Earnings Call Transcript - CIM Q2 2023

Operator, Operator

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

Victor Falvo, Head of Capital Markets

Thank you, operator, and thank you, everyone, for participating in Chimera's second quarter 2023 earnings conference call. Before we begin, I'd like to review the safe harbor statements. During this call, we will be making forward-looking statements, which are predictions, projections or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties, which are outlined in the Risk Factors section in our most recent annual and quarterly SEC filings. Actual events and results may differ materially from these forward-looking statements. We encourage you to read the forward-looking statement disclaimer in our earnings release, in addition to our quarterly and annual filings. During the call today, we may also discuss non-GAAP financial measures. Please refer to our SEC filings and investor presentation for reconciliation to the most comparable GAAP measures. Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call. We do not undertake and specifically disclaim any obligation to update or revise this information. I will now turn the conference over to our Chief Executive Officer, Phil Kardis.

Phil Kardis, CEO

Thank you, Vic. Good morning, and welcome to the Chimera Investment Corporation's second quarter 2023 earnings call. Joining me on the call are Choudhary Yarlagadda, our President and Co-Chief Investment Officer; Dan Thakkar, our Co-Chief Investment Officer; Subra Viswanathan, our Chief Financial Officer; and Vic Falvo, our Head of Capital Markets. After my remarks, Subra will review the financial results and then we'll open the call for questions. We continue to be active during the second quarter with securitization, stock repurchase, and liability management. We completed five securitizations during the second quarter, totaling nearly $1.4 billion. Let me describe our quarterly securitization activity at a high level. In April, we sponsored CIM 2023-I1, a rated securitization of non-QM & Investor Loans, totaling approximately $236 million. Approximately 87% of the capital structure was sold in the private placement to institutional investors. We retained a subordinate interest in securities with an aggregate principal balance of approximately $31 million and certain interest-only securities. Our average cost of debt to this securitization is 6.6%. We retain an option to call the securitized mortgage loan at any time beginning in April of 2026. In May, we sponsored CIM 2023-R4, a rated securitization of seasoned, reperforming residential mortgage loans totaling $394 million. We sold approximately 75% of the capital structure in a private placement to institutional investors. Chimera retained subordinate interest in securities with an aggregate principal balance of approximately $97 million and certain interest-only securities. Our average cost of debt for this securitization is 5.4% and we retained an option to call the securitized mortgage loans at any time beginning in April of 2028. In June, we sponsored CIM 2023-I2, our second rated securitization of non-QM & Investor Loans this year, totaling approximately $239 million. Approximately 85% of the capital structure was sold in a private placement to institutional investors. We retained interest in securities with an aggregate principal balance of approximately $36 million and certain interest-only securities. Our average cost of debt for this securitization is 7%. We retain an option to call the securitized mortgage loans at any time beginning in July 2026. We expect double-digit returns on the retained securities for these three securitizations. Regarding re-securitization, we terminated two existing trusts, CIM 2017-7 and CMLTI 2019-E. In addition to the loans from these two deals, Chimera added approximately $104 million in loans from our warehouse facility. We then issued CIM Trust 2023-R3 and CIM Trust 2023-NR2. These re-securitizations allowed us to: 1. avoid a step-up rate increase on the senior debt of one of these terminated trusts; 2. convert short-term repo funding into long-term non-recourse fixed-rate financing; and 3. recapture approximately $43 million in cash from the terminated trusts. Primarily as a result of our securitization activity this quarter, we reduced our recourse financing, primarily loan warehouse facilities by more than $500 million. And in total, through the first half of the year, we reduced our recourse financing by approximately $750 million. As short-term rates continue to increase this quarter, we prepared for a higher-for-longer rate environment. We added an additional $500 million one-by-one swaption, bringing our total swaption position to 1.5 billion, with an average pay-fixed interest rate of 3.56%. These swaptions give us optionality to hedge our net interest margin as rates remain elevated through 2024 and into mid-2025. In addition, our Board reauthorized our stock buyback plan and increased it to $250 million in the middle of June. Thereafter, we were able to repurchase more than 5.8 million shares for approximately $33 million at an average price of $5.66. The share repurchase was accretive to our shareholders. Our book value per share decreased by $0.12 or 1.6% quarter-over-quarter. The net change in book value plus dividends paid on our common shares resulted in an 80 basis point total economic return for the quarter, and a 2.8% total economic return for the first half of 2023. Looking ahead, while we believe it is likely that the Fed will raise rates one more time this year, we believe the rate hike cycle is nearing an end. Inflation is coming down slowly, while the economy and job market remain strong. The Fed's own staff no longer predicts a recession in 2023, and the Fed may well engineer a soft landing. We are also buoyed by the residential credit, which performed strongly during the quarter as well as by the strength of the housing market despite affordability issues. What does that mean for us? As we've discussed in the past, our portfolio continues to perform well. Our EAD challenges are primarily related to our costs of financing, not the credit quality of our portfolio. Once rates moderate and begin their decline, our portfolio is positioned to benefit. We would expect that this rate moderation and stability will allow us to refinance some of our more expensive financings, which will be positive for our earnings. On the other hand, to the extent that rates stay elevated for longer, we have 1.5 billion in swaptions, which we can exercise to support our interest margins into 2025. We continue to see interesting investment opportunities, and we think with the proposed bank capital regulations that additional investment opportunities will arise over the second half of 2023. We will continue to evaluate those opportunities along with our stock price relative to our book value with respect to continued stock repurchases. We have a number of tools in our toolkit from reducing our financing costs to repurchasing our stock to making accretive investments to drive shareholder value. We remain optimistic about our future. I would now like to turn to Subra to give a more detailed overview of our financial results.

