Matt Lambiase - President & CEO Rob Colligan - CFO Mohit Marria - CIO.

Douglas Harter - Credit Suisse Mike Widner - KBW Joel Houck - Wells Fargo Steve Delaney - JMP Securities.

Good morning and welcome to the Chimera Third Quarter 2014 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I'd now like to turn the conference over to Willa Sheridan.

Please go ahead..

Good morning and welcome to the third quarter 2014 earnings call for Chimera Investment Corporation. Any forward-looking statements made during today's call 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.

Additionally, the content of this conference call may contain time sensitive information that is accurate only as of the day of this earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information.

Participants on this morning's call include Matt Lambiase, President and Chief Executive Officer; Rob Colligan, Chief Financial Officer; Mohit Marria, Chief Investment Officer; Bill Dyer, Head of Underwriting; and Choudhary Yarlagadda, Head of Structuring. I will now turn the conference over to Matt Lambiase..

Good morning and welcome to Chimera's third quarter earnings call. We had an active quarter. I will make a few brief comments and Rob will report on the financial results and afterwards we will open the call up for questions.

The first point is that, Chimera's net income is up quarter-over-quarter and this is largely due to the fact that we added $6 billion of new agency mortgage-backed securities in the second quarter and the last of those purchases settled in early July and so now the run rate reflects the fully ramped position.

The key takeaway is that the company is operating at a relatively low overall recourse leverage ratio of 2.6:1 and is positioned to continue to produce a high dividend going forward.

In the third quarter, we engaged in two significant transactions, in the first transaction, we were able to collapse an additional $93 million of Re-REMIC bonds on our balance sheet. And this was similar to the transaction we executed in March.

We deconsolidated these positions into more liquid underlying bonds and we took profits on these transactions. The second transaction we previously announced Chimera purchased the subordinate bonds and the associated rights to call seven previously issued Springleaf mortgage-backed security deals.

Those deals encompass $4.8 billion of seasoned residential loans. Over the next two years, we will have the option to restructure these deals into new investments for our portfolio. And this option gives Chimera a deal pipeline without the costs or the risks of a traditional loan securitization conduit.

The loans and the deals are an average seven years old and were originated with full documentation by American General Finance to be held in their portfolio. We believe loans originated to be held in portfolio performed better over time.

While the loans do have lower FICO scores another loans we've securitized in the past, they are performing well and have strong pay histories.

We feel comfortable with the credit of this portfolio and believe it will be a source of quality investments for Chimera over the next two years as we exercise the calls, create new securitizations and then sell-off senior bonds in order to retain high yielding credit pieces.

Given the dearth of new issue bonds currently available in the non-agency mortgage market especially those with seasoned collateral, we believe we will be able to execute new securitizations at favorable terms. In the fourth quarter, we will complete the first of the seven planned securitization.

The bonds that Chimera will retain from that transaction in my opinion will have a better return profile than anything available in the secondary market, or what could be created in the new jumbo loan securitization. So looking forward, I believe Chimera is in a good position. We are earning a strong dividend, while operating at low recourse leverage.

Low leverage gives us the defensive posture to interest rates and the flexibility to take advantage of large transactions like Springleaf, when we see them. The Springleaf transaction should help to keep Chimera's dividend durable as we create high yielding investments to meet our portfolios reinvestment needs over the next two years.

And with that I will open it up – I will give it to Rob to go through the financial results for the quarter..

Thanks, Matt, and good morning. The financial highlights, I'll review will cover the third quarter and first nine months of 2014 compared to the second quarter of 2014 and the first nine months of 2013. Net income for the quarter was $378 million up from $105 million earned in the second quarter.

Net income for the first nine months was $582 million up from $290 million earned in the first nine months of 2013. It's important to note, net income on a GAAP basis includes several non-recurring or one-time gains this quarter. We had realized and unrealized gains during the quarter related to this portfolio.

The realized gains relate primarily to sales and exchanges of securities some of which were previously impaired. And the unrealized gains relate primarily to the Springleaf transaction that Matt alluded to.

It's also important to remember that we have elected fair value accounting for the Springleaf deal due to the size and the structure of the transaction. The fair value method will report changes through earnings providing transparency to our investors each quarter.

