Earnings Call Transcript - CIM Q2 2024

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Chimera Investment Corporation Second Quarter Earnings Call. Our host for today's call is Victor Falvo. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I would like to now turn the call over to your host. Mr. Falvo, you may begin.

Victor Falvo, Host

Thank you, operator, and thank you, everyone, for participating in Chimera's second 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, 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, Phil Kardis.

Phil Kardis, CEO

Good morning, and welcome to Chimera Investment Corporation's second quarter 2024 earnings call. Joining me on the call are Subra Viswanathan, our Chief Financial Officer, Dan Thakker, our Chief Investment Officer, and Vic Falvo, our Head of Capital Markets and Investor Relations. After my remarks, Subra will review the financial results, and then we'll open the call for questions. Throughout the quarter, we experienced some headwinds, but by the end of July, we have accomplished what I would call a period of firsts. This quarter, we successfully completed our first unsecured debt offering and received an inaugural investment-grade rating on the debt. We made our first large agency investment since before the pandemic. We have a long history of agency investments, and this provides us with meaningful income and liquidity. We committed to purchase a pool of RPLs, and at the end of July, sponsored our first RPL securitization since May 2023. And most importantly for our shareholders, we raised a dividend for the first time since March 2021. Last quarter, we noted that four main themes had emerged as we began the second quarter. Inflation was still higher than the Federal Reserve's desired rate. Economic data continued to indicate a strong economy. Long-term interest rates may not have peaked, and interest rates would experience increased volatility. Looking back over the quarter, market volatility was substantial, with 10-year Treasury yields starting the quarter at 4.2%, rising to 4.7% by late April, and dropping back to 4.4% by the end of June. The second quarter GDP significantly beat expectations, indicating that the economy remained strong. But there were signs that the economy was beginning to weaken. The labor market continued to cool, and inflation is now trending in the right direction, with the Fed's preferred inflation measure rising 2.5% in June, leading us to believe that while we expect interest rates to remain volatile over the near term, long-term rates appear to have peaked, and the economy may be heading towards more normalized inflation and perhaps a weaker economic environment. Last week, the Fed held interest rates constant, as expected, and at its press conference, Chairperson Powell suggested that a September cut could be on the table if inflation continues to slow down. However, he also emphasized that the Fed would make decisions meeting by meeting based on the totality of the data and balance of risks. After his comments, the non-farm payroll number released last week came in much weaker than expected, as the unemployment rate ticked up to 4.3%, an almost three-year high. While it's only a single month of data, the yield on the 10-year Treasury has dropped to around 3.9%, and it is looking increasingly likely that the Fed is going to cut interest rates in September. The housing market remains resilient. National home prices have continued to rise, though at a more moderate pace. The home equity buildup, which has occurred across America in the last several years, has been beneficial for our loan portfolio. We consolidate on our balance sheet over 109,000 loans, with an average balance of $108,000. The weighted average loan of our portfolio is over 15 years, and we estimate that the overall current LTV of our loan portfolio, through amortization and HPA, to be approximately 46%. Despite higher interest rates over the quarter and intra-quarter yield volatility, our book value was relatively flat for the period, and this quarter we raised our dividend from $0.33 to $0.35, a 6% increase. In May, we issued $65 million of 9% unsecured senior notes. These notes will mature in five years and are callable in whole or in part at the company's option on or after May 15, 2026. After the offering, the company received a BBB investment-grade rating from Egan Jones, a nationally recognized statistical rating organization. Our ability to issue unsecured debt helps us to further diversify our capital structure and provide long-term financing for a mortgage credit portfolio. The proceeds from the debt raised were immediately deployed into the purchase of approximately $377 million of agency CMO floaters. This investment is meant to generate income and provide liquidity until we eventually deploy the proceeds in loans or non-agency subordinate securities. We kept our recourse leverage low on the agency floaters, and we expect to generate low double-digit returns. In agencies, we also purchased $65 million of a guaranteed senior SLST securities, and we expect to generate