Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation First Quarter 2019 Earnings Conference Call and Webcast. [Operator Instructions] It is now my pleasure to turn the floor over to Emily Mohr of Investor Relations. Please go ahead..

Thank you, Lori, and thank you everyone for participating in Chimera's first quarter 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 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..

Good morning and welcome to the first quarter 2019 Chimera Investment Corporation Earnings Call. Joining me on the call this morning are Mohit Marria, our Chief Investment Officer; Bob Colligan, our Chief Financial Officer; Choudhary Yarlagadda, our Chief Operating Officer; and Victor Falvo, Chimera's Head of Capital Markets.

I'll make some brief comments, then Mohit, Rob will review the portfolio and financial results for the quarter. We will open up the call for questions thereafter. Chimera posted a solid 4.8% total economic return for the first quarter comprised of $0.50 dividend and $0.25 increase in book value in the period.

In January, we took the opportunity to add capital by issuing $200 million of preferred stock. This issue Series D has an 8% fixed coupon for the first five years and then converts into a floating coupon adjusting quarterly at three month LIBOR plus 533 basis points.

The Series D preferred is callable at the company's discretion any time after the five year fixed rate. Over the past two and a half years, Chimera has issued $930 million of preferred stock which has helped us grow our investment portfolio and lower the company's overall cost of capital.

The first quarter 2019 was another volatile period for the fixed income markets largely due to the actions of the Federal Reserve. In late March, the Fed stated that it was done raising rates for the rest of 2019.

This statement came as a surprise to most market participants who are still trying to understand the logic of the rate increase in December. Chairman Powell noted in his comments, its great time to be patient and this sent and all fear signal to the market to buy bonds.

Other post meeting comments from Fed officials sent the bond market higher in price and the yield on a 10 year treasury built at 2.37% after being at 2.76% at the beginning of March. The positive sentiment for U.S.

Treasury bonds was further compounded when German manufacturing data showed that their economy the bellwether of Europe was starting to slow which pushed German 10 year bond yields into negative territory.

Negative yields in both Germany and Japan started to raise the specter of a global economic slowdown, and the fear that the Federal Reserve may have over tightened interest rates and may need to cut in the future. Several economists and analyst have all begun to call for U.S.

recession later in 2019 or early 2020 period of time, when unemployment is at record lows and an economic growth seems to be modest with solidly positive. There appears to be a disconnect between equity investors who are driving the stock market to record levels and bond investors who were excepting low interest rate with a flat yield curve.

The current interest rate environment is less than ideal for our strategy. The U.S. Treasury yield curve is relatively flat and the LIBOR is slightly inverted with the three month LIBOR rate at 2.58% and 10 year interest rate swaps at 2.53%.

The shape of the yield curve is negatively impacting many financial companies by keeping short-term borrowing cost high, and portfolio reinvestment rates low. The longer the yield curve maintains the shape, the harder will become to maintain net interest spreads.

While we’re not immune from the effects of a flat yield curve, we do believe that it’s most likely a short-term anomaly. Historically the yield curve is normally positively slow and in the past has only inverted for relatively short period of time during economic transition.

As I stated on previous earnings calls, the end of Fed tightening cycle can be tumultuous as the market transitions to new economic expectations.

This year many bond investors have been trying to get ahead of his transition and are currently betting that the economic data will start to show a slowdown and the Federal Reserve will start cutting rates later in 2019 or early 2020.

While we would be happy with that outcome as it would lead to lower borrowing costs, and much better operating environment, we continue to manage our portfolio over long horizon and we remain prudent with hedge positions should interest rates unexpectedly rise. Our core portfolio residential mortgage credit continues to perform well. The U.S.

housing market fundamentals have moderated somewhat but made positive for our legacy portfolio. The March, S&P Case-Shiller national home price index showed a positive 4.23% increase year-over-year, which was down from 6.18 a year earlier.

We believe that a 4.23% increase is healthy and other data such as housing starts, existing home sales and new home sales looks healthy to us as well. The stronger U.S. employment physics reinforce our belief that the housing market is on solid ground and that the current dividend interest rates will only increase demand and affordability.

We’ve been successful in finding new investment opportunities and continue to believe that residential mortgage credit offers some of the best peaceful work profile available in the entire fixed income market.

Last night our Board of Directors announced a $0.50 per share of common dividend for the quarter and reinforced their earlier statement for their intention to pay $2 per common share for 2019. And with that I’ll turn the call over to Mohit, to discuss the portfolio activity in the quarter..

