CIM - NYSE

Good day, ladies and gentlemen, and welcome to the Chimera Investment Second Quarter 2023 Earnings Call. All lines have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, Victor Falvo, Head of Capital Markets. Sir, the floor is yours.

Thank you, operator and thank you, everyone, for participating in Chimera's second 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 investor presentation 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 Chief Executive Officer, Phil Kardis.

Thank you, Vic. Good morning, and welcome to the Chimera Investment Corporation's second quarter 2023 earnings call. Joining me on the call are Choudhary Yarlagadda, our President and Co-Chief Investment Officer; Dan Thakkar, 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'll open the call for questions. We continue to be active during the second quarter to securitization, stock repurchase and liability management. We completed five securitizations during the second quarter, totaling nearly $1.4 billion. Let me describe our quarterly securitization activity at high level. In April, we sponsored CIM 2023-I1, a rated securitization of non-QM & Investor Loans, totaling approximately $236 million. Approximately 87% of the capital structure was sold in the private placement to institutional investors. We retained a subordinate interest in securities with an aggregate principle balance of approximately $31 million and certain interest only securities. Our average cost of debt to this securitization is 6.6%. We retain an option to call to securitized mortgage loan at any time beginning in April of 2026. In May, we sponsored CIM 2023-R4, a rated securitization of seasoned, reperforming residential mortgage loans totaling $394 million. We sold approximately 75% of the capital structure and a private placement to institutional investors. Chimera retained subordinate interest in securities with an aggregate principal balance of approximately $97 million and certain interest only securities. Our average cost of debt of this securitization is 5.4% and we retained an option to call the securitized mortgage loans at any time beginning in April of 2028. In June, we sponsored at CIM 2023-I2, our second rated securitization of non-QM & Investor Loans this year, totaling approximately $239 million. Approximately 85% of the capital structure was sold in a private placement to institutional investors. We retained interest in securities with an aggregate principal balance of approximately $36 million and certain interest only securities. Our average cost of debt at this securitization is 7%. We retain an option to call the securitized mortgage loans at any time beginning in July 2026. We expect double-digit returns on the retained securities for these three securitizations. And now regarding re-securitization, we terminated two existing trusts, CIM 2017-7 and CMLTI 2019-E. In addition to the loans from these two deals, Chimera added approximately $104 million loans from our warehouse facility. We then issued CIM Trust 2023-R3 and CIM Trust 2023-NR2. These re-securitizations allowed us to: one, avoid a step up, rate increase on the senior debt of one of these terminated trust; two, convert short-term repo funding into long-term non-recourse fixed rate financing; and three, to recapture approximately $43 million in cash from the terminated trusts. Primarily as a result of our securitization activity this quarter, we reduced our recourse financing, primarily loan warehouse facilities by more than $500 million. And in total, through the first half of the year, we reduced our recourse financing by approximately $750 million. As short-term rates continue to increase this quarter, we prepared for a higher, for a longer rate environment. We added an additional $500 million one by one swaption, bringing our total swaption position to 1.5 billion, with an average pay fixed interest rate of 3.56%, These swaptions give us optionality to hedge our NIM at rates remain elevated through 2024 and into mid-2025. In addition, our Board reauthorized our stock buyback plan and increased it to $250 million in the middle of June. Thereafter, we were able to repurchase more than 5.8 million shares for approximately $33 million at an average price of $5.66. The share repurchase was accretive to our shareholders. Our book value per share decreased by $0.12 or 1.6% quarter-over-quarter. The net change in book value plus dividends paid on our common shares resulted in an 80 basis point total economic return for the quarter, and a 2.8% total economic return for the first half of 2023. Looking ahead, while we believe it is likely, the Fed will raise rates one more time this year, we believe the rate hike cycle is nearing an end. Inflation is coming down slowly, while the economy and job market remains strong. The Fed's own staff no longer predicts a recession in 2023 and the Fed may well engineer a soft landing. We are also buoyed by the residential by residential credit, which performed strongly during quarter as well as by the strength of housing market despite -- in spite of affordability issues. What does that mean for us? As we've discussed in the past, our portfolio continues to perform well. Our EAD challenges are primarily related to our costs of financing, not the credit quality of our portfolio. Once rates moderate and begin their decline, our portfolio is positioned to benefit. We would expect that this rate moderation and stability will allow us to refinance some of our more expensive financings, which will be positive to our earnings. On the other hand, to the extent that rates stay elevated for longer, we have 1.5 billion in swaptions, which we can exercise to support our interest margins into 2025. We continue to see interesting investment opportunities and we think with the proposed bank capital regulations that additional investment opportunities will arise over the second half of 2023. We will continue to evaluate those opportunities, along with our stock price relative to our book value with respect to continued stock repurchases. We have a number of tools in our toolkit from reducing our financing costs to repurchasing our stock to making accretive investments to drive shareholder value. We remain optimistic about our future. 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 second quarter 2023. GAAP book value at the end of second quarter was $7.29 per share and our economic return on GAAP book value was 80 basis points based on the quarterly change in book value and the second quarter dividend per common share. And for first half of the year, our economic return was 2.8%. GAAP net income for the second quarter was $18 million or $0.08 per share. On an earnings available for distribution basis, net income in the second quarter of approximately $28 million or $0.12 per diluted common share. Our economic net interest income for the second quarter was $67 million. For the second quarter, the yield on average interest earning assets was 5.6%. Our average cost of funds was 4.4% and our net interest spread was 1.2%. Total leverage for the second quarter was 4.2:1, while recourse leverage ended the quarter at 1.0:1. For financing and liquidity, the company had $670 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 agreements. We had $2 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 10.2% and our GAAP return on average equity was 5.5%. And lastly, our second quarter 2023 expenses, excluding servicing fees and transaction expenses were $14 million modestly lower from the first quarter. That concludes our remarks. We would now open the call for questions.

