Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation Third 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..

Thank you, Holly and thank you everyone for participating in Chimera’s third 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..

Thank you, Emily. Welcome to the third quarter 2018 Chimera Investment Corporation earnings call. Joining me on the call this morning are Mohit Marria, our CIO; Rob Colligan, our CFO; Choudhary Yarlagadda, our Chief Operating Officer; and Victor Falvo, Chimera's Head of Capital Markets.

I'll make some brief comments and then Mohit will review the activity in our portfolio and Rob will then go over the financial results. Afterward, we will open up the call for questions. Chimera posted solid returns for the third quarter considering the volatility in the fixed income markets.

In the period 10-year treasury bonds sold off 20 basis points closing the quarter at its highest yield since the middle of 2011. The Federal Reserve increased short-term federal funds target rate for the eighth time in the last three years and continue to pare down its holdings of U.S.

Treasuries and mortgage-backed securities adding over $100 billion dollars of additional supply to the market in the quarter. We believe the Fed will likely continue to raise the Fed funds target rate perhaps one more time this year and several times next year in an effort to cool down the expanding economy in order to stave off inflation.

Accordingly, the housing market is starting to show signs of moderation as mortgage rates have also hit their highest levels in seven years. Due to higher rates refinancing activities dropped off and homebuilder confidence has trended lower.

While residential mortgage credit prices have remained well bid to date, we think these macro trends have the potential to impact prices in the future. It is our opinion that we're most likely to see more volatility in the distinctive [ph] markets as the Fed continues to increase short-term interest rates.

History has shown us that the end of Fed tightening cycles can often create market dislocations and opportunities for those who are prepared. We took the opportunity late in the third quarter to raise additional capital issuing $260 million of preferred shares.

The Series C shares of a fixed coupon of 7.75% for the first seven years after which the coupon adjusts quarterly at 474 basis points over three months LIBOR.

Since the fourth quarter of 2016 we have raised over $700 million in capital through preferred shares which has helped us diversify our capital structure, lower our cost of capital while being accretive to our common shareholders. The additional capital should be beneficial for our portfolio should we see a widening of credit spreads in the future.

In the near term we plan to initially invest new capital in agency mortgage-backed securities. Agency mortgage backed securities have had a sharp decline in price over the last year which has in our opinion made them significantly more attractive from both prepayment and interest rate risk perspectives.

For example, Fannie Mae 30-year 4% coupon pass-throughs had a price of over 105% a year ago. Today the same securities trade around par. The prepayment speed assumptions on these securities have been cut in half over the period as well.

With 5 points lower in dollar price and slower prepayments functions in the year ago we believe this is a better entry point. The current market also allows us to hedge using longer duration interest rate swaps, because the flat yield curve prices longer duration swaps at approximately the same cost as shorter duration swaps.

Longer duration swaps should provide more protection if rates fell off and the yield curve steepened. And it's our belief that longer hedged agency mortgage-backed securities currently offers one of the best risk-adjusted return profiles in the entire fixed income market.

Agency pass-throughs have the added benefit of being highly liquid and can be a source of funds should new credit opportunities present themselves. In the past Chimera’s portfolio team has successfully sold agency mortgage-backed securities to invest in more attractive mortgage credit.

So to sum it up Chimera has the capital and liquidity to be opportunistic should the bond market become volatile and create opportunities in credit. And should the equity markets become volatile we also have the liquidity and desire to repurchase our shares as well.

While we remain cautious in the current market, our investors should understand that as our results showed this quarter Chimera is well-positioned to continue to earn a strong dividend and deliver meaningful total return to our shareholders in the quarters ahead. And with that, I'll turn it over to Mohit to talk about our portfolio in the quarter..

The U.S. economy continued to show significant strength in the third quarter and with somewhat more hawkish Fed commentary and some more confidence at the highest and record low unemployment, the Federal Reserve continued its march higher in rates. We continue to believe that the fed is on a path to higher rates.

However, with escalating trade tensions and slowing global growth, the path to rate hikes may be slower. Post quarter end, volatility has increased with both U.S. and international equities struggling to maintain their gains for the year. In addition, credit spreads have also widened to start the fourth quarter.

Given the backdrop of equities and credit spreads treasury yields initially continued to inch higher approaching 3.3% on 10 year treasury but retracing back to 3.1%. The sound economy remains beneficial to the performance of our seasoned mortgage loan portfolio.

