Earnings Call Transcript - CIM Q2 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Chimera Investment Corporation Second Quarter 2021 Earnings Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. It is now my pleasure to turn the floor over to Victor Falvo, Head of Capital Markets. Please go ahead.

Victor Falvo, Head of Capital Markets

Thank you, Bernie. And thank you, everyone, for participating in Chimera’s second 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 upon 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 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 CEO and Chief Investment Officer Mohit Marria.

Mohit Marria, CEO and Chief Investment Officer

Thanks, Vec. Good morning and welcome to the second quarter 2021 earnings call for Chimera Investment Corporation. Joining me on the call today are Choudhary Yarlagadda, our President and Chief Operating Officer, Subra Viswanathan, our new Chief Financial Officer, Kelley Kortman, our Chief Accounting Officer, and Vic Falvo, our Head of Capital Markets. After my remarks, Kelley will review the financial results and then we will open the call for questions. This quarter, we continue to make significant progress towards optimization of our liability structure. For the six months of 2021, we successfully refinanced 12 legacy securitizations, supporting more than $5.6 billion of loans. The results of these transactions have lowered our overall cost of debt by approximately 245 basis points and we expect this cost savings to continue to benefit our shareholders in the future. The housing market continues to be one of the most robust components of the U.S. economic recovery. The National Association of Realtors recently reported sales of existing homes at 5.9 million annual units with a median sale price of more than $363,000, up more than 23% from a year ago. Demand for single-family homes remains strong, while the inventory of homes available for sale persists near record low levels. According to Black Knight data and analytics, in June the national delinquency rate hit its lowest level since the onset of the pandemic, and is now back below the pre-Great Recession average. A 30-plus-day delinquency rate was reported at 4.4% of outstanding loans, down 42% on a year-over-year basis. Strong demand for existing homes, higher home prices and lower delinquency rates provide strong fundamental support for Chimera's large portfolio of seasoned, low-loan-balance mortgages. Interest rates on government bonds experienced both moves in the second quarter. Over the period the yield on 10-year Treasury notes fell by 27 basis points, while the yield on two-year Treasury rose by 9 basis points. Interest rates on money market instruments including overnight repo remain near zero. Investor demand for higher-yielding and fixed-income products was strong and spreads on credit products continued to tighten. Accordingly, the Bloomberg Barclays U.S. Corporate High Yield Index ended the quarter at 3.75%, its lowest yield ever. Tighter credit spreads, coupled with low absolute interest rates have presented attractive market opportunities to refinance our existing securitized debt and secured financing at significantly lower costs. As part of our continued collateral optimization strategy this quarter we called and refinanced fixed-rate legacy deals representing more than $1.5 billion of loans. The new securitizations successfully optimized our liability through the extraction of capital and lowering cost of debt. Our April deals, CIM 2021-R3 and NR3 on a combined basis totaled $813 million of securitized debt supported by $977 million of loans. The combined advance rate was 83%, enabling us to extract $125 million of capital by lowering our cost of debt for these loans by 200 basis points to 2.12%. Chimera retained $164 million of subordinate and IO securities as investments from these deals. New securitizations have calendar call dates. The R3 financing will be callable beginning April 2024, and the NR3 financing is callable beginning April 2022. In June, we issued $546 million CIM 2021-R4. The deal consisted of $464 million securitized debt, representing an 85% advance rate and a 1.97% cost of debt for these loans. The R4 freed up $98 million of capital and provided cost savings of approximately 180 basis points. Chimera retained $82 million of subordinate and IO securities as investments. The R4 financing has a calendar call beginning June 2024. We have provided additional details on page eight of our earnings supplement to further assist you in the analysis of this quarter's securitizations. Securitization has long been a cost-effective and efficient financing vehicle for Chimera. In the first half of 2021, Chimera's securitization activity enabled us to take capital, reduce the size and lower the cost of our outstanding secured financing. In conjunction with this year's securitizations we've also refinanced several of our outstanding secured credit facilities. We have made meaningful improvements with the average cost of our secured financing for residential credit assets in the second quarter at 3.5%, down from 4.9% at year-end. We've always been extremely prudent and diligent when making our long-term investment decisions. Our agency CMBS portfolio is constructed with explicit prepay protection. As interest rates have fallen and remained near historic lows we have been active in managing our agency CMBS to determine the best course of action between long-term hold, gain-on-sale, or securitization while reaping benefits through explicit prepay penalties. This quarter, through the combination of prepaid penalties received from our Ginnie Mae project loans and early payouts of non-agency credit, we generated one-time non-recurring income of $38 million. The prepaid penalties received this year are proof of concept for many of the positive convexity attributes we have regularly discussed over the years. Now, at the midpoint of 2021, I believe we have made a meaningful impact on our balance sheet. We have re-securitized debt supporting $5.6 billion of loans through seven separate securitizations, lowered our cost of securitized debt by over 245 basis points, lowered the cost of our repo credit facilities by 140 basis points since year-end, retired high-cost debt and warrants incurred during the pandemic, issued three jumbo prime securitizations totaling $1.2 billion, purchased more than $200 million of high-yielding fix-and-flip loans and increased our quarterly dividend by 10% to $0.33. Securitizations of loans lock in stable long-term financing for our loan portfolio. We have successfully refinanced many of our outstanding legacy deals and we have an additional five deals with $1 billion of unpaid principal balance that will become callable over the next six months. Looking forward, we continue to seek opportunities to further improve our liability structure. And as always, we stay the course as a patient, long-term investor focused on investments to provide our shareholders with stable book value and a sustainable and attractive risk-adjusted dividend. I will now turn the call over to Kelley to review our financial results for the period.