low to mid-teen returns on this investment. Throughout the quarter, we made new credit investments as well. We purchased $16 million non-agency subordinate bonds with an average coupon of 10.7% at a discount to their par value. And we expect to generate low double-digit returns on an unlevered basis. Combined with the purchases made in the first quarter, we purchased a total of $67 million of high-yield subordinate bonds on an unlevered basis. And lastly, this quarter, we committed to purchase re-performing loans that settled simultaneously in July into SIM 2024-R1, a rated securitization. The securities issued by the securitization had an aggregate principal balance of approximately $352 million, were sold in a private placement to institutional investors. These senior securities represented approximately 75% of the capital structure. We retained subordinate notes and certain interest-only securities with an aggregate principal balance of approximately $116 million. The deal was structured with a 30% cleanup call. Our average cost of the debt for this securitization is 5.7%. The loans for the securitization had a weighted average coupon of 5.6%, and a weighted average loan size of $228,000, and were 86 months seasoned on average. Following on SIM 2024-R1, we expect to continue to acquire and securitize mortgage loans, as well as further implement the company's call optimization strategy on our securitizations. The timing of these re-securitizations is impacted by many factors, including credit performance, prepayment speeds, interest rates, and market volatility. As we navigate the current market conditions, we're focused on maintaining low recourse leverage and managing our liquidity with a proper balance of both cash and unencumbered securities. Our credit portfolio continued to perform well in the quarter, with the credit performance of our portfolio continuing to be within or better than our original investment expectations on mortgage delinquencies, default rates, and recoveries. In summary, we've been able to access the capital markets and acquire accretive assets. We've started buying and securitizing loans and will continue to look for opportunities to acquire and securitize additional loans. We were able to restart agency RMBS for income generation, as well as for providing liquidity. And finally, we were able to raise our dividends. We are pleased with our performance for the first half of the year, and 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 go over Chimera’s financial highlights for the second quarter of 2024. GAAP net income for the quarter was $33.9 million, which amounts to $0.41 per share. The GAAP book value at the end of the quarter stood at $21.27 per share. Our economic return on GAAP book value for the second quarter was 1.4%, based on the change in book value and the quarterly dividend per share. Year-to-date 2024, the economic return on book value was 8.4%. On an earnings available for distribution basis, net income for the quarter was $30.3 million, or $0.37 per share. Our economic net interest income for the quarter was $73 million. The yield on average interest-earning assets was 5.9%, with an average cost of funds at 4.2% and a net interest spread of 1.7%. Total leverage for the quarter was 3.8 to 1, while recourse leverage finished at 1 to 1. In terms of financing and liquidity, the company concluded the quarter with $649 million in total cash and unencumbered assets. For hedging, as noted in the previous earnings call, we had $1 billion pay fixed rate swaps maturing in May. During this quarter, we exercised a swaption contract for $500 million notional and entered into a one-year swap for the same amount at a 3.76% pay fixed rate. Our outstanding repo liabilities had $2 billion in floating rate exposure. Additionally, we held $1.5 billion in pay fixed interest rate swaps at a weighted average fixed pay rate of 3.56% as a hedge for our floating rate liabilities. We also had $1.4 billion with non or limited mark-to-market features on our outstanding repo agreements, representing 52% of our secured RICO's funding. During the quarter, we hedged the interest rate execution risk on our 2024-R1 securitization with a short position of about $308 million in treasury future contracts, which was closed before the settlement of the R1 securitization. For the second quarter of 2024, the economic net interest income return on equity was 11.1%. Our GAAP return on average equity was 8.6%, and our EAD return on average equity registered at 7.1%. This quarter, we executed a 143 reverse stock split aimed at decreasing the number of outstanding shares of common stock to align with companies of similar market capitalization. We believe this move will enhance the appeal of the common stock to a wider group of investors, potentially reducing share price volatility in the long run. Lastly, expenses, excluding servicing fees and transaction costs, totaled $13.3 million, which is down $1.6 million from the first quarter, reflecting an 11% reduction. That wraps up our remarks. We will now open the call for questions.

