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Edited Transcript of CIM earnings conference call or presentation 3-May-18 1:00pm GMT

Q1 2018 Chimera Investment Corp Earnings Call

NEW YORK Jun 15, 2018 (Thomson StreetEvents) -- Edited Transcript of Chimera Investment Corp earnings conference call or presentation Thursday, May 3, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Emily Mohr

* Matthew J. Lambiase

Chimera Investment Corporation - President, CEO & Director

* Mohit Marria

Chimera Investment Corporation - CIO

* Robert Colligan

Chimera Investment Corporation - CFO

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Conference Call Participants

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* Eric J. Hagen

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* Leon G. Cooperman

Omega Advisors, Inc. - President, CEO & Chairman

* Sam Choe

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation First Quarter 2018 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.

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Emily Mohr, [2]

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Thank you, Lori, and thank you, everyone, for participating in Chimera's first 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 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 statements 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.

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Matthew J. Lambiase, Chimera Investment Corporation - President, CEO & Director [3]

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Thank you. Good morning, and welcome to the First Quarter 2018 Earnings Call for Chimera Investment Corp. 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; and Victor Falvo, Chimera's Head of Capital Markets. I'll make a few brief comments, and Mohit will discuss the portfolio activities followed by Rob reviewing the financial results for the quarter. We'll open the call for questions afterwards.

Before I start the call, I'd like to take a moment to review some of the changes on our Board of Directors that occurred in the quarter. After 11 years of service, Paul Keenan will retire from the board upon the completion of his term at the end of the month. Paul has been an outstanding Director. And we're thankful that we've had him on our board, and we wish him all the best for the future.

I'm happy to announce that Debra Still has joined Chimera's board during the quarter. Debra is the President and Chief Executive Officer of Pulte Financial Services, which includes the mortgage lending, title and insurance operations of the PulteGroup, one of the nation's largest homebuilders. Debra was Chairman of the Mortgage Bankers Association in 2013 and is currently a member of the association's Board of Directors. She has nearly 4 decades of experience in real estate finance and brings with her a wealth of knowledge regarding residential mortgages. Both management and the Board of Directors are excited to add Debra and her extensive mortgage background to our organization.

In the first quarter, Chimera had a 4.5% total economic return on book value, which is the product of our $0.50 dividend and $0.27 increase in book value in the period. On previous earnings calls, we've stated our opinion that residential mortgage credit was undervalued, and it was one of the best investment options in the entire fixed income market. That certainly was the case in the first quarter, as residential loan prices increased, while most other fixed income assets lost value. We remain bullish on the asset class, as stronger U.S. employment and higher home prices should bode well for credit performance going forward.

Residential mortgage loan prices have also benefited from nontraditional buyers who've entered the market to take advantage of the very strong credit dynamics. Even as other credit spreads widen in this quarter, residential mortgage loan prices remain well bid, which is very good for our book value.

We continue to see opportunities to purchase and securitize loans for our portfolio, which is a key component and a market differentiator within our core investment strategy. This quarter we added $368 million of season residential loans to our portfolio and securitized $549 million worth of loans in 2 separate transactions, one of which was a refinancing of existing securitized debt.

Interest rate volatility was high in the first quarter, with 3 months LIBOR rates rising faster than both the overnight federal fund rates and 10-year U.S. Treasury. In the period, management materially increased the size of interest rate swap position. This increase help mitigate some of our portfolio's duration and stabilize book value in the volatile market this quarter. Our interest rate swap position is a form of insurance, which helped us reduce some of the risk from higher funding costs in the future. While we are not perfectly hedged, I believe the portfolio team has made great strides in reducing the risk of higher funding costs, while retaining the ability to add more hedges, should the market condition require it.

In February, our Board of Directors reauthorized the $100 million of share repurchases. We executed approximately $15 million of that amount this quarter at prices below our December 31 book value. This is our first repurchase action since 2015 when we bought back $250 million worth of stock. We stand ready to buy back more shares and have $85 million remaining on the authorization.