Kelley Kortman, Chief Accounting Officer

Thanks, Mohit. I'll now review Chimera's financial highlights for the second quarter of 2021. GAAP book value at the end of the second quarter was $11.45 per common share. GAAP net income for the second quarter was $145 million or $0.60 per share on a fully diluted basis. Our core earnings for the second quarter was $130 million or $0.54 per share. Economic net interest income for the second quarter was $173 million. The yield on average interest-earning assets was 7% for the second quarter while our average cost of funds was 2.6%, resulting in a net interest rate spread of 4.4%. Total leverage for the second quarter was 3.32x while our recourse leverage ended the quarter at 1.02x. For the quarter, our economic net interest return on equity was 19%, and our GAAP return on average equity was 18%. Expenses for the second quarter, excluding servicing fees and transaction expenses, were $15 million, down approximately $3 million from last quarter. That concludes our remarks and we will now open the call for questions.

Operator, Operator

Our first question is from Doug Harter with Credit Suisse. Your line is now open.

Doug Harter, Analyst (Credit Suisse)

Thanks. Mohit, you mentioned the $38 million of benefit from prepays. Your presentation mentions $21 million. Can you just go into what that other $17 million is that you were referring to?

Mohit Marria, CEO and Chief Investment Officer

Sure. The $38 million comprises $21 million of agency CMBS securities that were recalled and have the explicit prepayment penalties associated with them. In addition to that, we had a handful of non-agency legacy deals that were called, not by us, but by other holders who exercised call rights and that led to an additional $14 million to $15 million of penalties that we received, or I should say accretion, as opposed to penalties on the non-agency side. And then some of the IOs that we hold in the Ginnie Mae project deals that were issued by third parties accounted for the other $2 million to $3 million that we received.

Doug Harter, Analyst (Credit Suisse)

Do you have handy how that benefit from calls has been in prior quarters?

Mohit Marria, CEO and Chief Investment Officer

So it hasn't been that large; it's been more muted in prior quarters. We've never had anything of this magnitude in the past. These were deals that were purchased very early on in 2009 and 2010 at very deep discount, so it hasn't been a meaningful number historically. Otherwise, we would have pointed it out on prior calls.

Doug Harter, Analyst (Credit Suisse)

Great. And then just shifting to the new investments. What areas do you see as most attractive today and what type of returns are you generating?

Mohit Marria, CEO and Chief Investment Officer

We continue to focus on business-purpose loans. We think that's a very attractive short-duration asset that produces mid-teens type of levered returns. We continue to grow that year-to-date as mentioned in the opening remarks. We've been successful in acquiring over $200 million. We're continuing to expand our parties on where we acquire that but that's still a large area of focus for us. In addition, the seasoned reperforming space provides returns as shown from the releveraging that we've done off of our existing deals. It's a place where you can optimize your equity and generate decent levels of returns. As loan buying has gotten more crowded, there have been new entrants that are aggressive, but as I've mentioned on several calls in the past, there's still a fair amount of loan sales that have to occur from the GSEs and other banks that will create opportunities in the future. We have been extremely busy. We've done seven legacy season prime securitizations, we've done three jumbo securitizations, and we've been bidding on loans unsuccessfully at times. But again, we're optimistic that things will come our way and we'll be able to acquire investments in the future. We don't have to make any rash decisions given the liquidity and the earnings being driven by our current call strategy.

Doug Harter, Analyst (Credit Suisse)

Helpful, thank you.

