Q3 2023 Chimera Investment Corp Earnings Call
Participants
Dan Thakkar; Co-CIO; Chimera Investment Corporation
Phillip John Kardis; CEO & Director; Chimera Investment Corporation
Subramaniam Viswanathan; CFO; Chimera Investment Corporation
Victor Falvo; Head of Capital Markets; Chimera Investment Corporation
Bose Thomas George; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Eric J. Hagen; MD & Mortgage and Specialty Finance Analyst; BTIG, LLC, Research Division
Stephen Albert Laws; Research Analyst; Raymond James & Associates, Inc., Research Division
Trevor John Cranston; MD & Equity Research Analyst; JMP Securities LLC, Research Division
Presentation
Operator
Greetings. Welcome to the Chimera Investment Corporation Third Quarter 2023 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.
At this time, I would like to hand the call over to Victor Falvo, Head of Capital Markets. Thank you. You may begin.
Victor Falvo
Thank you, operator, and thank you, everyone, for participating in Chimera's Third Quarter 2023 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 call over to our Chief Executive Officer, Phil Kardis.
Phillip John Kardis
Good morning, and welcome to the Third Quarter 2023 Earnings Call for Chimera Investment Corporation. Joining me on the call are Choudhary Yarlagadda, our President, Chief Operating Officer and Co-CIO; Subra Viswanathan, our Chief Financial Officer; Dan Thakkar, our Co-CIO; and Vic Falvo, our Head of Capital Markets. After my remarks, Subra will review the financial results, and then we'll open the call for questions.
I'd like to start by welcoming 2 new members to the Chimera team. Susan Mills has been elected to our Board of Directors effective November 13. She recently joined Academy Securities, a veteran-owned investment bank. Before that, she spent 36 years at Citibank, where she held various senior management positions and businesses related to North American residential mortgages. She brings a wealth of expertise and experience in the residential mortgage market, and we're very excited to have her as part of the team.
Also, Miyun Sung is joining us next week as our Chief Legal Officer. She has over 23 years of legal experience both as external counsel and in-house. She has spent the last 7-plus years as Senior Vice President, Chief Legal Officer and Secretary of Urstadt Biddle Properties Inc., a New York Stock Exchange listed equity REIT. We're excited to have her join the team.
During the third quarter, the fixed income market experienced both increased volatility and higher rates. In July, as expected, the Federal Reserve increased its Fed funds target rate by 25 basis points. And while the Fed paused their rate hikes at the September meeting, they did reduce the projected rate cuts in 2024 by half or 50 basis points. The resulting back up on the long end of the yield curve caused the 10-year treasury rate to increase 73 basis points over the course of the quarter to 4.57%.
The 10-year yield continued its climb after quarter end and briefly reached 5% in mid-October. These higher interest rates have moderately reduced the value of our portfolio. We saw our GAAP book value per share drop quarter-over-quarter from $7.29 to $6.90, a decrease of 5.4%. Considering the market conditions, we remain cautious and mostly on the sidelines, which left our investment portfolio relatively unchanged during the quarter.
We did, however, continue to focus on liquidity and liability management. This quarter, we added 3 new repo counterparties. And post quarter, we refinanced a high fixed rate non-mark-to-market facility into a new 2-year limited mark-to-market facility. We expect this facility will save us approximately $16 million in interest expense over the next 12 months.
What is our outlook? Looking ahead to the fourth quarter and into 2024, we are planning for rates to remain high. While inflation has moderated since last year, it remains much higher than the Fed's 2% target. And although it appears the Fed is nearing the end of its hiking cycle, recent data appears to support another rate hike. The U.S. labor market remains strong. Third quarter GDP increased to nearly 5%, and consumer spending increased more than expected in September. In addition to the Fed funds rate remaining elevated in 2024, we note the relatively quick escalation of long-term rates, driven by several factors, including the strength of the economy and the Fed pushing out rate cuts.
