Chimera Investment Corporation

Greetings and welcome to the Chimera Investment Corporation fourth quarter 2022 earnings conference call. At this time, all participants are on a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Victor Falvo, head of capital markets. Thank you. Please go ahead.

Thank you operator and thank you everyone for participating in Chimera's fourth quarter and full year 2022 earnings conference call. Before we begin, I'd like to review the safe harbor statements. During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties which are outlined in the risk factors section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statement disclaimer in our earnings release in addition to our quarterly and annual filings. During the call today, we may also discuss non-GAAP financial measures. Please refer to our SEC filings and earnings supplement for reconciliation to the most comparable GAAP measures. Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information. I will now turn the conference over to our CEO, Phil Curtis.

Good morning and welcome to the Chimera Investment Corporation's fourth quarter and full year 2022 earnings call. Joining me on the call are Chaudhry Nralagada, our President and Chief Investment Officer, Dan Thacker, our Co-Chief Investment Officer, Subra Viswanathan, our Chief Financial Officer, and Vic Falvo, our Head of Capital Markets. After my remarks, Subra will review the financial results, and then we will open the call for questions. Let me begin by briefly introducing myself. As many of you may know from our internalization in 2015, until I became CEO in December, 2022, I served as the company's chief legal officer and corporate secretary. Prior to that, I was a partner in a major law firm and among other things was the company's outside counsel from its IPO until I joined as chief legal officer. What you may not know is that I have a broad range of experience before I became a partner in a law firm, from serving on Capitol Hill and the executive branch, to a defense analyst at a think tank, to a Fortune 50 company, to being a doctoral student in economics. My career as a lawyer was primarily structuring very complex financial transactions. That structuring experience carried over into my work at the company where I've been heavily involved in all aspects of the company's business, including serving on the investment and valuation committees, as well as being involved in structuring its transactions. I'm not a regulatory attorney. I'm not a litigation attorney. My appointment as CEO is not the result of any regulatory or litigation issue at the company, but rather driven by my transactional and strategic experience. Also, let me note that while I have the transactional and strategic experience, I am not the chief investment officer. We view the return to our past, where the roles of CEO and CIO were separate, as critical to our success. Separating these roles will enable us to better focus on our long-term vision while staying keenly focused on investment opportunities and our portfolio. Now, before turning to our vision, let me hit the highlights of the fourth quarter and of the year. As you know, 2022 was challenging for us, especially during the last four months. Headline inflation peaked around 9.1% and the Fed raised its benchmark rate from near zero to a range of 4.25 to 4.5% by year end. As a student of economic history, and being old enough to have lived through the late 1970s and 1980s, the Fed falling behind inflation and rushing to catch up had a familiar ring. I remember when my wife and I purchased our first home in the late 1980s. We were happy with a rate around 9.5% because we had taken out an even more expensive second just to qualify for the first. But we understood the value of that home as an asset. Not only was the story familiar, but the impact on the company was expected. We saw our weighted average recourse borrowing costs increased to about 6.6% by year end, compared to about 2.3% for the prior year. We saw our earnings available for distribution decline to $1.08 for the year and to 11 cents for the fourth quarter, due primarily to a one-time hit for severance for our former CEO, and a 250 million fixed-rate non-mark-to-market financing we entered into to enhance our liquidity while protecting us from the impact of increasing interest rates on those assets. Including those two events, our EAD for the quarter would have been approximately 20 cents. During the latter half of the year, we entered several long-term non-mark-to-market facilities. We looked into the future. and we believe the statements by the Fed that they were going higher for longer and decided to take the prudent action of extending some of our financing into 2024 and beyond to a point where we felt more comfortable that the Fed would be done raising and would begin cutting. Such financing is, of course, more expensive than short-term financing, but it reduces our need for hedges to protect against margin calls which frees up cash for other purposes. Also, we know that we are building up significant equity in our securitizations, as my wife and I were with our first home, and protecting our retained subordinate bonds with such financing is in the long-term best interest of our shareholders, even at the expense of higher rates. But there were many positives during the fourth quarter. In addition to lengthening the term of our financings, We