Please note, given this accounting election, we may experience larger changes in earnings both positive and negative in the future in relation to this portfolio. Given the non-recurring and one-time items included in GAAP earnings, we have added core earnings as a new measure which removes these items.

On a core basis, net income for the third quarter was $116 million up from $83 million earned in the second quarter. Core net income for the first nine months was $282 million up from $263 million earned in the first nine months of 2013.

Moving to book value, GAAP book value for quarter end was $3.50 per share up 4% from the second quarter and up 8% this year. Moving to yields on the portfolio, the yield on average interest earning assets was 6.1% for the quarter and 10.7% for the first nine months of the year.

The average cost to funds including swap costs was 2.2% for the quarter and 3.9% for the first nine months of the year. The net interest spread was 3.9% for the quarter and 6.9% for the first nine months. And the net interest margin was 4.3% for the quarter and 7.9% for the first nine months.

As we discussed on our second quarter call, and as we expected the change in our asset mix has reduced our net interest spread and margin, but aims to increase our return on equity, which leads us to our net interest return on equity, there is a table on Page 68 of our Q, which shows 15.6% for the quarter up from 12% last quarter and up from 11.3% last year.

The annualized dividend yield for Chimera based on a $0.09 dividend and quarter-end stock price of $3.04 was 11.8%. That concludes our remarks, and we will now open the call for questions..

We will now begin the question-and-answer session. [Operator Instructions] Our first question will come from Douglas Harter of Credit Suisse..

Thanks.

Matt, I was hoping – as you do the first securitization of the Springleaf, the better returns – can you tell me where those are expected to come from – is that lower funding costs that are advance rates – how are you thinking about the opportunity there?.

Yes. I will let, Mohit speak to that..

Yes. Good morning, Doug. As far as the returns that we are expecting to get on to retain piece of the first call deal, it's primarily from two sources, one being the advance rates that we are achieving by selling the senior bonds from retaining the [mezzs] [ph].

And second is, also the execution on those senior bonds as Matt alluded the new issue supply is somewhat limited in the non-agency space and there is a proven track record for the Springleaf transaction. So there is a large following and investor base and we have been able to tap that in Q4..

Great. And then Matt, and talking about your low leverage and the ability to take advantage of bigger deals like this.

I guess how would you see your capacity to sort of ramp that leverage further – or further opportunistic acquisitions require some sale of agency or something else to kind of raise liquidity?.

That's a good question. It really depends on about the opportunity as it comes up. When you are running 2.6:1 leverage ratio – recourse leverage ratio, it's pretty low. And we certainly have the ability people will lend us more money to add non-agency assets that we see them. It was a very large transaction.

I would have no problem taking down the agency portfolio and using that capital, if it would get us a higher rate of return and increase the dividend over what we are currently doing in the agency portfolio..

Just on that – I mean from a capacity, I guess, do you have – how much capacity do you have to take down the agency from a sort of [hopeful] [ph] test or from a recompliance test?.

I think we have some room there. I don't think we were anywhere near the hedges right now. So we do have some room to adjust the portfolio and still be within our REIT requirements..

I mean if you think about it like this Doug, we were meeting our 40 act requirements back in the first quarter with a much smaller agency portfolio..

Okay. That's helpful. Thank you..

Yes..

The next question will come from Mike Widner of KBW..

Hey, good morning guys..

Good morning..

I guess a couple of questions here. First, just a real basic and simple one. In your prior releases you had kind of consistently mentioned both GAAP book and economic book.

I noticed in this press release, you just sort of talked about GAAP, I know you included both in the 10-Q, but I was just wondering if there is a reason why if you are sort of implying that – I don't know, I will just leave it at that..

I don't think that there is any desire to highlight one over the other. Obviously, we disclosed both. But, we are leaning towards the street textbook GAAP results for official communications. But, economic are there for people's reference. We haven't taken them out of our documents..

Okay. That makes sense. I mean this quarter; the GAAP book improved a fair bit more than the economic book.

Wondering if you could talk about like specifically why that?.

Sure. Well, I think a lot of it has to do with – the big trade was the Springleaf transaction. The company purchased I think approximately $770 million worth of actual bonds. And yet we are consolidating $4.8 billion worth of loans on our balance sheet.