Thank you, Matt. In the first quarter of 2019, we saw a reversal of what occurred in Q4.Equity markets rebounded at its credit spreads. In addition, the Federal Reserve in March retreated from the tightening bias over the past two years as concerns over global growth and lack of inflation took center stage. For the Fed on pause U.S.

treasury rates continued their decline in Q1 and now have decreased over 80 basis points on 10 year treasuries over the past five months. Shortened rates however decrease left moving to an inversion of the yield curve between three-month and 10 year treasuries.

Quarter-over-quarter our agency portfolio was largely unchanged, decreasing by about $300 million to $8.7 billion. Although the portfolio is similar in size to the previous quarter, the faster prepayment expectations paused by the decrease in treasury rate has substantially reduced the duration of these holdings.

By the result of the changes in prepayment expectations we have made a substantial reduction in our interest rate swap hedge position to better match the shorter duration of our agency pass-through portfolio. As we mentioned last quarter, agency CMBS has widened substantially and we were seated at to our position.

For the government shutdown for the first six weeks of the year has limited our ability to increase the portfolio meaningfully. We added roughly $187 million in agency CMBS construction loans for a portfolio in the quarter bringing our total to $3.1 billion.

Mentioning that unlike residential agency pass-throughs, our agency CMBS carried all protection which is extremely beneficial from a hedging perspective as rates have moved substantially over the past five months.

In our residential credit portfolio, we were able to take advantage of wider spreads early in the quarter by adding some non-agency securities. In addition, we also acquired about $112 million of residential transition loans of the portfolio. These loans have a weighted average coupon of 7.23% and a weighted average LTV of 70%.

Due to the short nature of these loans, we do not currently intent to securitize them. Lastly, this quarter we placed our second securitization packed by industrial loans. We priced $382 million of CIM 2019-INV1.

These loans on this deal have a weighted average coupon of 5.35%, and a 69 weighted average LTV, and the weighted average loan size of approximately 294,000. Chimera retained $41 million investment this deal. To summarize our activity it was a relatively light order for changes to the portfolio.

Given the current market volatility, shape of the yield curve and the recent shift in Federal Reserve policy, we believe it is prudent to exercise patience with the investment and portfolio growth. We continue to have ample liquidity in our agency portfolio and continue to seek out loan opportunities in credit investments.

I will now turn the call over to Rob to review the financial results..

Thanks Mohit. I will review the financial highlights for the first quarter of 2019.GAAP book value at the end of the first quarter was $16.15 per share and our economic return on GAAP book value was 4.8%,based on a quarterly change in book value in the first quarter per common share. GAAP net income for the first quarter was $101 million.

On a core basis, net income for the first quarter was $106 million or $0.57 per share down slightly from last quarter. Economic net interest income for the first quarter was $151 million compared to $154 million last quarter. For the first quarter, the yield on average interest earning assets was 5.5%.

Our average cost of funds was 3.4% and our net interest spread was 2.1%. Total leverage for the first quarter was six to one while recourse leverage ended the quarter at 3.9 to 1. For the quarter, our economic net interest return on equity was 16% and our GAAP return on average equity was 12%.

Expenses for the first quarter excluding servicing fees and deal expenses were $20 million up from the fourth quarter primarily related compensation expenses. We accelerated the cost of equity-based compensation in the first quarter as some employees have become retirement eligible.

In future years, prize awarded to these employee in the first quarter will be immediately expense and compensation expense may be lower in the second, third and fourth quarter.

For 2019 compensation maybe $12 million to $13 million per quarter for the remainder of this year although our compensation is now based Chimera’s financial performance relative to our peers and will be adjusted each quarter based on relative return on equity and total economic return.

That concludes our remarks, and we’ll now open the call for questions..

[Operator Instructions] Our first question comes from the line of Eric Hagen of KBW..

I am glad you guys addressed the prepay element of the portfolio. I assume that pertain mostly the agency portfolio though.

How should we think about pre-pays for the second quarter in particular for the securitized loan portfolio?.

This is Mohit. Yes, most of the prepayment expectation changes are based on the changes in the agency portfolio.

The non-agency and the loan portfolio continue to prepay where they have historically prepaid in the high single digits and we don't expect that to change even with the moving rates as those borrowers have had a refi for a long time but with limited options to refi which is what makes a loan portfolio very attractive..

Yes, so I think the yield in the securitized loan portfolio narrowed by - I think have in front me 20 basis points.

I guess that wasn't driven by prepays what was the driver of that?.

I think again the yields on the loan portfolio everyone of them on a quarterly basis that the cash flows some of the assumptions have changed.

I think again as these loans flush to the pipelines we have about 8% to 9% delinquent some of the severity experience are little bit higher than we expected and that change is reflected in the new cash flow assumptions causing to us late downtick in the yields..