acquired approximately 463 million of prime jumbo loans into a long-term financing facility, which is effectively fixed rate and non-mark-to-market. We believe the returns on this investment are accretive to our shareholders. We were able to reduce our mortgage loan mark-to-market exposure by approximately 100 million by sponsoring the SIEM 2022 NR1 securitization. Also, Our book value per common share increased to $7.49 at the end of the fourth quarter. The good news continued during January as we were able to access the securitization market and terminated four of our securitizations and issued two new securitizations, reducing recourse borrowing by approximately $139 million and releasing approximately $90 million in equity. We also committed to purchase approximately $700 million of re-performing loans, which we intend to settle into securitizations and believe the returns on these investments are accretive to our shareholders. We were also able to purchase additional business purpose loans and ended January with $365 million in cash. Finally, so far in February, we have committed to purchase approximately $200 million of non-QM loans which again, we believe will be accretive to our shareholders. So where do we go from here? Our mission is simple, to deliver attractive risk adjusted returns to our shareholders by being the best in class credit mortgage REIT. We believe our assets are very strong. We still have approximately 900 million of legacy non-agency RMBS on our balance sheet that continues to generate double digit yields for our portfolio. As of year end, we had approximately 11.4 billion fair value of mortgage loans, including RPLs, held for investment. These loans serve as the cornerstone of our business. The largest component of our loan portfolio is re-performing loans. These loans are very seasoned and, since purchase, have demonstrated consistent to improving metrics regarding both credit performance and prepayment histories. We have successfully securitized and resecuritized these loans throughout the years. Over time, these securitizations deliver and have historically provided opportunities for Chimera to release equity. Chimera uses this equity for either redeployment into new assets, retirement of debt, or distributions to shareholders through dividends. We view this ability to extract equity from our investments as a key differentiator for Chimera amongst its peers and can be a significant source of capital for deployment. We continue to see interesting and accretive opportunities in RPLs, non-QM, BPLs, and jumbo prime mortgages. While our focus during the past few years has been on RPLs, we expect to continue to diversify our loan purchases. In addition, we historically have had robust portfolios of agency RMBS and agency CMBS. We intend to rebuild these portfolios over time, both for their returns and for the liquidity to support our credit portfolio. Since REITs can't retain earnings, we often find ourselves able to raise equity during periods where the returns on credit assets are not attractive. Likewise, When the opportunities in credit are attractive, as they are now, it can be challenging to raise capital. We see these agency portfolios as a way for us to balance out these periods. We can grow our agency portfolios and use the increased liquidity to purchase credit assets when attractive or to support our financing of our credit assets during more challenged markets. While these portfolios will support our core business, we will manage these portfolios appropriate leverage and hedging to generate current income and to maintain book value to support both our dividend and our investment in credit assets. This is not a new strategy for us. We successfully used it from internalization until the pandemic. During that period, our combined agency RMBS and CMBS portfolio ranged from a low of about $4 billion to a high of slightly more than $12 billion depending on the opportunities to invest in credit assets. Now, we do think 2023 presents challenges. We saw a lot of positives in January and believe there are still positive trends. Nevertheless, we also see some dark clouds. Getting inflation down to 2%, if possible, is going to take some time. According to a recent Wall Street Journal article, the service industry's healthcare, hospitality, and so forth, account for 36% of all private sector payrolls. By the same token, the tech-heavy information sector accounts for only 2%. These service industries have accounted for approximately 63% of all private sector job gains over the past six months, and the labor demand in these industries remains strong. Accordingly, we believe the Fed, when it says, rates will go higher for longer. And we believe we have positioned ourselves to handle that outcome. We're also mindful of the second cloud, liquidity volatility arising from debt ceiling shenanigans. We're keeping our eye on our financing and role dates with respect to this cloud. Finally, there is the known unknown of geopolitical turmoil, Russia, China, Iran, and North Korea in particular. The impact of such turmoil is unknown, but between our long-term financing, hedging, and cash positions, we believe we are positioned to handle a variety of stress scenarios. Despite these clouds, I am optimistic about our future. We have a great team, outstanding assets, and a clear vision. I would now like to turn to Subra to give a more detailed overview of our financial results.