Management is keenly aware that book value is an important point of total return. And we work hard to balance the risk and reward in our portfolio. We materially increased our interest rate swap position to help mitigate the risk of higher rates. And we've been operating at relatively low recourse leverage, which affords us the ability to be an opportunistic investor when situations present themselves.

Chimera has a large and unique portfolio of residential mortgage credit assets, which should continue to perform well and produce solid income in the ever-improving economy. We like our portfolio, and we believe we are well positioned to continue to produce a strong dividend stream for our investors in the quarters ahead.

And I'll first turn the call over to Mohit to discuss the portfolio activities.

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Mohit Marria, Chimera Investment Corporation - CIO [4]

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Thank you, Matt. Q1 continued the trend of higher prices and tighter spreads in the residential loans and mortgage credit markets. The underlying credit in our portfolios continues to perform well and is performing better than our purchase expectations. Prepayments remain in the high single digits, while defaults and severities within our expected range.

Over the quarter, Agency MBS prices moved lower with comparable duration U.S. Treasuries, while Agency mortgage spreads moved wider. And as expected, the Federal Reserve raised the federal funds rate by 25 basis points to 1.75% in March. This is the sixth interest rate hike by the Fed this cycle, and the markets are expecting 2 more interest rate hikes in 2018.

With this backdrop, the yields will continue [this bear primer], which were even more pronounced in the interest rate swaps market. To help keep our funding cost balanced with our assets, this quarter we increased our hedge book and initiated an additional $2 billion of interest rate swaps.

The increased position yielded benefits to Chimera's book value as rates grow this quarter and will likely add marginal expense for our liability streams moving forward.

As Matt mentioned, we're in a pretty good spot with our hedge positions, and we will adjust our balances when and if necessary in quarters to come. In addition to the added hedges, we had an active quarter in the portfolio. This quarter we added $368 million loans with very similar characteristics of the seasoned mortgage loans Chimera purchased in prior years. The purchased loans had an effective weighted average coupon of 5.97%, an average loan size of $130,000. And the loans were on average 124 months seasoned with an 81% DTL LTV. Chimera securitized $549 million residential loans this quarter in 2 separate transactions.

$169 million was securitized in CIM 2018-R1, which was a re-lever of our CIM 2015-1 EC deal. In this transaction, we sold $140 million in debt, with a 365% weighted average cost of financing and retained $29 million of investment. Separately, Chimera securitized $380 million CIM 2018-R2. This deal included seasoned mortgage loans initially purchased in the fourth quarter of 2017, and combined with some of the $368 million loan purchased this quarter.

In CIM 2018-R2, we sold $266 million senior notes, while retaining $114 million for investments. The weighted average cost of our debt on this deal was also 3.65%. Post quarter-end, we had issued 2 more securitizations. $181 million CIM 2018-R3, which is a re-lever of CIM 2015-2AG, our second re-lever for 2018. And $380 million CIM 2018-J1, which is Chimera's first primarily jumbo securitization since 2012. We will discuss the 2018-R3 and 2018-J1 deals in more detail on the second quarter's earnings call.

In Agency, this quarter, we added $290 million in new acquisitions and commitments bringing our total agency CMBS exposure to $2.5 billion or roughly 49% of our total Agency mortgages exposure.

As we discussed on our February earnings call, our Board of Directors reauthorized $100 million repurchase of Chimera common stock. This quarter, we purchased 883,000 shares for a total of $15 million, an average price below our December 31 GAAP book value of $16.85. We have $85 million additional capacity of the existing authority, which we constantly monitor as a complementing tool available to us that help to maximize risk-adjusted returns for our investment portfolio and our shareholders.

2018 is off to a good start. Our 4.5% total economic return for the quarter was generated by strong portfolio performance on our assets and a disciplined portfolio management approach on our liabilities and capital structure.

