Chimera Investment Corporation

Greetings. Welcome to the Chimera Investment Corporation third quarter 2023 earnings call. At this time, all participants are in a listen-only mode. The question and answer session will follow the formal presentation. If anyone should require operator assistance during the call, please press star zero on your telephone keypad. 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.

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 of the most comparable gap 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 Curtis.

Good morning and welcome to the third quarter 2023 earnings call for Chimera Investment Corporation. Joining me on the call are Chaudhry Gharlagada, our President, Chief Operating Officer and Co-CIO, Subra Biswanathan, our Chief Financial Officer, Dan Thacker, 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 two 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 in 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, Myun 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 seven-plus years as senior vice president, chief legal officer, and secretary of Erstad 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 backup 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 gap book value per share drop quarter over quarter from $7.29 to $6.90, a decrease of 5.4%. Considering the market conditions, we remained 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 three new repo counterparties. And post-quarter, we refinanced a high fixed rate non-mark-to-market facility into a new two-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's 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 in 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 swaps, swaptions, and futures contracts to soften the impact of rising rates. Through these initiatives during the first nine 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 one 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 deliver, 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 four become callable in 2024, and another six 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 shareholders over the long term. I'll now turn the call over to Subra to review our financial results.

Thank you, Phil. I will review Chimera's financial highlights for the third quarter of 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 nine months year to date, Our economic return was 0% based on the change in book value since year end and the first three quarters dividends per common share. Gap net loss for the third quarter was 16.3 million or 7 cents per share. On an earnings available for distribution basis, net income in the third quarter of approximately 29 million or 13 cents 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 to 1, while recourse leverage ended the quarter at 1 to 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 one 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.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The 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. One moment, please, while we poll for your questions. Our first questions come from the line of Stephen Laws with Raymond James. Please proceed with your questions.

Hi, good morning. Phil, I wanted to follow up on some of your prepared remarks just about, I think you said 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? You know, and where do you look at, you know, where do you see returns kind of on new investments if you decide to deploy the capital offensively?

Hi, Stephen. Thanks for the question. So, you know, right now, I think we're happy with our liquidity position. But as we look for rates now being higher for longer, you know, we think to shore up liquidity makes sense. You know, if we think about our priorities, we look at, you know, 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. You know, and we look at, you know, 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, you know, are important. And I'm going to turn it over kind of where we're seeing some of those opportunities to Dan.

Yeah, sure. So this is Dan Thacker. So in terms of the opportunities, you know, 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 through those securitizations. I will point out that, you know, as far as the securitization economics is concerned, it's pretty stable, especially in the non-QM space with the newly originated, you know, high gross back loans with coupons around 8.5%. You know, that said, you know, recent deals on the AAAs are pricing in the high 100s versus mid-100s in the third quarter. So any more underperformance there will deteriorate the arc. So we are very cautious there. You know, obviously, the widening that we have seen on the non-QM AAAs has widened in sympathy with the agency RMBS. So it is kind of stable and compelling at this point, but it can, you know, deteriorate really quickly in the macro environment we are in. I don't know if that answers your question.

Yeah, that's helpful, Kala. I appreciate the comments. And just wanted to verify one thing. I think you mentioned $16 million savings and interest expense from the, you know, refinance of a higher-cost facility. six to seven cent benefit there annually. Is that right or is there an offset to that somewhere?

You know, I think, you know, yes. I mean, that's the number we expect to say, but, you know, as you're probably aware, in the early part of next year, two 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 if you, as you think about this, We believe that this 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. Gotcha. Great. That makes sense.

Thanks very much.

Thank you. Our next question has come from the line of Trevor Cranston with JMP Securities. Please proceed with your questions.

All right. Thanks. Good morning. Can you talk about what you guys are seeing in the bulk loan market, particularly, you know, 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? Thanks.

Yeah, I think right now, you know, from the bulk, we're not seeing that much. We've got to, you know, wait for the term facility to end, and so it's not been an area that we've been, you know, really focusing on right this, given the current situation.

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 protections 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. Thanks.

Yeah, so this was, you know, a significant facility for us in terms of, you know, our desire to refinance it. You know, 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 made sense for us to do that now. I think, you know, 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, you know, 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, you know, other opportunities, you know, right now the market has been functioning normally. We're able to roll. You know, really in the next, you know, what I would call high-cost facility, that refinancing opportunity will become in early 2025. Okay. Got it. That's helpful. Thank you.

Thank you. Our next questions come from the line of Bose George with KBW. Please proceed with your questions.

Hey guys, good morning. Actually, what's the incremental ROE on, you know, new money you're putting to work? And when we think about, you know, the existing returns, you know, how long, if rates remain stable, you know, 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 kind of think about the returns in this portfolio if rates essentially remain stable.

Right. So the current portfolio, this is Subra. Thank you for your question. Um, so the current, you know, in my prepared remarks, I mentioned that the current economic, you know, um, net economic returns on our portfolio or ROE is about 10, 10.4%. Now that's excluding hedge expenses or, you know, excluding, um, other, other, uh, administrative and other, uh, GNA income costs for us. Right. So the 10.4% is what we are, we are seeing. And that is on this high rate environment. Obviously, you know, 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.

Okay. And actually, in terms of the, you know, sort of getting to a more normalized ROE, you know, then does it really kind of depend on rates coming down or just restructuring some of the liabilities over time? You know, just trying to think about ways, you know, that this gets to on a net basis to a double digit ROE.

Yeah, so sure. This is Phil again. So as I mentioned, we had one, you know, high, really high cost facility that we were able to refinance and the next one's 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, you know, a chunk of that already. The rest of it's going to come from some rate moderation.

Okay, great. Thanks.

Thank you. Our next question has come from the line of Eric Hagan with BTIG. Please proceed with your questions.

Hey, thanks. Good morning. Sorry if I missed this, but did you guys say what your current book value was, you know, through October? And then, you know, going back to the liquidity, I mean, what's the right way to think about just the incremental liquidity that's being generated, you know, like on a monthly or quarterly basis just based on paydowns, right? It's just natural kind of CPR.

Thank you. Go on, Dev. Oh, sorry, this is Phil. On the book value since the end of the quarter, I'm going to turn that over to Dan Thacker.

Yeah, yeah, Eric. So I think the investor debt that we released last night, we had stated roughly down to 2%, but given the strong rally that we had in the rates market post the Fed, we are closer to down being 2% versus 3%. Okay, great.

And then I think you asked Rilla to pay downs. Is that correct?

Right. Yeah, just the way to think about liquidity that's being generated sort of incrementally just through, you know, kind of natural, you know, paydowns.

Yeah, so I think, you know, right now the portfolio is running around six CPR in terms of kind of where the paydowns are coming. I hope that's, you know, helpful to you.

Okay. Yeah, and then how are we thinking about the option value you have to, you know, call and re-securitize the existing portfolio? And really just kind of how sensitive you see that optionality being to interest rates, you know, going forward here.

Yeah, 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, you know, the size of the senior, the size of the transaction. uh that you would uh in terms of when you refinance it so you look at all those factors and so right now you know the longer uh those stay out you know the better uh in this environment yeah and then and then obviously as the cpr picks up it it's just going to be more creative so you know we have this optionality now and we think it's very valuable but we're going to to be um cautious, you know, in terms of in the near term. But as rates begin to moderate, we'll start to look at this more and more closely.

Okay. All right. Thank you, guys.

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 Curtis for any closing comments.

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.

This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.