Loan performance has been steady and continues to perform better than the assumptions initially made at investment. We continue to execute upon our call strategy optimizing our outstanding securitized loan liabilities. This quarter we called CIM 2015-3AG and refinanced the loan collateral into CIM 2018-R5.

The deal size was $380 million and we issued $256 million of securitized debt at a yield of 3.8%. We were able to reduce our financing costs by 104 basis points while maintaining a similar advance rate. Retained [indiscernible] loss adjusted yield of mid-high single digits. Late in the third quarter we also issued $408 million CIM 2018-IND1.

This is Chimera's first securitization of investor based residential mortgage loans. The underlying loans in this yield were eligible for purchase by both Fannie Mae and Freddie Mac. These loans are unlike our seasoned low loan balance portfolio. They are newly originated and have weighted average grade of 5.9% and weighted average balance of $279,000.

The average credit score was 763 and had a 32% debt to income ratio. These loans were on average three months seasoned with a weighted average loan to value of 68% and no loans exceeded 80% loan-to-value at origination. We retained $40 million investment in the field at a level of loss adjusted yield of mid-high-single digits.

Subsequent to quarter end in October we called our fourth and remaining deal eligible for call in 2018. CIM 2015-4AG was refinanced into $478 million CIM 2018-R6. We will discuss this deal in more detail on our fourth quarter earnings call.

As Matt mentioned, the back up in interest rates we currently find agency mortgage-backed securities to provide an attractive risk-adjusted return for our portfolio. This quarter we added $2.5 billion to our agency portfolio consisting of $1.9 billion in Fannie Mae 4s, $341 million in Fannie Mae 5s and $235 million of agency CMBS.

As we continue to try to protect book value we have added $1.34 billion in swap hedges mostly with longer tenures to take advantage of the shape of the yield curve.

Our total agency portfolio now is comprised of $2.5 billion agency CMBS, $6.7 billion residential agency pass-throughs with coupons ranging from 3.5% to 5% and the total agency portfolio is now $9.3 billion.

Given the strong price performance of mortgage credit in 2018 relative to rising interest rates, we have been very disciplined and selective in our approach to mortgage credit investments and successful in finding value and securitizing the investor loans.

The backup in interest rates coupled with the Federal Reserve reducing the size of its portfolio, leading to lighter mortgage spreads is helping to create new opportunities for agency mortgage investments. Since we raised capital late in the third quarter as of September 30, the capital has not yet fully been deployed.

As we continue to put new capital to work, agency mortgage investments provide good spreads income for Chimera while representing a large pool of liquidity in our investment portfolio should we see attractive long term residential mortgage credit investment opportunity.

I will now turn the call over to Rob to discuss the third quarter financial results..

Thanks Mohit. I will review the financial highlights for the third quarter of 2018. GAAP book value at the end of the third quarter was $17.02 per share. Our economic return on GAAP book value was 3% and 10% for the first nine months of the year based on the increase to the GAAP book value and dividends per common share.

GAAP net income for the third quarter was $147 million compared to 109 million last quarter. On a core basis, net income for the third quarter was $112 million or $0.60 per share, up from $110 million or $0.59 per share last quarter.

Economic net interest income, which includes the impact of our interest rate swaps, was $148 million, up from $147 million last quarter. Interest income is up versus prior quarter as a result f the increase in our agency portfolio. For the third quarter the yield on average interest earning assets was 5.8%.

Our average cost of funds was 3.6% and our net interest spread was 2.2%. Total leverage for the third quarter was 5.1 to 1, while recourse leverage ended the quarter at 2.8 to 1. Our economic net interest return on equity was 16%. Our GAAP return on average equity was 17% for the quarter.

Expenses for the third quarter excluding servicing fees and deal expenses were $14.3 million. Expenses are up from last year as a result of equity compensation expenses, but are down from last quarter primarily due to lower legal expenses. That concludes our remarks. I will now turn the call back to the operator for question-and-answers..

[Operator Instructions] Our first question is going to come from the line of Jason Arnold, RBC..

Good morning. Nice results here this quarter.

I was just looking at your agency buys in detail, you focused in on the 4% coupons and reflecting on our basis nicely on what you had commented on agency prices, can you talk about your focus on those coupons and then maybe add a little extra context on your rate outlook and kind of how you see things going out? I know you said more hikes are kind of coming, tap might be slower but maybe just again a little bit added context will be helpful? Thank you..

Hi Jason, this is Matt and I'll just say that the agencies where we're buying our pretty much plain vanilla pass-throughs, not a lot of pay ups on them, and we're buying maybe some shorter recently originated paper and it is liquid as you can get, because that's really the - what we want to have in the agency portfolio is liquidity.