For the first 4 months of the year, we have called and re-levered 2 securitizations and have added 2 additional deals for potential calls later this year. The credit portfolio continues to perform well and Agency pass-through spreads are widening as we have been expecting. We will continue to adjust with market conditions and utilize all portfolio management tools, including share repurchases to maximize our adjusted portfolio returns for our shareholders.

I will now turn the call over to Rob to review the financial results for the quarter.

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Robert Colligan, Chimera Investment Corporation - CFO [5]

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Thanks, Mohit. Here are the results for the first quarter of 2018. GAAP book value at the end of the first quarter was $17.12 per share. And our economic return on GAAP book value is 4.5%, based on the quarterly increase in book value and the first quarter dividend per common share. GAAP net income for the first quarter was $230 million, compared to $98 million last quarter. On a core basis, net income for the first quarter was $109 million or $0.58 per share, compared to $116 million or $0.62 last quarter.

Net interest income for the quarter was $148 million, compared to $158 million last quarter. The decrease in net interest income relates primarily to higher interest expense incurred during the quarter, resulting from higher borrowing rates.

For the first quarter, the yield on average interest earning assets was 6.2%. Our average cost of funds was 3.7%, and our net interest spread was 2.5%. Total leverage for the first quarter was 4.6:1, while recourse leverage ended the quarter at 2:1. Our net interest return on equity was 15.9%, and our GAAP return on average equity was 26% for the quarter, as the investment portfolio experienced net mark-to-market gains during the quarter.

Expenses for the first quarter, excluding servicing fees and deal expenses, were $14 million. As discussed during the fourth quarter earnings call, expenses are up as a result of equity compensation expenses. The company also incurred legal expenses related to loan warehouse facilities.

That concludes our remarks. We'll now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Sam Choe of Crédit Suisse.

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Sam Choe, [2]

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I was just wondering if you could talk about the asset yields. And I mean -- it seems like you dropped off a little bit? And how you are seeing that trending for 2018?

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Mohit Marria, Chimera Investment Corporation - CIO [3]

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Sure, Sam. This is Mohit. New asset acquisitions are obviously tighter as our opening remarks states. Yield compression, as a result of the investor demand for residential credit, remained strong. The decrease in the net interest margin as a result of more of the interest expense on the REIT are going up and just pay downs on our higher yielding assets, reducing some of the yield that we're earning on our existing assets.

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Robert Colligan, Chimera Investment Corporation - CFO [4]

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Yes, this is Rob. So I just add that the new assets, like Mohit was saying, are yielding less than what we previously purchased and that's a big driver on the assets side.

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Operator [5]

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

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [6]

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It's Eric on for Bose. My first question is just on the buyback. I'm hoping you can just provide a little commentary on what that says for returns in the market? I mean, I think your comments were clear that asset yields have come down, but maybe you can just kind of square the commentary from, Matt, your opening remarks? Just, I guess, I heard you said that you were bullish and just what that implies for buying back stock?

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Matthew J. Lambiase, Chimera Investment Corporation - President, CEO & Director [7]

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I mean, I would say that we are in the bond market. And when prices go up, yields go down. I mean, I think that's the general pattern for our book value. Our book value is going up, and therefore, asset yields are coming down, at least the returns are coming down in the residential market. I am bullish on credit. I think credit has still got a long way to go. I think the assets that we have are very hard to come by in this marketplace. I mean, again, in my opinion is that, they're going to be well bid going forward. When I look at all the investment options out there, and if our stock trades below book value, I think that's the best investment option in the market, full stop. I mean, I think that's a great investment for the company and for our shareholders. And we certainly stand ready to buy back shares should that happen. And we've been managing, I think, a pretty conservative strategy. And it's been paying off for us, and it's been paying off for the shareholders. A 4.5% economic return in a very difficult market, in a very difficult fixed income market, like we had in the first quarter, is a win, and our shareholders should be happy. And I think it gives us a tremendous amount of opportunity to look at other things in the mortgage market. And I am just -- I am bullish on residential mortgage credit. And I think I'm very bullish on our rates of return that we're going to be able to produce for our shareholders going forward.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [8]

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Okay. That's certainly fair. I am hoping you can just provide a little bit of commentary on the jumbo securitization? And I know that maybe you'll give a little bit of more color in that quarter but -- I guess, it's this quarter. But just share the loss adjusted yields that you had on that deal?