Thank you, Phil. I will review Chimera's financial highlights for the fourth quarter and full year 2022. GAAP book value at the end of the fourth quarter was $7.49 per share and our economic return on GAAP book value was 3.8% based on the quarterly change in book value and the fourth quarter dividend per common share. Our economic return for the full year was negative 27.3%. Gap net income for the fourth quarter was $79 million or $0.34 per share. And gap net loss for the full year was $587 million or $2.51 per share. On an earnings available for distribution basis, net income in the fourth quarter of approximately $0.11 per diluted common share and $0.16 per diluted common share after excluding a one-time severance expense related to the separation of our former CEO. And for the full year earnings available for distribution was $256 million or $1.08 per share. Our economic net interest income for the fourth quarter was $77 million and $436 million for the full year. For the fourth quarter, the yield on average interest earning assets was 5.5%. Our average cost of funds was 3.9%, and our net interest spread was 1.6%. Total leverage for the fourth quarter was four times to one, while RICO's leverage at the end of the quarter was 1.3 to one. For the year, our economic net interest return on equity was 14.7%, and our gap return on average equity was negative 16.7%. And lastly, our full year 2022 expenses, excluding servicing fees and transaction expenses, were $72 million, modestly up from the previous year. That concludes our remarks. We will now open the call for questions.

Thank you. Ladies and gentlemen, the floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that's star 1 to register a question at this time. The first question is coming from Bose George of KBW. Please go ahead.

Hey, guys. This is actually Mike Smith on for Bose. So you mentioned that you intend to rebuild the agency MBS and CMBS portfolios. Just wondering, you know, how big do you envision this kind of getting as a percentage of capital? And then, you know, what's the timeline for getting there?

Hi, this is Phil. Thanks for the question. You know, there isn't a specific timeline. You know, we'll look at the opportunities in the market for both. And depending on kind of relative value, we'll start moving into those assets. As to the size, I think what we'll be looking at is a minimum of which we think is a – minimum size of portfolio to be effective in this space or to be efficient, but the actual size will depend on kind of the size of our credit portfolio and where we see the future going in terms of possible investment. So we're not going to peg it to, you know, 10% or 25%. We're going to look at it more holistically at the time.

Great. Thanks. And then on the loan purchases, I was wondering, are you able to purchase the loans and kind of securitize it roughly at the same time to kind of avoid the risk of you know, holding those loans on balance sheet and funding it with repo?

That's correct. That is our intent there. You know, it could be the case that we, because of timing, that we end up warehousing them for a week or so. But the intent of when we purchase these is to settle right into securitizations.

Great. And then maybe just one more. You noted that the purchases would be accretive. Can you just kind of walk through what's the expected ROE and kind of what does this assume in terms of structural leverage, and does it assume any repo leverage on the retained pieces?

Yeah, we think it's, you know, we're talking about something in the mid-teens for returns, and that would include leverage on the retained pieces.

Great. Thanks a lot for taking the questions.

You bet.

Thank you. The next question is coming from Trevor Cranston of JMP Securities. Please go ahead.

Hey, thanks. Good morning. You guys talked about, you know, broadening out the types of loan purchases you're going to be making, you know, more so beyond the traditional RPLs as we go forward. You know, between the new categories of non-QM and BPL, for example. Can you talk about where you see a bigger opportunity in terms of how much supply of loans is available and the type of returns that you think you can get on those investments? Thanks.

Well, first, we really like BPLs. We think the returns are very good, and we like the short duration. At times, it can be challenging to acquire that in size, but we're always looking for opportunities there. And so, but in the non-QM, it's something that we traditionally haven't played in, but in terms of some forms of investor loans and the like in that category, we're now finding to be attractive and opportunities are coming our way and where we think we'll be buying more of that on a go-forward basis.

Okay, got it. And then the question on the dividend. I mean, so fourth quarter earnings, you know, excluding the one-time stuff, seemed to have still trended, you know, downwards as cost of funds has increased. Can you maybe just talk about how you guys are thinking about the dividend given that trend and maybe any other considerations that the board takes into account beyond just the EID metric when you guys are setting the dividend? Thanks.