Because we think as the markets progress here and if we get more volatility we will be able to take down this position kind of like what we did earlier in like say 2014 when we pared down the agency position to go after some large pools of mortgage credit. So the – we're hedging ourselves longer duration than I think we've done in the past.

We have put on a lot of 10 year swaps against the newer agencies that we've purchased and I think the idea here, at least the internal house feel is that the 10 year treasury should be I think a little bit higher over the next course of the year if the Fed keeps raising rates and I think that's how you put on longer duration hedges.

And if that happens if rates back up and the yield curve steepens, I think we'll be in a pretty decent position with the way we've hedged ourselves at the moment and Mohit can talk about the actual pools..

Yes and Jason as Matt alluded to given the premium on the coupon stack, very little of the mortgage universe, I think maybe 5% to 7% is actually refinance able at the moment. Spec pool pay ups haven't come down in sympathy with where rates are in prepayment outlooks are going into total seasonally adjusted months.

So to the extent spec pools pay up to come down a bit we can sort of maybe alter the portfolio, but given forward the trading rate around par prepayments aren't that big a concern for us right here. We don't have to monetize the absolute yield levels and lock in healthy spread for the agency portfolio..

Okay, great color. Thank you.

And then I guess just one follow up on kind of that opportunistic potential deployment of capital, is there like a segment of the loan side or the credit side that you'd say hey, if that particular bucket came down in value because of market dislocation, we'd be all over that or is there just more kind of a price based approach when it happens if it's cheap and we like it we'll go after it, maybe just some added color there if you please? Thanks..

Sure, I mean this year we've done a mix of RPL loans. We've done some prime jumbo loans and as stated in the opening remarks, we've done our first investor deal. We're open to looking at all of the loan opportunities out there. So I think pricing has been the biggest issue in terms of finding attractive assets.

If any of those become more attractive with the uptick in volatility we would take advantage and deploy capital in any one of those spaces..

Okay, fantastic. Thanks very much gents..

Thank you..

Our next question will come from the line of Trevor Cranston, JMP Securities..

Thanks. Little bit of a follow up to one of the previous questions about the agency portfolio. It sounds like you're hedging quite a bit of the duration on those bonds, but you also mentioned in the prepared remarks that spreads have widened in October in particular.

Could you comment or provide an estimate on how your book value has performed so far in the fourth quarter?.

Hi Trevor, this is Mohit..

Hi Mohit..

So post quarter end as you mentioned rates had initially sort of sold off approaching 330 kind of ratchet back to 310 and we’re on 312 to 315 this morning, book value and spreads have widened on top of that. I think we expect book value through October to be down roughly about 1% currently based on the hedges we have..

Got it. Okay, that's helpful. And then the second question on new investment opportunities particularly on the credit side, so you talked about the, the investment loans that you guys are securitized.

Are there any other opportunities in the more newly originated loan space that you guys are seeing? And can you also maybe sort of compare the returns that you guys think are available like within the investor loan securitization versus, what you're seeing in the agency market today? Thanks..

Sure, so let me talk about the loan space first. I think the RPL space still offers an attractive opportunity set to the extent prices come down to where they were 18 months ago. I think the supply is there. I think we've - year-to-date we've had over $30 billion of RPA loans come out whether it be from the GSEs and/or private investors.

I think even in the fourth quarter we're going to see north of $10 billion of supply coming out of that space. And again, if prices soften a little bit here, I think that would be helpful for us to sort of start potentially buying some more loans there.

On the new issue side, I mean we've played on the prime jumbo side of the deal in Q2, did our first investor deal here in Q3, we're also looking at non-QM all those opportunities that's especially in the non-QM side are a little bit smaller than the RPL space.

To aggregate a deal size could require anywhere between one to three months, though the volumes haven't picked up there in size. We think the opportunities that are in the investor side could be a lot greater.

I think as that box continues to widen, we could have a meaningful amount of originations there that could lead to decent securitization and the economics on what we would retain would be attractive.

If you compare the levered returns on doing a loan securitization in term financing versus acquiring agencies, I would say on a levered basis they are similar returns. Keep in mind that the leverage that you would use on your credit investments are going to be significantly lower than the leverage you would use on the agency portfolio..

Alright, that makes sense. Okay, thank you..

Our next question will come from the line of Bose George, KBW..

Hey, thanks. Good morning. It’s Eric on for Bose. Just a follow up on book value, I mean I know you guys mentioned that credit spreads had widened a bit.