Operator, Operator

Your first question comes from Doug Harter with UBS. Your line is open.

Doug Harter, Analyst

Thanks. Good morning. I'm hoping if you could give us an update on how book value is trending so far in the third quarter, given the significant moves in rates.

Phil Kardis, CEO

Hi. This is Phil, Doug. I'm going to turn this over to Dan.

Dan Thakkar, CIO

Yeah. Hi, Doug. Good morning. As you know, markets have been pretty chaotic the past few days, although they did recover to an extent yesterday. Based on a deal pricing Monday, price talk on a couple of deals being marketed right now, and some trading that we have seen in the subs, we see spreads approximately 20 to 30 basis points wider. So I would say our book value is up around roughly 2%, primarily because of the rates that have rallied close to 50 to 60 basis points in the intermediate part of the curve since the quarter end. But I would still caveat it that markets are still trying to find their footing as we speak. If you had asked this question yesterday or the day before, we would have given a very different answer.

Doug Harter, Analyst

Completely understand, Dan, but thank you for that update. And then, Phil, you guys issued the unsecured note during the quarter. Can you talk about how big a part of the capital stack that can be in your appetite for continuing to access additional forms of capital for growth?

Phil Kardis, CEO

So, as we think about things, I mean, we do believe that growing our asset base will lead to us growing the dividend, which is going to be in the best interest of shareholders over the long-term. And so we think that at that rate, we could and did acquire accretive assets. And as we think about it, we're looking at it relative to our overall size, how this debt will begin to roll in two years. So we're going to be, I think, in the beginning, relatively modest, keeping all those factors in play. But we do think it is an interesting and important piece to add to our overall capital structure. But we're going to be cognizant about its size relative to overall, because we're going to have to be thinking about two years from now, three years from now, our ability to either call that debt or refinance it. So, keeping it appropriately sized, given our size is what we're looking for.

Doug Harter, Analyst

Great. Thank you.

Operator, Operator

Your next question comes from Bose George with KBW. Your line is open.

Bose George, Analyst

Hey, guys. Good morning. Actually, I wanted to ask, what's the best way to think about your rate hedge or rate exposure, EAD exposure as the Fed's cutting rates? You've got, I guess, the piece of your repo that's not hedged with swaps. You've got your preferred several repriced down. Kind of sort of looking at the big picture of that, I mean, do you feel like that gets you to a double-digit EAD as the Fed, if the forward curve is right or just color on that would be great.

Phil Kardis, CEO

I'm going to turn this over to Subra.

Subra Viswanathan, CFO

Hey, Bose. Thanks. Look, we think rate cuts will impact both EAD both positively and also significantly, right? To answer your question specifically, we have about $2 billion of floating rate liabilities, and hedging those, we have about $1.5 billion of swaps. The rate on these swaps is pay fixed at 3.56%. So, to the extent that the rates fall below the 3.56%, we will begin to pick up additional income as long as we don't put additional hedges from there on, right? So, that's in context of what the liabilities and the swaps with the hedges. In terms of preferred, we have $525 million of preferreds that are currently floating. So, any rate reduction will continue to benefit that. There is also a small piece, another $200 million piece, I believe, which is in preferreds that will go floating in the last quarter of 2025. So, that could increase a little bit. I'm sorry, it's $200 million? Sorry, it's a $200 million piece.

Bose George, Analyst

Okay, great. Sorry, go ahead.

Phil Kardis, CEO

Sorry, I didn't mean to interrupt. Go ahead, Subra.

Dan Thakkar, CIO

No, I think if we've answered is there, I think, was there, we thought maybe we'd gotten what you're looking for.

Bose George, Analyst

Yeah, I did. So, actually, I did get that. Thanks. Actually, switching over then to book value sensitivity, I mean, you answered Doug's question on the book value. Just but prospectively just thinking about, again, if the forward curve is right, rates are down, but spreads kind of tighten over time as things stabilize. Is there a good way to think about your potential benefits to your book value as that happens?