Got it, okay. And would you…..

I would say the only other thing is obviously as we add to the portfolio some of the newer assets may have a slightly lower yield than what we had in the past. The older portfolios when we bought several years ago given the rate curve at the time had a little bit higher yield than what we’re finding in the market right now..

Yes, I imagine some of it was due to mix, the mix shift so thanks for clarifying that. The second question just how comfortable are you guys with the amount of preferred in the capital structure right now.

I mean, I think leverage for the overall business is pretty contained I mean around six times but I guess that doesn't really address the leverage on common stockholders.

So how do you kind of think about your capacity overall to run with perhaps more preferred or I guess are you comfortable with the overall level that you have right now?.

Yes, sure I’ll start on that one. Yes, the preferred markets have been good for us. I think the market have been opened, its lowered our overall cost of capital. It is not our preferred way of raising capital and I think it helped us broaden the investor base as well.

I think we have a much broader retail and institutional investor base then we did before. We started issuing preferreds and I think that in the short-term at least that would probably be our go to if we needed additional capital..

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

This is actually Josh on for Doug.

First off was there any material impact of the tightening of the spread that we saw between three month LIBOR and one month repo on earnings in the quarter?.

Josh this is Mohit again. No, in fact for the majority of Q1 repo rates were reflective of higher given the Fed rent in late December I think we're going to see the benefit of the downtick in three months LIBOR more reflective in Q2 as opposed to Q1. I think weighted average repo cost for Q1 was north of 270/271 roughly..

And then can you guys give us any update on how you're thinking about how book values trended since March 31?.

Yes, I think on the credit side spreads are little bit firmer so supportive of book value, loan pricing remains low a bit so that's also supportive of book value. On the agency side given the rally more is a lagged a little bit. So I would say book value is flat to maybe slightly up..

Your next question comes from the line of Trevor Cranston of JMP Securities..

I was wondering if you could talk a little bit more about new investment opportunities, here you commented that you had liked agency CMBS last quarter but were only able to add a little bit.

I was curious if you guys still find any value there, and also if you could maybe talk about opportunities on the credit side in terms of securities versus loans and what you're seeing there? Thank you..

So I’ll start with the agency CMBS side. Yes, we still find those - that asset class attractive. I think as it's just the size of that market is relatively small.

Annual originations tend to be anywhere between 12 to 18 billion so aggregating that takes a little bit longer over the four years we've been in the space we've built the portfolio from 0 billion to 3.1 billion and the aggregate. And Q2, from what we've noticed historically has been a slower origination period.

So we think that could be challenged to add assets here, but to the extent when it comes to market we will do so. As I mentioned in the opening remarks, the benefit of adding net asset is a call protection that they offer unlike the shortening we experience on our agency portfolio.

The CMBS portfolio had a less material impact on the duration given the prepay penalty associated with those assets. On the non-agency side, we still think there's attractive opportunities there it’s just the level of competition that exists.

The loans there were over 10 billion of loan sales in Q1, we went after some, but we’re not as aggressive as some others. We still feel that both the GSEs have plenty to go there and to the extent they meet our return hurdles we will go after those assets. On the legacy CUSIP side, that's a bit of a challenge, the shrinking space.

As I mentioned on our Q1 call given where spreads ended on the new issue side at the end of Q4, we were able to take advantage of some of that spread widening early on, but as the markets stabilized those spreads came in quite materially and rates rallied of the all in yield available on those assets didn’t look as attractive as it did in early Jan but we're hoping - again we’ll pick spots to add assets judiciously that meet our return hurdles..

And then just one follow comments on - you're talking about - when you're talking about the LIBOR and the repo markets and where the repo rate was at the end of the quarter. I think you showed around 273.

Have you guys seen any change in repo pricing since March 31?.

Yes, I mean I think one month, two month, three months are relatively flat and they have come in from the 273 to the 265, 264 area and that sort will be reflective in Q2.I don’t have really like see the full impact, given some stuff was on longer-term and we put it on in Q1, but you will see the 273 tech down in Q2.

And we think given the change in Fed rhetoric, that number should gravitate lower to a one month LIBOR..

Your next question comes from the line of Matthew Howlett of Nomura..

Just getting back to the credit towards your agency mix shift.

It sounds like you still sort of predominantly position were more agency CMBS I mean instead of those Ginnie Mae side, so sort of can we look at overall leverage moving higher as you add those assets going forward and will that continue until you see to sort of better opportunities to add credit?.