Subra Viswanathan, CFO

Thank you, Phil. I will review Chimera's financial highlights for the second quarter of 2023. GAAP book value at the end of the second quarter was $7.29 per share and our economic return on GAAP book value was 80 basis points based on the quarterly change in book value and the second-quarter dividend per common share. For the first half of the year, our economic return was 2.8%. GAAP net income for the second quarter was $18 million or $0.08 per share. On an earnings available for distribution basis, net income in the second quarter was approximately $28 million or $0.12 per diluted common share. Our economic net interest income for the second quarter was $67 million. For the second quarter, the yield on average interest-earning assets was 5.6%. Our average cost of funds was 4.4% and our net interest spread was 1.2%. Total leverage for the second quarter was 4.2:1, while recourse leverage ended the quarter at 1.0:1. Regarding financing and liquidity, the company had $670 million in total cash and unencumbered assets at quarter-end. We had $1.5 billion of non or limited mark-to-market features on our outstanding repo agreements. We had $2 billion floating rate exposure on our outstanding repo liabilities. We had $1 billion pay-fixed interest rate swap at a rate of 3.26% as a hedge position for our liabilities. We also had $1.5 billion in swaptions to pay fixed for one year beginning in the second quarter of 2024 at an average rate of 3.56% as a hedge position for liabilities. For the quarter, our economic net interest income return on equity was 10.2%, and our GAAP return on average equity was 5.5%. Lastly, our second quarter 2023 expenses, excluding servicing fees and transaction expenses, were $14 million—modestly lower than the first quarter. That concludes our remarks. We would now open the call for questions.

Operator, Operator

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

Bose George, Analyst

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

Phil Kardis, CEO

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

Bose George, Analyst

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

Subra Viswanathan, CFO

Okay. So I just want to make sure. With the 10.2%, we expect our top-line interest income to stay consistent with what we have. Expenses really depend on where the rate is. If we expect an additional 25 basis point increase in interest expense, that will offset some of that. But what we focus on right now is to have a consistent economic return based on our net income, or our interest income projections being consistent across quarters.

Bose George, Analyst

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

Phil Kardis, CEO

This is Phil. That's correct. As we seek accretive investments, we will need to grow in size and also require some reductions in rates.

Operator, Operator

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

Doug Harter, Analyst

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

Phil Kardis, CEO

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

Doug Harter, Analyst

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

Phil Kardis, CEO

Yeah. As we've said in the past, the EAD is one of the metrics the board looks at. It is a useful guide but isn't exact in terms of what our dividend paying capacity is. We look at that capacity and consider the future as rates are moderating. We believe we'll be able to refinance some of our more expensive financings, which will help us on our earnings. There are opportunities to continue to grow into that. Right now, what our portfolio is generating, the board feels comfortable paying that dividend.

Operator, Operator

Your next question comes from Trevor Cranston with JMP. Your line is open.

Trevor Cranston, Analyst

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

Phil Kardis, CEO

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

Dan Thakkar, Co-Chief Investment Officer

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

Trevor Cranston, Analyst

Okay. Got it. Appreciate that. Thank you.

Operator, Operator

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

Phil Kardis, CEO

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

Operator, Operator

Thank you everyone for attending the Chimera earnings call. That does conclude today's call. Have a wonderful rest of your day.