Chimera Investment Corp Q3 FY2024 Earnings Call

Greetings, and welcome to the Chimera Investment Corporation Third Quarter Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce Victor Falvo, Head of Capital Markets. Thank you. You may begin.

Thank you, operator. And thank you, everyone, for participating in Chimera's third quarter 2024 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 disclaimers in our earnings release and 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 for 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, Phillip Kardis.

Thanks, Vic. Good morning, and welcome to the Chimera Investment Corporation's third quarter 2024 earnings call. Joining me are Subra Viswanathan, our Chief Financial Officer; Dan Thakkar, our Chief Investment Officer; and Vic Falvo, our Head of Capital Markets and Investor Relations. After my remarks about the quarter, I will briefly discuss our recent acquisition announcement, and then Subra will review the financial results before we open the call for questions. Following a lengthy period of rising rates, inflation has eased to a level where the Federal Reserve is now more focused on a weakening labor market. In September, the Fed reduced the funds rate by 50 basis points and indicated another similar reduction by the end of the year. The market responded by anticipating a faster decrease in interest rates than the Fed's projections. U.S. Treasury note yields ended the quarter significantly lower, showing a positive slope from two years to ten years for the first time since mid-2022. We believe that achieving a lower short-term funding cost and a steeper yield curve will enhance our future operating performance. Since the start of the fourth quarter, treasury yields have increased due to improved economic data and concerns regarding trade and the federal deficit. As the market adjusts, we expect one or possibly two more rate cuts this year, but anticipate that they will be smaller, in 25-basis-point increments. The fundamentals in the housing market are strong for residential mortgage credit. Home prices are up around 5% year-over-year, and the rates of delinquencies and defaults remain low. Although existing home inventories have recently risen to their highest point in four years, they align with pre-pandemic levels. On a broader scale, the ongoing housing supply shortage should continue to support home prices, albeit at a slower pace. Investor demand for mortgage credit securities remains robust. Non-agency RMBS issuances for 2024 could reach $100 billion, which would represent a 40% increase compared to 2023. Although credit spreads in the residential market have contracted significantly since the beginning of the year, they still offer attractive comparisons to investment-grade and high-yield corporate bonds. We believe the current market conditions are well-suited for our residential credit strategy. In July, we sponsored a $468 million securitization of seasoned RPLs called CIM 2024-R1. We sold securities through a private placement with an aggregate value of about $352 million, which is 75% of the capital structure. We retained approximately $116 million in subordinate bonds in certain IO securities. Our average cost of the debt sold was 5.7%. In August, we issued $75 million worth of 9.25% unsecured notes due August 15, 2029, which can be called starting August 2026. This was our second unsecured bond issuance of the year, bringing our total issuance to $140 million. While we prefer repurchase agreements and securitized debt as a low-cost financing source for our loans, issuing unsecured debt allows us to diversify our capital structure and invest in new, profitable assets. With this issuance, we produced and settled $543 million in agency CMOs. We expect that the levered return on this investment will positively contribute to our earnings and exceed our debt costs. These investments will provide attractive returns and capital for future investments in residential loans and credit securities. During the quarter, we purchased about $47 million in non-agency subordinate bonds from newly issued mortgage securitizations backed by RPLs and small balance commercial properties. These were acquired at a discount to their par values, with expected mid-teen returns. This quarter, we also committed to purchasing $118 million in residential transition loans, which we plan to close in the fourth quarter. These loans share characteristics with previous residential transition loans we've bought. We will use leverage through our warehouse facilities for these loans and anticipate achieving levered returns in the mid to high teens. Recently, we signed a definitive agreement to acquire the Palisades Group, an alternative asset manager focusing on residential mortgage credit based in Austin, Texas. Palisades provides asset management services and oversight to third parties and manages third-party funds in the residential credit space. Like our team at Chimera, Palisades has a successful track record of analyzing and investing in residential mortgage credit. We were particularly impressed by their capability in conducting detailed asset-level analysis, evaluating borrower credits, and maintaining high-quality data validation and loan monitoring. These strengths align well with and enhance Chimera's existing business. Additionally, Palisades brings a proven suite of proprietary technologies, which, when combined with our internal capabilities, will bolster our strengths in both portfolio and credit risk management. The acquisition of Palisades is complementary, allowing us to offer a new fee-based asset management service for those interested in investing in residential mortgage credit. Once completed, Chimera and Palisades will have over $30 billion in notional value across loans and real estate, enhancing our residential credit expertise and fostering partnerships with established investment management and insurance companies. We are excited about this transaction and expect it to close in the fourth quarter, providing benefits in 2025. Upon completion, Jack Macdowell, the Co-Founder and Chief Investment Officer of Palisades, will become Chimera's new Chief Investment Officer. What does this mean for Chimera's shareholders? We are optimistic about our business, continuing to find new opportunities and increasing our quarterly dividend by 12% over the past two quarters. As we near the end of 2024, the Federal Reserve has reduced short-term interest rates by 50 basis points, and further reductions may be forthcoming. Residential credit markets are robust, aligning with our business strategy. We have established a new source of unsecured funding through capital markets, and we believe the acquisition of Palisades will strengthen and expand our existing business and create new growth opportunities. Throughout the remainder of the year, we will work diligently to finalize this acquisition. Chimera has a long and successful history of buying and securitizing residential credit assets, and with the addition of Palisades, we will enhance our capabilities and create a new fee-based third-party investment management business. We are committed to working hard for our shareholders and will continue to seek the best long-term outcomes for the company. I will now turn the call over to Subra to discuss our quarterly financial results.