I mean can you just give us a general sensitivity for your book value as it relates to mortgage spreads? I guess somewhat generically or generally I mean just kind of what we can observe for the legacy market and the CRT market, I mean how can we sort of triangulate those spreads and relate them to your, to the spreads in your portfolio and of course book value? Thanks..

Sure. Hey Eric, it’s Mohit again. So spread widening on the credit assets has been more concentrated on new origination, CRT like product. I think sort of month to date CRTs are anywhere between 15 to 20 basis points wider. I think the legacy assets have more technical bent to them and I don't think those have widened out has significantly as CRTs have.

I think the performance there continues to warrant adjustments in what your last adjusted yields are going to be. So I think those may have lined up maybe two to five basis points, nothing as meaningful as on the CRT side.

I think spread on new issue whether it be prime jumbo loans, some of the weighted RPL transactions have also lined up I would say again to the tune of 5 to 10 basis points there as well and as how that relates to our portfolio, we don't have any CRTs currently. So I would say our legacy portfolio is maybe a basis point or two wider, if that much.

I think if you looked at the latest remit that came out in October performance continues to improve defaults really running lower. The delinquency pipelines are cleaning up. Severities are lower. I think those are all positive to our portfolio. And the same thing applies for the sort of the loan portfolio that we've built.

The vast majority of our $12 billion plus of loans are over 130 month seasoned. And given the favorable housing conditions for legacy assets, I think that's also producing better than expected performance on our loan portfolio.

I think some of the softness that Matt referred to on the housing numbers are on newer origination stuff and I get that the collateral that we are focused on whether it be prime jumbo and or investors, the credit metrics we spoke about give us plenty of comfort and a credit event on those type of loans..

Great, that's great detail. Thanks Mohit.

And then on the financing side, I mean what percentage of your securitized debt at this point is fixed and what percentage is floating, and what's the weighted average margin over, I assume it's one month LIBOR for your floating rate debt?.

Yes, the spread ranges anywhere from L plus 175 to L plus 200 on the floating rate secure debt portion.

I want to say we still have 50% of our securitized debt is still floating rate, but as you are aware all the deals have a three-year call option embedded in them which I think our last floating rate deal that we've done was 2017, so in 2021 that is up for call to the extent we need to re-lever and adjust that to a fixed rate debt..

Okay, so everything that you guys have pretty much called has been put into a fixed rate coupon and where I mean fixed rate…?.

Everything is until Q3?.

Yes, got that, and where are fixed rate coupons sort of trending like for, if we were to model out sort of the securitization pipeline that we assume for the portfolio, let's just say next year, I mean where can we expect that coupon to be? Thanks..

I mean some of that's going to be driven by where all in rates are but I think if you look at weighted securitizations at the top of the capital stack it's probably trading anywhere between swaps plus 70 to 80, that puts you just under 4% currently. And on a non-weighted side you're probably looking at a coupon four and eight to four in a quarter..

Yes and I'd just like that, when it comes to us issuing debt, we prefer fixed, but if somebody has got a good bid for the senior bonds and their floaters and we can do an off balance sheet swap, I mean, my thing if we get the best rate for my shareholders, so we will do floating rate deals if it makes more economic sense than fixed and I don't want to give anybody the impression that we don't, we're looking at the economics of each individual transaction..

That's correct. I mean we have the ability to match that data to put on our hedges to change that floating rate exposure to fixed rates outside of the deal as well right yes..

Yes, definitely, great, that's great color guys. Thank you..

[Operator Instructions] Our next question will come from the line of Doug Harter, Credit Suisse..

Hey guys this is actually Josh Bolton on for Doug.

Given the current preference for agencies and an expectation for additional volatility and spread widening, can you talk about realistically how big we could see the portfolio allocation to agencies become? And then also in that context, how are you thinking of leverage when thinking about capacity and the ability to take advantage of additional spread widening? Thanks.

Hey Josh, this is Mohit again. I mean, I think to the extent the agency portfolio continues to look compelling, I mean we could grow that, to deploy the capital that we raised in Q3, we could use that to reinvest the pay downs we were experiencing both on the agency portfolio as well as the non-agency portfolio.

So I mean, I think the backup that you just laid out with spread widening a pickup in volatility could be a good time to take advantage of that going into Q4.

But we hope that spread widening is not limited to just the agency product and it also reflects on the credit products, as we just had on the prior question, the CRT market has wind up 20 to 25 basis points. Hopefully that carries far into the rest of the spread product as well and we could deploy capital there on a go forward basis as well..