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Matthew J. Lambiase, Chimera Investment Corporation - President, CEO & Director [9]

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Well, I would just say, just refer on that deal specifically. It was a very small deal for us. It was about $380 million. It's jumbo prime origination. We haven't done -- this is a first origination -- jumbo prime deal that we've done since 2012. Now these are qualified mortgages, so they don't have the risk/retention requirements that the other securitizations that we've got, we may have. And this deal did not consolidate on our balance sheet. And our investment in the deal was very small. So as we -- so I would look at this and make sure that people are aware, that this is us looking for opportunity in a market that we haven't been in a long time. And I wouldn't read too much into it, but we are -- we really just stand ready to look for new opportunities and look in different areas. Now Mohit, you can go through the...

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Mohit Marria, Chimera Investment Corporation - CIO [10]

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So on the economic front, as we continue to state, these search for yields on the investor base remains strong. We saw strong sponsorship on the sub-stack on the deal. And to Matt's point, our equity in the deal is muted, but we'll generate favorable return to the portfolio and be accretive to what we have currently.

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Operator [11]

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(Operator Instructions) Your next question comes from the line of Leon Cooperman of Omega Advisors.

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Leon G. Cooperman, Omega Advisors, Inc. - President, CEO & Chairman [12]

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I just continue almost every quarter to congratulate you guys on the fine job you're doing on your transparency. And I think it's excellent. And I have nothing critical to say, but I do have one question. How much excess liquidity do we have? Because it is clear from your actions that you think your book value is probably understated, given the quality of your assets. And whenever Mr. Market gives you a chance to buy your stock back below book value, you prefer to employ your capital that way than raise your dividend, even though the dividend is below our recurring earnings. So my question is, there's not -- you never could do too much of a good thing. The buyback is only 3% of the equity market cap. How much excess liquidity do we have if we got into a bear market and the stock is persistently sold below book value? How much could you buy back prudently? The question is, how much excess liquidity do we have in the company that's not employed?

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Matthew J. Lambiase, Chimera Investment Corporation - President, CEO & Director [13]

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Yes, essentially, I'll start here. So we have $85 million authorized. I think, obviously, we would have discussions with the board and could authorize more. We are very focused on managing the capital stack and making sure we have adequate liquidity, especially in a dislocated market. And if we get to that, the capital markets are opened for us. We speak to the banks weekly. If we want to raise capital in a convertible form or a preferred form, I think we could do that and adjust the capital stack a little bit to reduce the equity float. But I think that there is a -- also, pay downs from our portfolio, we could even rotate that into new investments. We could use that as additional -- an additional source to buy back more share. So maybe to summarize, we are authorizing at $85 million. There probably a little bit more room. We'll see how things go through the rest of the year.

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Leon G. Cooperman, Omega Advisors, Inc. - President, CEO & Chairman [14]

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Okay, we're not talking the order of magnitude that you could buy back 10% or 15% of the company, if the market gave you that opportunity? Or you're saying you possibly could?

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Matthew J. Lambiase, Chimera Investment Corporation - President, CEO & Director [15]

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No, I think, what -- I don't have a number for you. But I would say that we brought back $250 million back in 2015. And I think if the market opportunity was there, personally I would vote for that, too, if we could get the stock at a big discount, so yes. We've done that in the past. There was no reason to think that we wouldn't do it going forward.

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Operator [16]

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At this time, there are no further questions. I'll now turn the call to Matthew Lambiase for any other additional or closing remarks.

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Matthew J. Lambiase, Chimera Investment Corporation - President, CEO & Director [17]

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Well, thank you for participating in the Chimera Investment Corporation First Quarter 2018 Earnings Call. And we look forward to speaking to you on the next quarter.

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Operator [18]

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