Thank you, Phil. I will review Chimera's financial highlights for the third quarter of 2024. GAAP net income for the third quarter was $113.7 million or $1.39 per share. GAAP book value at the end of the third quarter was $22.35 per share. For the third quarter, our economic return on GAAP book value was 6.8% based on the quarterly change in book value and the third quarter dividend per common share. And year-to-date 2024, our economic return on GAAP book value was 15.6%. On an earnings available for distribution basis, net income for the third quarter was $29.9 million or $0.36 per share. Our economic net interest income for the third quarter was $71.5 million. For the third quarter, the yield on average interest-earning assets was 6.1%, our average cost of funds was 4.5%, and our net interest spread was 1.6%. Total leverage for the third quarter was 3.9 to 1, while recourse leverage ended the quarter at 1.2 to 1. For financing and liquidity, the company ended the quarter with $648 million in total cash and unencumbered assets. For hedging, we had $2.5 billion floating rate exposure on our outstanding repo liabilities. We had $1.5 billion pay interest rate swaps at a weighted average fixed pay rate of 3.56% as a hedge position for our floating rate liabilities. The company also has a long position in $500 million one-year swaption on a one-year pay fixed interest rate swap with a blended rate of 3.45%. We had $1.4 billion in either non or limited mark-to-market features on our outstanding repo agreements representing 43% of our secured recourse funding. As Phil mentioned, we closed our CIM 2024-R1 securitization during the third quarter. As part of our strategy to mitigate securitization execution risk on certain securitizations, we closed out $307 million of short five-year treasury futures contract position to protect the net interest spread of CIM 2024-R1. For the third quarter of 2024, our economic net interest income return on equity was 10.6%. Our GAAP return on average equity was 20.3%. Our EAD return on average equity was 6.8%. Also for the third quarter, the company increased the common stock dividend to $0.37 per share, up from $0.35 in Q2 and $0.33 in Q1. And lastly, for the third quarter 2024 expenses, excluding servicing fees and transaction expenses were $12.8 million, down modestly from the second quarter. That concludes our remarks. We will now open the call for questions.

Our first questions come from Trevor Cranston with Citizens JMP. Please proceed with your questions.

Hi, thanks. You talked a lot about some of the opportunities you guys are seeing on the loan side. One thing we've heard from some of the non-bank originators recently is a focus on trying to grow home equity lending. I was wondering if you could talk about what you guys are seeing there and if you think that's a potential opportunity for Chimera to participate in in the future? Thanks.

Listen, yes, we are looking at that space, and it actually is an area that Palisades has some experience in. And it's an area that we are looking at pretty closely. It just hasn't worked for us right now, but we've heard the same things and we're seeing things that are interesting. We just haven't found something yet to pull the trigger on.

Okay, got it. And then in terms of the overall interest rate exposure or net duration of the portfolio, could you say where that was at September 30? And also, maybe provide an update on book value given the move in rates in the fourth quarter so far? Thanks.

I will now hand it over to Dan Thakkar to discuss the book value. Regarding the other aspect, we haven't typically disclosed that information publicly, but I’ll let Vic explain our thoughts on how book value has changed since the end of the quarter.

Yes, the sell-off in the rates market has become more pronounced, similar to what we all observed, with intermediate treasuries losing all the gains they had in the quarter, plus some. I would say compared to the end of the quarter, we are flat this morning, Trevor.

Okay, great. Thank you.

Thank you. Our next questions come from the line of Doug Harter with UBS. Please proceed with your questions.

Thanks. Just to follow up on that. When you say you're flat from the end of the quarter, I guess what are you comparing that timeframe to? Just to make sure we're on the same page.

So the book value as of end of 9/30 versus the move today. That's what we're looking at.