Also, the growth of the federal deficit and associated interest cost, coupled with concerns about participation by China and Japan and treasury auctions and the Fed effectively engaged in quantitative tightening, have created supply imbalances, which have helped push long-term -- excuse me, supply and demand imbalances, which have helped push long-term rates higher and we believe for longer.
In fact, the sustained move in the 10-year treasury yields above 5% cannot be ruled out. Home sales are on pace for the slowest year since the great financial crisis, elevated home prices, constrained housing inventory and high mortgage rates have created a trifecta of headwinds perpetuating the housing affordability crisis.
Apart from the data-driven volatility, there is also a rising risk of government shutdown and an escalation of the war in the Middle East that can further exasperate volatility in the capital markets. So what's our strategy? We continue to manage our business with the belief that interest rates, both short and long term, will be higher for longer. Our focus remains on strengthening our balance sheet and managing our liabilities. To help reduce various risks associated with recourse financing, we frequently seek longer-dated maturities, obtain non or limited mark-to-market terms and utilize financial derivatives such as swaptions and futures contracts to soften the impact of rising rates.
Through these initiatives during the first 9 months of 2023, we have reduced our recourse financing by more than $800 million. We have non or limited mark-to-market financing on 57% of our outstanding recourse financing. We have hedged $1 billion or roughly half of our floating rate financings with a weighted average swap rate of 3.26%. And we have $1.5 billion in swaptions, which give the company the option to pay a fixed rate of 3.56% for 1 year beginning in the second quarter of 2024. Even in this higher rate environment, our assets continue to perform well.
Our interest income quarter-over-quarter and year-over-year is relatively unchanged. Credit performance on our portfolio has been better than our original investment expectations. We believe our portfolio is unique. Most of our securitizations are backed by approximately $11 billion of re-performing loans with low LTVs and an average seasoning of 17 years, which we expect will continue to perform well over a range of economic conditions. Our securitizations continue to delever.
And depending on future interest rates, we will be able to terminate and take out cash when appropriate. In addition to focusing on liability management and liquidity, we intend to optimize our investment portfolio, and we will seek opportunities to acquire assets that will improve our returns and liquidity. Finally, to improve our liquidity and better position ourselves for investment opportunities, we have reduced our dividend to a level consistent with what we expect to earn through the end of next year. We believe that it is prudent in this macroeconomic environment and in the best interest of our shareholders over the long term to reset the dividend.
Today's market conditions are challenging, but we remain optimistic about our future. Our portfolio continues its strong performance, both in income generation and credit. Our securitizations continue to deliver with 14 deals callable in 2023, another 4 become callable in 2024 and another 6 in 2025. We believe that as our financing costs decrease, we expect our economic performance will significantly improve. We believe we're taking prudent steps which will benefit Chimera's shareholders over the long term.
I'll now turn the call over to Subra to review our financial results.
Subramaniam Viswanathan
Thank you, Phil. I will review Chimera's financial highlights for the third quarter 2023. GAAP book value at the end of third quarter was $6.90 per share, and our economic return on GAAP book value was negative 2.9% based on the quarterly change in book value and the third quarter dividend per common share. And for the 9 months year-to-date, our economic return was zero percent based on the change in book value since year-end and the first 3 quarters dividends per common share.
GAAP net loss for the third quarter was $16.3 million or $0.07 per share. On an earnings available for distribution basis, net income in the third quarter of approximately $29 million or $0.13 per diluted common share. Our economic net interest income for the third quarter was $66 million. For the third quarter, the yield on average interest-earning assets was 5.8%, our average cost of funds was 4.5%, and our interest spread was 1.3%. Total leverage for the third quarter was 4.1:1, while recourse leverage ended the quarter at 1:1.
For financing and liquidity, the company had $606 million total cash and unencumbered assets at quarter end. We had $1.5 billion of either non or limited mark-to-market features on our outstanding repo arrangements. We had $1.9 billion floating rate exposure on our outstanding repo liabilities. We had $1 billion pay fixed interest rate swap at a rate of 3.26% as a hedge position for our liabilities. And we had $1.5 billion swaptions to pay fixed for 1 year beginning in the second quarter of 2024 at an average rate of 3.56% as a hedge position for liabilities.