So really if you think about it, if were to look at – we have the right by buying those $770 million worth of Springleaf bonds. We have the right to call all the underlying bonds in the structure. And the bonds in the structure are not as valuable as the underlying loans themselves.

So the difference between the value of all the bonds in the structure and the value of the loans is roughly $160 million..

That's right..

And that's the difference that we – that's going to be the cash flow of this transaction over the – that's what GAAP is telling us is what the value of those cash flows are going to be over the next two years as we exercise these calls..

Yes. That makes sense..

And that's one of the reasons just to add and why we put those numbers in the financial sometimes the underlying collateral moves faster than the bonds that we actually own. And some times it's the other way. So we would like to put out both statistics, so that you could see on a relative value basis how the portfolios are moving..

Great. Appreciate that. So I guess I have some detailed questions on the Springleaf transaction just because it seems rather significant than we say..

Yes..

As you indicate you bought about $770 million worth of bonds, I was wondering if you could sort of help me understand – what you paid for those and as you indicated, I mean, I think it was $139 million write-off of the assets. I thought that was also the….

Of the loans, $770 million worth of bonds increased a little bit in value over the quarter just like all non-agency bonds did in the quarter. They went up a little bit. It's really the loans that we don't actually – we are consolidating, but we actually own the securities at the moment.

So the $770 million of what we own went up a little bit what we were consolidating is the bigger – is the bigger value change..

So I guess – that's I mean I guess that sort of what I'm trying to make sure, I understand. And now again, so you bought that $770 million worth of bonds, is that basically the price you paid for them or is that just sort of what you are – the net that you are carrying and I guess the first piece I'm trying to put my hands around..

Yes. That's the price we pay for the security. Yes..

So that's the purchase price and you are saying there is very little appreciation in that or….

They went up a little bit over the quarter, but nothing obviously, not a $140 million like the loans..

Well, that's the piece that was really trying to figure out is, tell me, if I have this wrong, but I mean there was – like you said $139 million effectively fair value gain that flowed through GAAP income..

Right..

On the asset side and then there was also I believe a $30 million, $29.5 million decline that flow through GAAP on the liability side..

That's right..

That's right..

Okay. So net this contributed a $169 million….

To your GAAP book value, right..

Your GAAP book value, okay. So I think I get that.

One piece that I didn't entirely follow is, I believe the 2011 piece is – I don't know if its seller financed or its back on repo or could you explain that piece to me, what – and how that sort of shows up in the financials?.

When you say the 2011 piece, the 2011 piece of Springleaf or….

The Springleaf 2011-1 that was mentioned in the Q that I don't have the exact wording in front of me.

But, it's structured on repurchase with somebody, also as I look at sort of the liability side, I mean the number, I was just having a hard time taking the math add without assuming that piece is somehow financed elsewhere I think the line item would be, I don't know, does the question make sense?.

Yes. I understand, it's a little bit complicated.

In the Springleaf deals at the third anniversary of each deal there was a call right, so when we acquired the entire portfolio, the first deal was ready to be called and the deal that Matt talked about the first Springleaf deal that we collapsed and are in the process of resecuritizing now and we will close that in the fourth quarter.

That was almost essentially 100% financed from time of acquisitions through when we ultimately restructure sell and create a 2014, I think [SEM-1] [ph] will be deal name which will disclose the economics in the fourth quarter.

So there is really very little – probably no equity from a training perspective in that deal from the time of acquisition through time of ultimate securitization..

Okay, I got you, because I mean what I was just trying to figure out was if I look at like on the balance sheet, the securitized loan balance is $4.8 billion, around the liability side the securitized debt of fair value is $3.7 billion. So I mean there is $1.1 billion difference between the two.

It's obviously not $1.1 billion in equity, so I'm trying to figure out what happened to the other 350.

I think what that says in the Q and what you tell me is that probably shows up in payable for investment purchased and that's part of the resecuritization process basically?.

That's right. I think we do have – we did have some – if you look at the payable from investments purchased at $848 million, we had about $500 million of agency purchases that crossed over quarter end the rest of that is Springleaf..

Got you. Okay, appreciate that. And I guess for a final one if I may, this is obviously a significant part of the portfolio at this point just trying to thing about how to model the economics of that.