We will now conduct a question-and-answer session. [Operator Instructions] Your first question comes from George Boss of KBW. Your line is open.

Hey, guys. This is Bose. Actually, I had a couple of questions. First, on the expenses, it did come down this quarter. Can you just sort of talk about the outlook for expenses going forward?

We expect the expenses to remain constant. Obviously, some of the variable expenses such as servicing fees and transaction expenses would vary depending on, if we increase the number of loans. But as paydown happens, some of these variable expenses will continue to go down. But otherwise, our G&A expenses, we expected to be pretty benign or pretty consistent as we have.

Okay. Great. Thanks. And then, just in terms of the current returns, so you showed that economic ROE, I think it was 10.2%. How does that compare to the incremental ROEs that you're getting on stuff that loans you're buying and securitizing currently?

Okay. So I just want to make sure. So what we project right now, the 10.2%, our scenarios we expect our top line interest income to stay consistent with what we have. Expenses, really it depends on where the rate is. If we expect an additional 25 basis point increase in interest expense, so that'll, somewhat offset some of that. But what we focus right now is to have a consistent economic return based on our net income, or our interest income being projecting to be consistent across quarters.

And so when I take that number and sort of the expenses, run rate expenses as a percentage of equity, I mean, for you guys to get to kind of a double-digit ROE on a net basis, does it require like either more scale or reach to come or what kind of scenarios, like, how do you get from here to sort of that run rate double-digit net ROE?

This is Phil. That's correct. I mean, as we look for accretive investments, we'll have to -- we need to increase our size and we'll need some rates to come down as well, both.

Okay. Great. Thank you.

Your next question comes from Doug Harter of Credit Suisse. Your line is open.

Thanks. Can you talk about the decision on the dividend and in light of kind of where earnings are and kind of the expectations?

Sorry, you broke up a little bit. I think you were asking about the dividend? Hello?

Yes. Sorry. I think cut out there for a second. So just sorry, just repeat, can you talk about the board's decision around the dividend in light of where current earnings are and your expectations around, kind of getting back to covering the new dividend?

Yeah. So as we've said in the past, the EAD is one of the metrics the board looks at. It's a useful, a guide. It isn't an exact in terms of what our dividend paying capacity is and we look at what that capacity is. We look at kind of as we mentioned looking forward into the future, as rates are moderating, we believe we'll be able to do refinance some of our more expensive financings which will help us on our earnings. And so we think there are opportunities to continue to grow into that by the same token. Right now, what we're portfolios generating, the board feels comfortable at paying that dividend.

Thank you.

[Operator Instructions] Your next question comes from Trevor Cranston with JMP. Your line is open.

Okay. Thanks. Good morning. Can you elaborate a little bit on the type of opportunities that you think could emerge coming out of the banks as a result of the capital requirement changes and what you think the timing of opportunities emerging there could be over the second half of the year? Thanks.

Sure. We'll turn this over to Dan, who can address that.

Yeah. So, Trevor, so as you said, there is a strong likelihood that mortgage banks will have to earn more capital against residential mortgage pools. So this should push more residential mortgage origination to non-backward originators and result in more private label securitization. We will see those opportunities in the future. As you said, one thing I will say that even without that we are being shown large inventories of discounted underwater mortgages given the consolidation going on in the banking space. At this point, the opportunity that we are seeing is primarily in the prime jumbo, low LTV kind of paper.

Okay. Got it. Appreciate that. Thank you.

At this time, there are no further questions. I would like to turn the call back over to management for any closing remarks.

Hi. This is Phil Kardis. Thank you for participating in Chimera Investment Corporation's second quarter earnings call and we look forward to discussing our third quarter earnings call in November. Thank you.