I think what’s happened in the rates market and sort of the negative convexity at you know all the level of waste they are at now, levered agencies look marginal. I think you know if you can find credit opportunities we would definitely be going after those. We feel, like I had mentioned earlier the GSCs have some loans to sell.

There are going to be added another 10 billion in Q2 and we are hoping that again, given what’s happened to that securitization market on the new issue side coupled with the rate value that the all in cost of issuing debt will be beneficial in both in leg up and sort of going after loans a little more aggressively than we did in Q4 than Q1..

Just in other words, these are largely re-performing or non-performing loans and what you're saying is….

Re-performing..

Re-performing loans.

If I hear you saying is the ability to securitize these market rates basically improve that levered returns and the securitization that offsets some of the higher loan prices that may come out on the packages?.

That's correct. I think if you look back to where spreads have been on the new issue side. In Q1 of 2018 spreads were on rated stuff maybe swaps of 55 to 60 and on the non-rated stuff maybe 20 basis points to 25 basis points wider than that.

We ended the year at – on the rated stuff at swaps at 125 and on the non-rated stuff that swaps 160 and if you look at where you could do those transactions now is coming from 125 on rated side to 105-ish roughly, so maybe they are in about 20 bps and on the non-rated side, like I said again, pick 20,so maybe around swaps stuff 125 to 130.

That25 to 30 basis points of spread tightening equates to about a point in change on the execution of the overall loan package and that sort of gives you some little room to get higher levered returns on the equity piece that you would retain..

And just anyway to quantify the total size of these packages for the remainder for the year, is it 20 billion that they come out from Fannie Freddie? Is it higher than that?.

I think again, some of that supply demand the agencies or the GSEs will see based off of what how much cash is on the sidelines. So I don’t think they really intent to upsize the less demand seriously picks up.

I think we're looking at about 4 billion to 5 billion between the two GSEs on a quarterly basis, so that 20 billion over the course of the year and supply coming from them. In addition to them, there’s going to be some bank selling of loans as well. I think you can see anywhere between 25 billion to 30 billion of RPL loans come to market in 2019..

Great.

And then just last question, I think I saw your – look at non-agency repo cost tick down, if I had that clear, are the banks lowering the spread on that product given the improvement in credit quality just to know whether you are standing on some of the recourse that you're applying to some of your credit assets from the banks?.

That’s the case I think spreads on non-agency repo shave come in considerably over the last two years and continued to inch down. There’s plenty of cash on the sidelines that wants these assets. I mean, agencies are funding at LIBOR plus 15, 20.Well, while credit assets are funding at LIBOR plus followed anywhere between 125 to 150.

In addition to that, we've been able to extend our repose without any give up in the rate as well so we've extended from three months, six months, so in some cases we’ve done trace over two-year, so that's also beneficial to the portfolio..

Your next question comes from the line of Eric Hagen of KBW..

As a follow-up to the last question, have haircuts changed for non-agency product as well I think you're clear that the rate has come down but it has the level of haircuts also dropped?.

It has. I think as the performance of the assets materialized, haircuts have come in from 35%, down to 20% depending on the asset type, and in some cases on the prime jumbo size even in spite of that of around 10%..

Thanks for the numbers there.

And then I seem to look back on my notes every 90 days ago, and I still like this kind of my broken record question about how much debt, how much securitized debt is callable over the next call it 12 to 18 or 24 months? Can you guys give us that that number?.

So for the remainder of this year we have one deal in Q4, that becomes callable, which is the CIM 2016-4. 2020 will have more optionality.

We have 2016, one, two, three deals which have four year calls and at the time they were issued all of those become callable late Q1, early Q2 and I think the securitized debt on those is probably north of $1.5 billion that becomes callable I guess in the early part of 2020. And then we have some deals later that year that also become callable.

So 2020 could potentially be big refi year depending on where rates are and where the market is at that point in time..

It’s our option?.

Correct. None of these are mandatory calls. They are optional calls at our discretion to the extent the markets cooperate..

And just to kind of put the value on those options or just think about it mentally and kind of pairing together your opening remarks about the Fed and how the expectations have changed there.

I mean, the option to call those bonds wouldn't – there’s not as much urgency to call those bonds given changes in your Fed rate expectations over the next couple of years.

Am I kind of thinking about that right? The cost of funds in the portfolio sort of reflective of where it should be if Fed funds don't change, that’s kind of order trends there?.

But I think it’s going to be a combination of what the Fed is doing, what type of these deal shave delivered.

So we own a larger portion of the equity, if you can optimize that leverage back structurally that’s going to be beneficial to us even if rates are unchanged or the cost of that debt is unchanged, so it’s going to be a balancing act between maintaining optimal leverage and maintaining the all in sort of financing cost..