If I go by what you have shown in the Q and here in the press release, I mean it looks like you are expecting assets – you have experienced asset yields on that of about 703 was a percentage, I mean is that a fair assumption for the – sorry interest income component or I guess I'm thinking about – maybe that's even – I guess the question is, how to model it and I mean, I guess what I'm thinking about as you are showing a 7% asset yield about 3.25 cost of funds, you got to do something with the fair value assumptions as well.

But, I mean, how do we think about flowing that through?.

I think that would be a good way to start to use the spreads and one of the reasons why we broke that the Springleaf deal as a separate line item was exactly for that reason so you can look at the average coupon on the portfolio and the financing and an attempt to model out.

Now, what you are seeing obviously, this quarter, I wouldn't expect the large gain that we had to recur. But, then again, it's a $5 billion portfolio say $160 million is roughly 3ish%. Again, I think a big move in one quarter, but we could have some big swings as I mentioned in my comments up or down just given the size of the portfolio.

I don't know Mohit, you have any other comments from a modeling perspective that you want to share..

I think Rob, you are right. I mean the biggest thing to focus on is the coupon on the earnings assets minus where we would finance it through the securitization market that's a good way to model the Springleaf transaction collective..

Yes. And then of course, we have to model some run down in fair value is the principal runs down….

Absolutely, yes..

So I lied about one more, I guess just help me understand the – and then I will stop, but help me understand the collateral into – these arms, are they fixed rate, I mean 703 seems like a high yield for a stuff that's seven years old, if it's arm I think they would be in their active reset predominantly.

So I guess I'm just trying to understand the coupon and how that may or may not change? And then in the same thing on the liability side, I mean are there step ups or step downs that's all kind of get called away anyway and no need to worry about it..

Sure. On the collateral side these are all primarily all fixed rate assets. And as Matt alluded to these are lower FICO borrowers, but loans are originated in 2005, 2006. So there is plenty of pay histories regarding all of these loans. As far as performance has been actually pretty good on this security.

But, even if something was non-performing there is enough coupon to work with in terms of modification to get the person come in again.

As far as the liability side of it goes most of the liabilities are also structured as fixed rate securities and there is no step up involved in all of these securities expect as Rob alluded to every three years these securities will become callable and at our discretion if you feel the economics of call these deals both have alluded to somewhere on the collateral side..

Yes. Matt mentioned the FICO scores and then this transaction there were some FICOs that were lower than some securitizations we have done in the past. And while FICO scores are very useful tools when we are reviewing loans, this portfolio has seasoning which is even better.

And to the extent that these loans have performed – 70% of the loans in the portfolio have never missed the payment, I mean right on average 7 year seasoning..

Yes. As an old credit analyst I certainly appreciate that 7 years of payment history is better than a FICO score..

Yes..

Appreciate that.

And just – last piece on the collateral, I mean is this interest only or they just for the purposes of sort of thinking about pay downs, so they add over their IO periods or they still IO?.

Now, most of them are non-interest only maybe a handful of very small percentage of portfolio will be but even that should be coming up for a reset, I mean most of these would be 101 IOs, which again, I guess that was the seasoning of the portfolio how they should be approaching that reset period now or in the next year or so..

But those are you said small portions I mean most of the part its pretty close to fully amortized..

Yes. They are fully amortizing loans..

Okay, great. I will stop there. Appreciate all the thoughts and comments guys and nice quarter..

And if you have other questions just give us a call..

I will do..

Thanks Mike..

And our next question will come from Joel Houck of Wells Fargo..

Hi. Good morning. My question on Slide 2, the recourse debt to equity in the residential credit portfolio is only like 0.4, as you guys complete kind of the securitization program, where do you see – can you tell us where that kind of levels off, obviously, it's going higher.

But, how do you think about total recourse leverage under credit booking as this plays out?.

Well, this transaction as I said before we purchased 700 -- roughly $770 million worth of bonds. Mohit and the investment team sold roughly $270 million worth of non-consolidated credit bonds in our portfolio to fund the equity. And then we used about the remainder in a one-year committed facility.

And I think as we start doing these securitizations over the course of the year, we are going to be paying down that facility. So I would imagine over the course of the year, you will see less recourse leverage on the credit..

Less recourse leverage..

Yes..

Okay.

And as you guys as you said you have a capacity to take down the agency book?.

Yes..

How are you thinking about the convexity profile given that you have a very good hedge in terms of the credit book, are you more out to hedge less than the agency book, are you just going to play down in the middle?.