Yes, and I'd just like to add to that too is that, we've been running our company with very low recourse leverage for a very long period of time. So when you get into an environment like this when agencies are in our opinion much more attractive than credit, it gives us the flexibility on our balance sheet to go after those opportunities.

So we have a lot of room ahead of us should we see good opportunity there..

Great, thanks guys..

Our next question will come from the line of Steven laws, Raymond James..

Hi, good morning. Thanks for taking my questions. A couple of things have been hit on already, but I wanted to ask about the agency CMBS. I know it looks like it's now above 10% the commercial portion of the portfolio. I know there's some attractiveness there with the prepayment protection, ability to hedge those assets.

Can you talk about the pipeline there, how big can that get? I know it's only limited supply, but maybe some color on that asset would be great?.

Sure, hey Steven, it’s Mohit again. As you stated the sort of the opportunity set there is limited. I think on an annual basis originations range anywhere between $12 billion to $18 billion. We've had a pretty successful year so far in adding product there.

We did see some spread widening there in Q3 and took advantage of it and grew that portfolio north of $500 million. And as you stated, I mean the portfolio started in 2014 and we're up to a little over $2.2 billion.

To the extent we could increase that number, we would like to, like if it does offer a better convexity pickup to the agency product currently, it has similar financing and liquidity as pass-throughs do, so to the extent we can continue to grow that we are focused on doing so..

Great, are there any other assets out there that you look at, I know you've touched on the whole loans and RPLs and different opportunities there, is there any asset class you don't have in the portfolio now that you think is starting to look attractive, you're spending more time on?.

I mean again. I think we're looking at all opportunities available on the residential mortgage sides whether it be QM single family rental, non-QM investor loans, RPLs and I think it’s whatever we could at the most cash flow from the investments we're making is going to ultimately be put into the portfolio..

Great and then I guess one final kind of larger macro picture. You touched on the set in the prepared remarks and then kind of where rates are going with the economy and I think unemployment is at multi-decade lows and they've been very focused on fighting off inflation here.

So where do you think we are in the residential credit cycle on - underwriting standards have been pretty conservative here since the crisis compared to older loans, but how do you think about that with rates continuing to move higher, unemployment potentially moving the other way, how does that impact your investment decision as you think about residential credit performance going forward?.

Well, I think we're still very constructive on residential mortgage performance. Obviously, more people working, housing prices doing better, I think it's just going to be very good for delinquency and very good for mortgages in general.

I think looking at originations, I think credit - the credit boxes that the originators are making loans in are still very tight. And I think that's good for actually mortgage backed securities going forward too for their performance.

I think you know that the big issue is really duration in the marketplace and how like Mohit said, a lot of the mortgages in the agency market are 3.5% and 4% coupons and they're not refinancable now. So we're seeing refinancing activity dry up and that market slowing down pretty dramatically.

So it's that lack of supply of new stuff coming into the market being met with the supply of the Fed coming out of their portfolio. It's going to teeter-totter back and forth and you're going to have some opportunities there I think in the agency market, but we're very constructive.

I think the Fed is right now in a very tough spot, going into December. I think if I was Powell [ph] I'd probably pause here and see what happens to the economy and take it up again maybe in March.

But if they keep pressing this and they keep raising rates here and the market looks a little skittish, there's a chance that you could see some significant volatility in credit and we're - that's what we're preparing for at least..

Great, well Matt, Mohit, thank you both for the comments. I appreciate you taking my questions..

Thanks..

Our next question comes from Bose George, KBW..

Thanks for taking the follow up.

I think I got on the investor property deal a coupon of 59, but did you say what the loss adjusted yield was on that?.

The coupon is actually 5.09..

5.09, okay. Sorry about that..

The losses yields on our investment are going to be mid-high-single digits..

Got it, and where are you guys sourcing those from?.

We're working with a bank, money center bank that's sourcing the collateral and we're just in an agreement on a package of that, on a pricing work for both parties..

Okay and is the flow agreement, I mean as they make more loans you guys are the only source that are prepared to buy them?.

No, I think it has to work for both parties to the extent we can agree on a price. You can do a transaction but it's not a full agreement..

Okay, thank you. Thanks for the color..

Thank you. I'll now turn the call back over to Matt Lambiase for closing comments..

Well, thank you for joining us on the third quarter 2018 Chimera Investment Corp Earnings Call and we look forward to speaking to you in the New Year for the fourth quarter results..

Once again we’d like to thank you for participating on today's conference call. You may now disconnect..