Your next question comes from the line of [indiscernible] of UBS..

I was just wondering more generally given the change in the rate environment that you called out whether any new asset classes that you haven't really participated on in to date might be sort of coming on your radar given the change of environment, whether it's MSR or something else that might pencil here where it hasn't really in the past?.

We, as Mohit said in his remarks, we had started looking into and purchase the small amount of the picks in flip or transition loans. We think they are kind of interesting in this marketplace and I think the levered returns on them look pretty attractive. I would also say that we still like mortgage credit here.

We actually think there’s still upside in residential loans, especially these re-performing loans. I think the housing market is very good and I think if you looked at it just from short total return, I don't think there's at this moment any reason why you wouldn't continue to try to add to that portfolio. So we like it.

Its just you know, right now for us is trying to find the fine paper that meets our recurring hurdles. And we have been successful doing it. So I really don’t see us having any drift away from portfolio that we currently have.

And Mohit?.

That’s right, and I think to reinforce we look at all the different asset types available from an investable landscape standpoint. As some of these products are relatively new post prices such as this transition fixed and flip loans.

As that market has grown the origination volumes have grown, it's created the opportunity to add something more meaningfully that could impact their portfolio as opposed to taking smaller size of the 5 million and 10 million.

So I think as the opportunity side on the origination side has grown we've added that to the portfolio to complement our current holdings..

Your next question comes from the line of Jim Young of West Family Investments..

Could you just clarify some of the details for your new compensation package, what are the drivers and parameters that are - will determine the overall comp level? Thank you..

Sure Jim, this is Rob. There is two main drivers one is return on equity and the other is the total economic return. So their consistent measures that will be calculated for our company compared to the peers in the monetary index and whatever we perform based on relative performance with the peers is how we’ll get paid.

So for the top we had paid more but middle or bottom we had paid less. The old compensation contracts were based on static hurdles. So we think this makes sure that we’re executing well and competitive versus the peers..

And who is in your - the overall comp group?.

Sure. So we’re using the Mortgage REIT Index the 30 companies or so that are in that Index..

Your next question comes from the line [indiscernible] a Private Investor..

There has been a lot of ringing of hands and gnashing of teeth about the creeping rate of repo financing of agencies and treasuries above the IOER.

You say it kind of backed off a little bit after subsequent to March 31, but do you have any thoughts as to if there's any particular change in supply demand in the organized funding rate that has caused this to happen?.

It’s kind of a mystery actually the interest on excess reserves should be closer to Fed fund rate you think. I don't have a good reason why it's where it is and where the money markets are trading.

People have said that they might be something to do with the dollar shortage in the emerging markets in China specifically that they don't have enough dollars. It’s a very strange phenomenon going on in the front end of the yield curve and the funding curves. And I just think it's got to be temporary.

There have been a couple of research analysts out saying that the Fed is going to take some action to get things back in line. I only believe that this is temporary. I would say for our funding purposes we're not seeing any diminution of people willing to fund our positions. In fact we’re taking on new lenders on a regular basis.

People are very eager to lend against non-agencies, they are very eager to lend against agency mortgage-backed securities and the credit markets. And specifically the funding markets for these assets are amazingly liquid at the moment.

So it’s a little bit of distortion in rates we are seeing in the front end, but you've got to think that it's going to be a temporary at least I believe it’s going to be temporary..

And as follow up, would you say that as you've seen the agency/guaranteed repo rate call higher against these other benchmarks.

The non-government guaranteed rates have tightened up a little bit to guaranteed rates such as the overall time is not as much?.

That's right Jim. As mentioned earlier the Feds on the credit side of the book have come in quite materially over the course of the last two years and continue to grind in as the housing market is robust and the performance of the legacy securities, as well as the new issues is down performs better than expectations.

So those Feds are reflective of that..

And your Ginnie projection, your various project loans how do you finance those, what kind of term do you like put on those and where do they trade in terms of financing in the financing market - the relatively short term as opposed to long-term securitized finance market relative to agencies?.

Massive finance right on top of agency. Ginnie guaranteed as Fed, so they have a similar haircut and similar financing rate and it could go out 1, 2, 3 months longer if you need deep, but the rate is indifferent as is the haircut..

Thank you. I'll now turn the call to Matthew Lambiase for any additional or closing remarks..

Well thank you for joining us on the first quarter 2019 Chimera Investment Corporation's earnings call and we look forward to speaking to you on the second quarter's call. Thank you..

Thank you for participating in today's conference call. You may now disconnect..