We believe we are range bound. And in terms of interest view and we are hedged to that view. And I think that's we are pretty conservative in our hedges. So I think right down the middle of the line..

Okay, all right. Thanks Matt..

The next question comes from Steve Delaney of JMP Securities..

Good morning. Thanks for taking the question. Not to beat a dead horse, but because I think great color on Springleaf in response to Mike's questions.

But going back not so much how you funded the $770 million, but when we look at the consolidation, the $4.8 billion asset and the $3.7 billion senior note liability that will leave us with credits of $1.1 billion and obviously, you indicated you bought $770 million. It seems to me there was another $200 million or $300 million of a credit entry.

And I was just curious if you – if that represents some type of a stock credit reserve you may have set up on the $4.8 billion of loans. Just help me try to understand the difference between the $1.1 billion and $770 million purchase price? Thanks..

Yes. Sure, Steve. If you look at the balance sheet, in our payables for investments that number is $848 million, there is $348 million of that relates to the Springleaf 2011 deal that we are in the middle of resecuritizing..

Got it. Okay, you did explain….

You bring it back down to that 770ish number..

I get where I need to be. Okay. Thanks. Sorry about that. You did comment on that.

And I guess looking forward this is obviously a very creative and opportunistic way, opportunity for you to access whole loan collateral and if we just look out next year and beyond, are you guys thinking about trying to set any infrastructure in place that will allow you to sort of directly aggregate or source whole loans for securitization going forward regardless of whether we are talking about front jumbo and QM.

Just kind of thinking how what Chimera is going to look like from a platform standpoint going forward. Thanks..

Thanks Steve. We have been looking and we continue to look at those opportunities. For our purposes we purchased loans in the past through forward commitments with CHH back in 2008..

Yes..

We had the capability – we still obviously have underwriting and the ability to securitize here in-house. What really is the difference right now to us is that the economics of the jumbo prime securitization market really aren't there to build out the infrastructure in my opinion.

The issue is, if you want to hire a lot of people put loans up on a warehouse and then take the risk of poor execution on the securitization. The economics are really razor thin and the bonds that you take back in the new issues securitizations to the way we look at things just look not as attractive as other opportunities.

I would tell you that if those things were to change, if the economics on the jumbo prime securitization would have changed we would be in it whole-heartedly and we would be building out an origination infrastructure and then spending the money to do it.

But, until the economics are there it just doesn't seem like something that makes an awful lot of sense for me to do at the moment. And this – that's one of the reasons why we thought this deal was terrific is because it does give us two years worth of new issue bonds to bring to the marketplace without really any of those infrastructure cost..

Sure. Understand, makes sense. And of course, I guess one thing we have to watch and see is whether that RMBF 2.0 market does morph into maybe non – in QM products that might look a little bit more like the kind of the loans you bought here the collateral you are buying here on the Springleaf..

We have been all over these opportunities and looking at and have been trying to make the market – it's very unfortunately and it's frustrating for I think everybody in the space, the economics really aren't there at the moment..

Yes. And just one last thing, I know it's presumptuous given that – and great work on the step up in core earnings because you are fully covering in excess of your $0.09 dividend. I believe that the Board had indicated in an earlier press release that it intended to pay or expected to pay a $0.09 dividend for the fourth quarter.

I was just curious whether the – the sharp rise in increase – is that something the Board might revisit or should we – when we think about the dividend should we think about 2015 might the first time the Board might take a look at the dividend in terms of possibly increasing it? Thanks..

I think the fourth quarter we have already announced that we are going to pay the $0.09 that hasn't been declared yet – but we announced that..

Yes..

I think 2015 – I think the company we want to see how the portfolio acclimates and where the run rate of the company is and I think the Board will make a decision there..

Okay. Well, thanks for the comments and the color, helpful..

Thank you, Steve..

Thanks Steve..

This concludes our question-and-answer session. I would like to turn the conference back over to Matthew Lambiase for any closing remarks..

Thank you very much and thank you all of you for joining us on the earnings call. I just want to thank my investment team here. They have done a terrific job this quarter, really finding some great opportunities that's going to create long-term value for our shareholders. And we all look forward to speaking to you on the fourth quarter earnings call..

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect..