Chimera Investment's (CIM) CEO Matthew Lambiase on Q1 2018 Results - Earnings Call Transcript

Chimera Investment Corporation (NYSE:CIM) Q1 2018 Earnings Conference Call May 3, 2018 9:00 AM ET

Executives

Emily Mohr - Investor Relations

Matthew Lambiase - President and Chief Executive Officer

Mohit Marria - Chief Investment Officer

Robert Colligan - Chief Financial Officer

Choudhary Yarlagadda - Chief Operating Officer

Victor Falvo - Head of Capital Markets

Analysts

Sam Choe - Credit Suisse.

Lee Cooperman - Omega Advisors

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation First Quarter 2018 Earnings Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question and answer session [Operator Instructions].

It is now my pleasure to turn the floor over to Emily Mohr of Investor Relations. Please go ahead.

Emily Mohr

Thank you Dory, and thank you everyone for participating in Chimera’s first quarter earnings conference call. Before we begin, I would like to review the Safe Harbor statements.

During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties, which are outlined in the Risk Factor section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statement disclaimer in our earnings release in addition to our quarterly and annual filings.

During the call today, we may also discuss non-GAAP financial measures. Please refer to our SEC filings and earnings supplement for reconciliation to the most comparable GAAP measures. Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information.

I will now turn the conference over to our President and Chief Executive Officer, Matthew Lambiase. Please go ahead.

Matthew Lambiase

Good morning, and welcome to the first quarter of 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 will make a few brief comments, and Mohit will discuss the portfolio activity followed by Rob reviewing the financial results for the quarter. We will 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 are thankful that we've had him on our Board and we wish him all the best in the future.

I'm happy to announce that Deborah Still has joined Chimera’s Board during the quarter. Deborah is the President and Chief Executive Officer of Pulte Financial Services, which includes the mortgage lending, title and Insurance operations of the Pulte Group, one of the nation's largest homebuilders.

Deborah was chairman of the Mortgage-Bankers Association in 2013 and is currently a member of the association's Board of Directors. She has nearly four 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 Deborah 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 a $0.27 increase in book value in the period. On previous earnings call we've stated our opinion that residential mortgage product was undervalued and that 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. At stronger U.S. employment and higher home prices should bode well for credit performance going forward.

Residential mortgage loan prices have also benefited from non-traditional buyers who have entered the market to take advantage of the very strong credit dynamics. Even as other credit spreads widen this quarter, residential mortgage loan prices remain well bid which was 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 had a $368 million of season residential loan through our portfolio and securitized $549 million worth of loans in two separate transactions, one of which was a refinancing of existing securitized debt.

Interest rate volatility was high in the first quarter with three month LIBOR rates rising faster than both the overnight federal funds rate and 10 year U.S. Treasury. In the period management materially increased the size of interest rates swap position. This increase helped mitigate some of our portfolios duration and stabilized book value in the volatile market this quarter.

Our interest rate swap position is a form of insurance, which helps us reduce some of the risk of 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 conditions require.

In February, our Board of Directors reauthorized the hundred million dollars of share repurchase. We executed approximately $15 million of that amount this quarter at prices below our December 31st 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 part of total return and we work hard to balance the risk and reward in our portfolio. We've 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 to turn the call over to Mohit to discuss the portfolio activity.

Mohit Marria

Thank you Matt. Q1 continues the trend of higher prices and tighter spreads in the residential loans and mortgage credit markets. The underlying credit on our portfolio 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. Treasury 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 market are expecting two more interest rate hikes in 2018.

With this backdrop, deals will continue to bear [indiscernible] which was 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 increase position yielded benefits to Chimera's book value as rates - this quarter and will likely add marginal expense to our liability streams moving forward. As Matt mentioned, we are 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've an active quarter in the portfolio. This quarter we added 368 million loans very similar characteristic of this season mortgage loans Chimera purchased in prior years. The purchase 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 season with an 81% [VPL LTV] (Ph).

Chimera securitized 549 million residential loans this quarter and two separate transactions. 169 million was securitized in CIM 2018-R1 which was a relever of CIM 2015-1DC deal. In this transaction, we sold 140 million in debt with a 365% weighted average cost of financing and retain 29 million in investment.

Separately, Chimera securitized 380 million CIM 2018-R2. This deal included season mortgage loan initially purchased in the fourth quarter of 2017 and combined with some of the 368 million loans purchased this quarter.

In CIM 2018-R2 we sold 266 million senior notes while retaining 114 million for investment. The weighted average costs worked out on this deal was also 3.65%. close to quarter end we have issued two more securitization, 181 million CIM 2018-R3 which is a relever CIM 2015-2AG our second relever for 2018 and 380 million CIM 2018-J1 which is Chimera’s first time jumbles securitization since 2012. We will discuss the 2018-R3 and 2018-J1 deals in more detail on the second quarter's earnings call.

In agencies, this quarter we 290 million of new acquisitions and commitment, bringing our total agency CMBS exposure to 2.5 billion or roughly 49% of our total agency mortgage exposure. As we discussed on our February earnings call, our Board of Directors reauthorized 100 million repurchase of the Chimera common stock.