For the quarter, our economic net interest income return on equity was 10.4%, and our GAAP return on average equity was 0.3%. And lastly, our third quarter 2023 expenses, excluding servicing fees and transaction expenses, were $12.6 million, modestly lower than the second quarter.
That concludes our remarks. We will now open the call for questions.
Question and Answer Session
Operator
(Operator Instructions) Our first questions come from the line of Stephen Laws with Raymond James.
Stephen Albert Laws
Phil, I wanted to follow up on some of your prepared remarks just about -- I think you said you kind of remain cautious, mostly on the sidelines. Can you talk about -- are you happy with current liquidity position, which seems pretty defensive. How do you think about your appetite for more stock repurchases or possibly something else in your capital stack? And where do you look -- where do you see returns kind of on new investments if you decide to deploy the capital offensively?
Phillip John Kardis
Stephen, thanks for the question. So right now, I think we're happy with our liquidity position. But as we look for rates now being higher for longer, we think the shore up liquidity makes sense. If we think about our priorities, we look at liquidity right now first. We do think there are going to be investment opportunities in the near term that are going to come to us, and we would look to the extent that we have the liquidity to deploy then.
And we look at stock repurchases, whether it's common or preferred, under a variety of factors. But at least in the near term, that's probably the third option for us. We're looking more at liquidity and investment opportunities. And we think those are -- and I'm going to turn over kind of where we're seeing some of those opportunities to Dan.
Dan Thakkar
Sure. So this is Dan Thakkar. So in terms of the opportunities, we think the primary capital allocations will be between non-QM, especially in the DSCRs, BPLs and Jumbo Prime to the extent we are able to source that. We're targeting mid-teens returns to those securitizations. I will point out that as far as the securitization economics is concerned, it's pretty stable, especially in the non-QM space with the newly originated high gross WAC loans with coupons around 8.5%.
That said, recent deals on the AAAs are pricing in the high 100s versus mid-hundreds in the third quarter. So any more underperformance there will deteriorate the ARB, so we are very cautious there. Obviously, the widening that we have seen on the non-QM AAA has widened in sympathy with the Agency RMBS. So it is kind of stable and compelling at this point, but it can deteriorate really quickly in the macro environment we are in. I hope that answers your question.
Stephen Albert Laws
That's helpful color. I appreciate the comments. And just wanted to verify one thing. I think you mentioned $16 million savings in interest expense from the refinance of a higher cost facility. A $0.06 to $0.07 benefit there annually? Is that right? Or is there an offset to that somewhere?
Phillip John Kardis
I think yes. I mean that's the number we expect to say, but as you're probably aware, in the early part of next year, 2 of our preferreds are going to reset from fixed to float, at least we expect that's what's going to happen based on our current information of the applicability of the federal law to those particular things. And so I think as you think about this, we believe that this financing -- refinancing has been very positive for us, but it really is going to be primarily offset by what we expect to happen to our preferred stock.
Operator
Our next questions come from the line of Trevor Cranston with JMP Securities.
Trevor John Cranston
Can you talk about what you guys are seeing in the bulk loan market, particularly from the banking sector, and if you're seeing a material increase in supply coming out from banks looking to get ahead of regulatory changes?
Phillip John Kardis
Yes. I think right now, from that bulk, we're not seeing that much. We got to wait for the term facility to end. And so it's not been an area that we've been really focusing on right this -- given the current situation.
Trevor John Cranston
Okay. Got it. And then on the loan facility that you refinanced moving from the non-mark-to-market to a limited mark-to-market, can you elaborate a little bit on kind of what the change in the terms of that facility are in terms of protection for you guys? And also maybe comment on if you think there are further opportunities to refinance any of your other facilities into a sort of lower cost alternative at this point.