Okay.

Yes.

Great. And can you just talk about with the acquisition of Palisades, kind of how you think about growth in, kind of like broadly defined AUM, how you would think about whether you want that to kind of be on the balance sheet for Chimera versus kind of third-party funds and how you would look to balance that?

Sure. So right before I answer, I just want to make sure to clarify. I think what we meant to say on the book value is we've given up, most or nearly all of the gains that we showed at the end of the third quarter relative to the end of the second quarter. So most of that increase…

So that would be more flat with the second…

That's correct.

Okay, that makes sense. Thank you.

Okay, yes. Okay, on Palisades, that is something we are working through in terms of how we're going to think about third-party asset management in the fund business. We will develop a pretty detailed allocation policy that will work well for Chimera's shareholders and any limited partners and any future funds that we create through that. That's kind of an early-stage business for them and we'll look to grow that, but we'll look to grow it in a way that's beneficial for all parties. And then, as I said, their third-party asset management is an interesting business and to the extent we will look to grow that as well and they have capabilities, both investment and collateral management that we'll find useful on our own portfolio.

I appreciate that. And then just one more on interest rate exposure. How do you think about your kind of earnings EAD exposure to the short end? I know you updated your swap positions, but just how to think about your kind of your net interest spread or earnings sensitivity to lower short-term rates or a steeper curve?

Hi, Doug. This is Subra. Thanks for the question. To think about it, EAD will respond positively and significantly. At the end of the quarter, our floating rate liabilities were approximately $2.5 billion, which will continue to benefit us. For hedging these floating rate liabilities, we have $1.5 billion in swaps at a rate of 3.56%. While some of the advantages from the decrease in floating rate liabilities will be offset by these swaps losing some benefits, we will still see advantages as rates drop below 3.56%. I would also like to remind you that most of the swaps mature by the end of the second quarter of 2025, so we will need to reassess our hedging strategy then. Additionally, we have about $525 million in preferred dividends, which are also floating rate, so we will see immediate benefits due to changes in floating rates. Separately, we have some longer-term liabilities maturing early in 2025, totaling about $115 million. As we restructure these, we'll see some benefits. Furthermore, as we make paydowns and reinvest, we hope to reinvest in higher-yielding assets. This summarizes our interest rate sensitivity and its impact on EAD.

I appreciate that, Subra. Very helpful.

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

Hi, good morning. This is Frankie Labetti on for Bose. I just wanted to touch on the fact that your EAD seems to be run-rating around the $0.36 to $0.37 range. Can you just discuss some of the drivers that can get you from here to a double-digit net ROE after expenses, please?

I just explained some of the expected growth in EAD. As rates decrease, we will continue to see growth. In my earlier comments, I mentioned that our return on economic net interest, or net interest income return on EAD, is about 10.6%. So, from an economic standpoint, we're achieving 10.6%. As rates decline and our interest expenses decrease, we will experience additional benefits. There are some investments, like our LP investment in an RIA, that don't pass through EAD, but we will gain value from those as well. Even when they don't affect EAD directly, from an economic net interest income perspective, we are experiencing growth and will continue to do so.

Thank you. And then just a follow-up. Given the current environment, where do you see the best opportunities for investing incremental capital going forward? Thanks.

Yes. So, we did the RPL deal, right? So just like the deal, we expect to make low to double-digit returns in there. And in addition, like Phil also talked about in his prepared remarks that we found attractive pockets of relative value on non-agency subs and deployed capital there. So those are the things that we are targeting in addition to looking at every sector which kind of meets our return bogeys in non-QM as well as home equity stuff that we just mentioned.

Thank you.

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

Hi, good morning. This is Jake Katsikis on for Eric. Thanks for taking my question. Just wondering if you could walk through the opportunity you have to potentially raise the dividend further or more quickly if you're able to resecuritize the callable debt. Thank you.

Okay, so I'll start with that. So just like when we raised capital and we're able to invest it accretively, I think that adds to the earnings power of the portfolio. We've held off on the relevering of some of the existing deals, in part because we could raise capital with a lower hurdle than we could in terms of collapsing those deals at the time. But they've now paid down further and rates have come down. So we are looking more aggressively and given where the securitization market is to begin to look for opportunities to relever and pull cash out. And we think there's opportunities to reinvest that money accretively, which will be a driver to enhance the returns on the portfolio.

Great. Appreciate that color. Thank you.

Thank you. There are no further questions at this time. I'd now like to hand the call back over to Phil Kardis for any closing comments.

Thank you, everyone, for participating in our third quarter earnings call, and we look forward to speaking to you next year when we give our fourth quarter and fiscal year 2024 report. Thank you very much.

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