Sure, thanks. You know, EAD is one of the metrics. It's not the only metric, and at times it's a, you know, it's a good measure for certain aspects, but not, you know, 100% foolproof. So I think the board looks at a variety of factors, including kind of the total cash that the portfolio is generating, some of which, you know, just is not captured in kind of the EAD metric. We also bear in mind, as I mentioned, you know, that we have equity in our securitizations. And so, you know, depending on the timing and what our needs are, we may tap that from time to time. So we have all those factors go into it when we think about or when the board thinks about the dividend. And so they were, given where the portfolio is, they were comfortable with declaring the, you know, the first quarter dividend at at 23, despite kind of where EAD is at the present moment. Okay. Appreciate the comments. Thank you. Sure. No problem.

Once again, ladies and gentlemen, that is star one. If you would like to register a question at this time. The next question is coming from Lee Cooperman of Omega Family Office. Please go ahead.

Thank you very much. I'll just make an observation. You said you're a student of history. Any student of history with no interest rates were going up. Why were you not hedged earlier than now?

You know, that is something that, you know, in hindsight, the company should have done. I mean, that we're right now looking kind of on a go-forward basis. I mean, we have had a change in leadership. We do have a vision of where we're going. We do have, you know, a structure and a strategy with respect to hedging versus, you know, our longer-term financing. And so... That's where we are. I am a student of history, but to be frank, that is in our past, and what we're focusing on is fixing it and moving forward.

All right, so it was a question that was previously asked, but you talked around it. The way you want to run the company, what is a reasonable return on equity for us to generate on our $7.49 a book value?

It's really our dividend return, you know, 10%, 12% range. Well, 10% return on equity wouldn't do it.

10% return on equity would be a 75-cent dividend. That would imply a cut.

Jump into her.

Hey, Lee. This is Subra. Historically, the dividend yields on our stock has been around 10% to 12%, and that's where we expect our dividend to – where our investments are currently yielding, and that's where we see the dividends to be – the return on capital to be expected from the stock.

So what are you saying? The return on equity determines the distributable income, which will determine the dividend. So you're saying that the return equity should be 10% to 12%? Yeah. Right, okay. That would imply the dividend is kind of iffy at this level, that should we assume as shareholders that there's a good chance the dividend might be reduced in the next 12 months, or do you think the dividend is likely maintained?

No, I think right now we feel where the dividend, where our portfolio is in terms of – throwing off cash and the new investments we're making, it's hard to predict where the future is in terms of the markets and potential dark clouds that we talked about. But right now, we feel good about that 23% dividend.

Thank you. And I assume, given the balance sheet, you have plenty of capital to run the business. You don't need additional capital.

Yeah, we have plenty of capital to run the business as it's currently constructed. But as we mentioned, in terms of growing the other portfolios and investment opportunities, I'll just be straight. We're not going to shy away from raising money if that money is raised at a rate that's appropriate for us to reinvest in the assets. So if we see a positive return to that capital, we won't shy away from raising additional funds.

Equity, would you consider equity financing at these levels?

I would consider equity financing depending on the investment opportunities at the time that we could access the market. Yes. So you would sell stock at a discount to book value? No, I didn't say that. I said that we would.

I'm asking. I'm asking. Look, let me tell you what my view is. Wall Street has created a lot of companies in this VDC, MLP, REIT space that only work when the stock is sold at a premium to NAV because what happens is You sell stock, you buy assets, you raise a dividend. You sell stock, you buy assets, you raise a dividend. When you go with discount to NAV, it's game over. It's only the smart guys that basically either merge to become more efficient to generate synergies or basically buy back stock at discount. The idea of selling stock at a discount to book value makes absolutely no sense, and we should consider winding up the affairs of the company and giving back the money to the shareholders. So we made a mistake. Our stock has been a disaster.

Yeah, I mean, we don't disagree with that. I mean, our intent would be to raise a book. I mean, the reason I pause for a second, it depends in terms of what the opportunity is. And if we feel that it's massively accretive, we would at least consider it. But that's not our going in position.

Very good. Thank you. Good luck.

Thank you.

Thank you. At this time, I would like to turn the floor back over to Mr. Curtis for closing comments.

I'd like to thank everybody for joining our earnings call and, frankly, my first earnings call. It's been a pleasure to have the opportunity to speak to you, and I look forward to doing so in the future. Thank you.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.