Subra Viswanathan, CFO

I mean, depending on the magnitude of the rate and the spread moves, which eventually we think it's going to happen after the market sort of settles down, the only thing I can say is it should be a positive impact to our book value.

Bose George, Analyst

Okay, great. Thanks.

Operator, Operator

Your next question comes from Stephen Laws with Raymond James. Your line is open.

Stephen Laws, Analyst

Hi, good morning. Can you touch on the callable security, securitizations, how you see that playing out, and has the rollover in rates or changed your expectation of repayment speeds and kind of how quickly or the amount of deals you'll call and look to re-securitize to free up additional capital?

Phil Kardis, CEO

This is Phil. As we've stated in previous calls, one of the first actions we’re considering is in our deals due to the potential for loan performance and the chance to reduce overall financing costs. We have analyzed various factors, and recently, given the hurdle rate, raising capital at 9% debt has proven to be a more effective strategy. With the possibility of Fed rate cuts on the horizon, we believe the timing will become even more favorable with those adjustments. We were very close to moving forward with our deals, and the financial conditions are likely to enhance once the Fed begins to cut rates. Our initial approach was accessing the market at 9%, and we will continue to monitor re-securitizations. Additionally, as rates decrease, we will also start considering other non-NRs. I hope that provides some clarity.

Stephen Laws, Analyst

It is. And to kind of drill down a little bit, I mean, is it possible to quantify any of that as far as how much capital you think you could free up, or maybe once you execute the calls and re-securitizations, kind of what the incremental return would be on that capital as you kind of optimize deployment?

Phil Kardis, CEO

Yeah, that is something that we were looking at, but even as Dan talked about thinking about book value, it's depending on so many factors, it's really at that moment. I do think in the past we've done these re-levers where we think it's going to be a material improvement to the company, and so I can kind of quantify it that way. But at this point, thinking about when we might do it in the future and what it means, it's really hard for me to be much more specific other than things are moving in the right direction. And when we do it, we'll do it when it's going to be a material benefit to the company.

Stephen Laws, Analyst

Sure, sure. A lot of moving assumptions in that question. Lastly, I thought it was notable that loan portfolio delinquencies are at the lowest level since 2019. Can you talk about what's driving that strong performance? Is it aggressive resolutions on probable loans? I mean, it seems typically as long as pool season, you see increased delinquencies, but I thought that was, that strength in loan delinquencies was notable, so I was hoping you'd comment on that.

Phil Kardis, CEO

Yeah, if you think about it, it really is kind of reverting back to kind of pre-pandemic, so it's a little bit of a reversion to the mean kind of post-pandemic. And it's been a trend down since, it kind of spiked up in 20. So I think maybe the better way to look at it is we're kind of now worked our way through the pandemic, and we're kind of reverting back to a pre-pandemic level given the seasoning of our portfolio.

Stephen Laws, Analyst

Great. I appreciate the comments this morning. Thank you.

Operator, Operator

Your next question comes from Eric Hagan with BTIG. Your line is open.

Jake Katsikis, Analyst

Good morning. This is Jake Katsikis on for Eric. Thanks for taking my questions. I want to talk about prepayment activity. Are you guys expecting to see a pickup in it as a result of the recent interest rate moves? And can you maybe pinpoint at what level of rates you think prepayment activity would begin to accelerate more meaningfully? Thank you.

Phil Kardis, CEO

Go ahead.

Dan Thakkar, CIO

It’s still too early to make a definitive call on this, but if we examine our RPL portfolio, it has varied from nearly 6 CPR to the low to mid-double digits. Should mortgage rates decrease significantly from this point, we might anticipate our RPL prepayments returning to the low to mid-double digits range.

Jake Katsikis, Analyst

Great. Thank you so much.

Operator, Operator

At this time, there are no further questions in queue. I'd like to turn the call back over to Mr. Phil Kardis for any closing remarks.

Phil Kardis, CEO

Thanks for participating in our earnings call. And we look forward to speaking to you with our third quarter results.

Operator, Operator

This concludes the Chimera Investment Corporation second quarter earnings call. Thank you for attending. And have a wonderful rest of your day.