This quarter we repurchased 883,000 shares for a total of 15 million at an average price below our December 31, GAAP book value of 1685. We have 85 million additional capacity under the existing authority which we constantly monitor as a complementary tools available to us that help maximize risk returns for 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 discipline portfolio managing approach on our liabilities and capital structure. For the first four month of the year, we have called relevered to securitizations and have added two additional deals for potential cause later this year.

Our 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 tool, 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.

Robert Colligan

Thanks Mohit. Here are the results of 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 in 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 a 116 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 to 1, while recourse leverage ended the quarter at 2 to 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 and compensation expenses. The Company also incurred legal expenses related to loan warehouse facilities.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Sam Choe of Credit Suisse.

Sam Choe

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

Mohit Marria

Hey sure Sam, this is Mohit. New asset acquisitions are always obviously tighter as our opening remarks states. You know yield compression as a result of the investor demand for those into credit remains strong the decrease in the net interest margin is a result of more of the interest expense in the reflow going up and just pay downs on our higher yielding assets reducing some of the yield earning on our existing assets.

Robert Colligan

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

Sam Choe

Got it. That’s it from me. Thank you.

Operator

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

Unidentified Analyst

Thanks good morning its [Eric] (Ph) 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.

Matthew Lambiase

Well yes. 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 and rates of return are coming down in the residential market.

I'm 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 and they are going to - my opinion is that they are going to be well bid going forward.

When I look at all of the investment options out there and if our [indiscernible] is below book value I think that's the best investment option in the markets full stop. I mean I think that's a great investment for the Company and for shareholders and we certainly stand ready to buy back shares should that happen.

And you know we've been managing I think a pretty conservative strategy and it's been paying off for us, and it's paying off for the shareholders. A 4.5% economic return in a very difficult market, 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 you know it gives us a tremendous amount of opportunity look at other things in the mortgage market and I’m bullish on residential mortgage credit and I think I'm very bullish on our rate to return that we're going to be able to produce for our shareholders going forward.

Unidentified Analyst

Okay, yes that's certainly fair. I'm hoping you can just provide a little bit of commentary on the Jumbo securitization. I know that maybe you will give a little bit more color next quarter, but I guess it’s this quarter, but just share the loss adjusted yields that you hit on that deal.

Robert Colligan

Well you know I would just say that on that deal specifically it was a very small deal for us, it was about $380 million, its Jumbo prime origination. This is the first Jumbo prime deal that we've done since 2012, you know these are qualified mortgages, so they don't have the risk retention requirements that the other securitization that we make have and this deal did not consolidate on our balance sheet.

And our investment in the deal was very small. So you know, so I wouldn’t look at this and I will 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 really just getting ready to look for new opportunities and look at different areas. Mohit.

Mohit Marria

Yes. On the economic front as we continue to see the faster 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 investment in the deal is muted, but we will generate favorable returns to the portfolio and be accretive to what we have currently.

Unidentified Analyst

Okay, great that's helpful. Thanks.

Operator

[Operator Instructions] Your next question comes from the line of Lee Cooperman of Omega Advisors.

Lee Cooperman

Thank you very much. I continue almost every quarter to congratulate you guys on the fine job you are doing and your transparency I think it's excellent. and I have nothing critical to say, but I do have one question. How much excess liquidity 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 - market gives you a chance to buy your stock back below book value, you prefer to employ your capital that way then raise a dividend, even though the dividend is below our recurring earnings. So my question is, you never could do too much of a good thing, the buyback is only 3% of the equity market cap how much excess liquidity we have, we've gotten into a bear market and stock persistently we sold below book value how much could you buyback prudently? In other words the question is how much excess liquidity we have in the Company that's not employed.

Mohit Marria

Yes. I will 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 capitals back and making sure we have adequate liquidity, especially in a dislocated market if we get to that.

The capital markets are open for us you know we speak to the banks weekly, if we wanted to raise capital in a convertible form or a preferred from, I think we could do that and adjust to capital back a little bit to reduce the equity flow.

But I think that there is also pay downs from our portfolio but then we will take that into new investments, we could use that as an additional source to buyback more share. So, maybe to summarize, we are authorized at 85 there is probably a little bit more room, we will see how things go through the rest of the year.

Lee Cooperman

When you talking about order of magnitude that you could buy back 10% or 15% of the company, if the market gave you that opportunity or are you saying possibly could.

Matthew Lambiase

No I think, you know what I don’t have a number for you, but I would say that we bought 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 have done that in the past, so there was no reason to think that we would do it going forward.

Lee Cooperman

Good, good. Well you guys have done an excellent job, I congratulate you and [indiscernible]. Thank you.

Matthew Lambiase

Thank you very much. I appreciate it.

Operator

At this time, there is no further question. I will now turn the call to Matthew Lambiase for any additional or closing remarks.

Matthew Lambiase

Well thank you for participating in the Chimera Investment Corporation’s first quarter 2018 earnings call and we look forward to speaking to you on the next quarter.

Operator

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