equation where spreads have come in quite meaningfully since the wides in March, financing costs are also coming in. I think on the agency side again, they're pretty sticky. And the Fed has done -- illustrated what they're going to do. And those costs are around 20 to 25 basis points between 1 month to 12 months. On the credit side, depending on credit profile, I mean those spreads have come in and I think will continue to come in as the overall use of financing has decreased from the Street. And I think there's a balance sheet to be had there. But I would think as we head into Q4 and Q1, financing costs there should come in as well.

Your next question comes from Stephen Laws of Raymond James.

Just a follow-up on Bose's question. Can you maybe give us some color -- I think it will be in the Q later, but can you talk about where the asset marks and liability marks are today versus year-end?

Yes. Sure, Stephen. I think if you take a look at the press release, maybe one way to look at it, obviously, this quarter was really good in terms of recovery of book value. But on a year-to-date basis, we haven't completely retraced our marks. And so if you take a look at our earnings statements through the 9 months, we're still down about $172 million. Now the asset mix has changed a little bit, but -- that's a material amount, that can still come back and add to book value, get closer to the book value numbers that Mo was mentioning earlier today.

Great. And I appreciate the color there and quantifying that. When we look at the shift in agency assets, declined sequentially, but [ so ] corresponding in a pretty sizable increase in asset yield. Can you talk about what you're seeing there and kind of the -- when did that portfolio shift change? And I guess leverage was down, so how does that impact kind of what the maybe weighted average leverage for the quarter versus what quarter end was as we think about the go-forward earnings power of the quarter end balance sheet?

This is Mohit. So as far as the agency CMBS portfolio, we've spent the better part of the last 6 years acquiring those assets. And that's gone sort of -- I wouldn't say a vastly different rate environment, but we did have some lower-yielding assets that were also effectively termed phantom. We locked in some NIM relative to the hedges we had put in place. So those asset sales that we've done, that we completed in Q3 led to a higher base case yield on what we retained. So I think that's the change there. It's not necessarily the addition of new assets, it's just selling the lower-yielding assets to optimize that portfolio. I think we will continue to monitor where those assets trade relative to all protection that's embedded in these securities. So with -- as you know, we have no hedges on, so it's also a good way for us to manage the duration of that portfolio given that it is a longer-duration asset outright. So if rates remain here and the price action is pretty strong and there's a lot of demand both from the investor base as well as the Fed, then we would continue to take advantages of that. As far as the overall leverage and how to think about that, obviously, we've decreased leverage throughout the year, and we're at about 1.3x at the end of Q3. I think we're probably going to remain around these levels probably through year-end. And then as we're a year removed from COVID, the elections are in the review mirror, we will see if we want to adjust that back upwards and have more assets -- earning assets on the books. But relative to our dividend and our core earnings, we're out earning that currently, so we don't see a current need to sort of spend the cash.

[Operator Instructions] Your next question comes from Trevor Cranston of JMP Securities.

When you were talking about the opportunity set for credit investments, I guess one asset class you didn't mention was non-QM loans. So I was wondering if you could maybe comment on kind of what you're seeing in terms of supply of newly originated non-QM and if that is an asset class that you guys are looking at adding into the portfolio.

Sure. Yes, that's an asset class we spent a lot of time looking at over the last 18 months. Gladly, we've missed some of the hiccups they experienced in that class in Q1 and Q2. And as a result of those hiccups, I think origination volumes have gone down quite significantly with a lot of originators effectively turning off that posit of what was available to -- the financing wasn't there, warehouse lines weren't there and the securitization market wasn't there. As that sort of reverted, a lot of the warehouse lines have been cleaned up. Originations are picking back up as our warehouse line availability for those products. So again, we will evaluate those relative to the other loans that we're focused on, primarily being seasoned reperforming, agency-eligible investor loans, and see how the returns on the equity pieces compare relative to the non-QM space. I mean we've had a lot of in-depth discussions over 18 months with different originators and potential partners to source that collateral. But like I said, it's just in relation to other opportunities available to us.

Okay. Great. And then, obviously, you guys had a strong book value number in 3Q. Can you comment on what you've seen in terms of credit spreads so far in the fourth quarter and how that's impacted book value quarter-to-date?

Sure. I would say credit spreads are unchanged as we -- from September 30 through November 1 here. I think with the uncertainty around the election, that sort of kept spreads in check. As we get some more clarity in the coming days, weeks on that, I think spreads will grind tighter. We feel the [ ready ] space hasn't had the same sponsorship as all the other spread products from the Fed. So I think it still offers, on a relative basis, higher returns. And that should continue to sort of grind spreads in tighter in the near term, which is beneficial for our assets and book value.

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

Just really 3 questions. What is the fully diluted share count now, assuming any dilutive securities below $10, let's say? Because you did a lot of financing at a difficult time, but the -- what is the share -- fully diluted share count that we should be looking at? That's question number one.

Sure. The fully diluted is 265 million.

I didn't hear you. 265 million or 365 million?

265 million.

Got you. Okay. The 1.3 in recourse leverage, I think you addressed it a moment ago, but that's the level you're comfortable at and you might take it up sometime next year depending upon circumstances? Or you want to keep it at that level?

No, I think we're comfortable with that heading into year-end. And I think to the extent everything sort of stabilizes, we look to take it up in 2021.

How do you view the $1 billion of cash? How much is your minimum cash you need to run the business? And how much additional cash you have that you can invest where we could assume some kind of spread? What I'm trying to figure out is whether your current earnings are below normalized earnings because you have unemployed cash.

Well, I mean we're -- as a levered company, we always try to keep cash holdings to a minimum. I mean it's really about underlevered assets on the balance sheet. And I think when we're looking at the business right now is that we have ample liquidity. I think as Mo said, we have an election today that I think can go on for another couple of days here or maybe even longer. There's some uncertainty there. I think we're cautious about year-end. And I think just as -- what we've been through this year, I think it makes sense for the company to husband some of its cash and keep itself in a lower gearing going into year-end. And when things kind of settle out, we can take up leverage. And I think we're just trying to be prudent given where we've seen in the volatility in the markets. And I think it makes sense, at least for the next 2 months or so, just to be in a much more conservative posture.

I agree. It makes sense. You talked about the election results in the next few days. Do we have a bias in terms of -- I mean it's personal, but in terms of our business? Do we care about the outcome? I mean it seems to me the most important thing that came out of the election results thus far is the repudiation of the left.

Yes. I think the best thing that happened -- I mean, first of all, I mean, the housing market is screaming, and I think that's great for our portfolio and for the credit of our portfolio. So that's terrific. I don't think that's going to change with the election results. And I think regardless of what happens in the presidential election, it looks like the Senate is going to be very close, maybe stay Republican, which I think a divided government is probably not a bad thing for different markets.

My own two cents is I'd be very careful. I mean somebody is going to wake up one day and say, who pays for the party when the party is over? It took 244 years to go from no national debt to $21 trillion, and that's going up 15%, 20% a year. It's not sustainable. Somebody has to wake up, so I'd be careful. But good luck, guys.

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

Well, thank you for participating in the third quarter 2020 earnings call for Chimera Investment Corp., and we look forward to speaking to you early next year.

Thank you for participating in today's conference call. You may now disconnect your lines, and have a wonderful day.