Phillip John Kardis
Yes. So this was a significant facility for us in terms of our desire to refinance it. It was a longer-term facility that allowed us the ability to refinance after a year. And given where we were able to find financing, it makes sense for us to do that now. I think we're just on some of the particular terms, since it was post quarter end, we'll have some more detail in our next statements that will go through that.
But it is a limited mark-to-market with a cap on the rate, and this is where we think the savings will come from since it's significantly below where we were financing. As far as other opportunities, right now, the market has been functioning normally. We're able to roll that really in the next, what I would call, high-cost facility. That refinancing opportunity will be coming in early 2025.
Operator
Our next questions come from the line of Bose George with KBW.
Bose Thomas George
Actually, what's the incremental ROE on new money you're putting to work? And when we think about the existing returns, how long -- if rates remain stable, when does that roll kind of into the new ROE? And I guess part of it, I guess, is the cost to fund the maturities you've been talking about. But just to kind of think about the returns on this portfolio, if rates essentially remain stable.
Subramaniam Viswanathan
So the current portfolio -- this is Subra. Thank you for your question. So the current -- in my prepared remarks, I mentioned that the current economic -- net economic returns on our portfolio or ROE is about 10.4%. Now that's excluding hedge expenses or excluding other administrative and other G&A and comp costs for us, right? So the 10.4% is what we are seeing, and that is on this high rate environment. Obviously, if you buy assets which are yielding higher than what we have today, that 10.4% is potentially going to grow. That's where we are.
Bose Thomas George
Okay. And then actually, in terms of the sort of getting to a more normalized ROE, then does it really kind of depend on rates coming down or just restructuring some of the liabilities over time? Just trying to think about ways that this gets to -- on a net basis to a double-digit ROE.
Phillip John Kardis
Yes. Sure, this is Phil again. So as I mentioned, we had one really high cost facility that we were able to refinance, and the next one is not until the first month or so of 2025. So I think really the financing abilities in terms of restructuring high costs, we've done a chunk of that already. The rest of it is going to come from some rate moderation.
Operator
next questions come from the line of Eric Hagen with BTIG.
Eric J. Hagen
Sorry if I missed this, but did you guys say what your current book value was through October? And then going back to the liquidity, I mean what's the right way to think about just the incremental liquidity that's being generated like on a monthly or quarterly basis just based on paydowns, just natural kind of CPR?
Phillip John Kardis
This is Phil. On the book value since the end of the quarter, I'm going to turn that over to Dan Thakkar.
Dan Thakkar
Yes. So I think in the investor deck that we released last night, we had stated roughly down to 3%. But given the strong rally that we had in the rates market post the Fed, we are closer to down being 2% versus 3%.
Phillip John Kardis
And then I think you asked relative to paydowns. Is that correct?
Eric J. Hagen
Right. Yes, just a way to think about liquidity that's being generated sort of incrementally just through kind of natural paydowns.
Phillip John Kardis
So I think right now, the portfolio is running around 6 CPR in terms of kind of where the paydowns are coming. I hope that's helpful to you.
Eric J. Hagen
Okay. And then how are we thinking about the option value you have to call and resecuritize the existing portfolio? And really just kind of how sensitive you see that optionality being to interest rates going forward here?
Phillip John Kardis
Yes. So it's sensitive to interest rates. Obviously, as rates decline, it makes it more economic. It also depends on how the transactions have paid down, the size of the senior, the size of the transaction that you would -- in terms of when you refinance it. So you look at all those factors. And so right now, the longer those stay out, the better in this environment. And then obviously, as the CPR picks up, it's just going to be more accretive. So we have this optionality now, and we think it's very valuable, but we're going to be cautious in terms of -- in the near term. But as rates begin to moderate, we'll start to look at this more and more closely.
Operator
Thank you. We have reached the end of our question-and-answer session. I would now like to turn the floor back over to Phil Kardis for any closing comments.
Phillip John Kardis
Thanks, everyone, for participating in our third quarter earnings call, and we look forward to speaking to you in February with our call related to fiscal year 2023.
Operator
This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.