Operator, Operator

We will take our next question from Eric Hagen with BTIG. Your line is now open.

Eric Hagen, Analyst (BTIG)

Thanks. Good morning. I was hoping to get your perspective on how the expiration of the foreclosure moratorium impacts the portfolio and what the overall approach will be in extending any modifications to seasoned reperforming borrowers around the pandemic, including what percentage of the portfolio was still in a COVID-related forbearance.

Mohit Marria, CEO and Chief Investment Officer

Overall, the delinquency pipeline of our seasoned reperforming portfolio didn't materially change from pre-pandemic to post-pandemic. Our 60-plus-day delinquency pipeline was around 9% prior and it may have inched up to about 10% at one point. It has since reverted back to around 9% on aggregate. As far as what we plan to do on extensions or other strategies related to servicing, since all of these loans are in trust we do not control the servicing within the governing documents and the PPM of these deals. There is a loss mitigation matrix that servicers have to follow and they have to perform best practices on their own. So we don't really have much control over the servicing of these deals on a go-forward basis.

Eric Hagen, Analyst (BTIG)

All else being equal, should investors see the expiration of the foreclosure moratorium as an incremental positive for the reperforming portfolio, or is it really a neutral event?

Mohit Marria, CEO and Chief Investment Officer

We didn't see much cash flow disruption. If you think about the portfolio composition, the average balance of our mortgage loan is under $100,000 and the average mortgage payment is just north of $800 a month. So from a cash flow perspective we didn't see much change as a result of the pandemic. Overall, the mortgage universe as highlighted in the opening remarks shows delinquencies have come down. The end of the moratorium should be positive from a cash flow perspective, given strong home price appreciation year-over-year coupled with continued low mortgage rates. Borrowers having challenges could potentially refinance or reset to lower their rates and reduce payments.

Eric Hagen, Analyst (BTIG)

Got it. And one housekeeping item on the credit portfolio: what's the LTV in the loans held for investment at this point?

Mohit Marria, CEO and Chief Investment Officer

Loans held for investment, that LTV is probably mid-80s, but that number is from the time those loans were acquired. Once we securitize those loans, we will update the BPOs and that number will probably go lower given the strong housing price appreciation.

Operator, Operator

We will take our next question from Bose George with KBW. Your line is now open.

Mike, Analyst (KBW)

Hey, everyone, this is actually Mike on for Bose. Just on the funding costs today, because your materials show 2.6%, I'm wondering where you see this going in the near term, maybe the second half of 2021. And then how does that relate to your expectations for run-rate core earnings?

Mohit Marria, CEO and Chief Investment Officer

On the securitized debt side, financing costs have come down quite significantly and similarly on our recourse borrowing given low rates and dealer appetite to finance those assets. On the recourse side I don't really see much more improvement that could take place given where spreads are, although it depends on liquidity in the system, which at the moment is plentiful. On the securitized debt side we still have five deals between now and year-end that are callable totaling $1 billion of UPB. If you look at the supplement, the last page highlights the deals that are callable and the amount of secured debt outstanding. I think that could still drive earnings in the back half of the year. If you look at where that debt was issued relative to where we've been able to get some deals done, it could be north of a 100-basis-point reduction in financing cost on those deals.

Mike, Analyst (KBW)

Great. That's helpful color and then just one more for me. How is book value at quarter end?

Mohit Marria, CEO and Chief Investment Officer

Book value and market-value spreads have been pretty sticky. So I would say unchanged from where we ended June 30.

Operator, Operator

We will take our next question from Trevor Cranston with JMP Securities. Your line is now open.

Trevor Cranston, Analyst (JMP Securities)

Thanks, good morning. On the income you guys got from the legacy bonds being called this quarter, I was curious if there's any particular reason you would point to as to why some of those deals started to be called this quarter in particular. Was it widespread across counterparties, or one particular counterparty calling some legacy deals?

Mohit Marria, CEO and Chief Investment Officer

Good morning, Trevor. As it relates to who's calling the deals I'm not really sure who owns the call rights on these transactions. But it was across shells and across different issuers on the legacy side where deals got called. Given how strong the new-issue securitization market has been it is an attractive time to call deals and issue new debt, especially when new-issue pricing and loan pricing are supportive. So I'm not surprised this activity has taken place. Since 2019 activity slowed down meaningfully in 2020 as a result of COVID and the forbearance moratoriums, but as those items go away we expect activity to pick up. We haven't seen that much meaningful activity in prior quarters and we highlighted the amount of accretion we realized this time.

Trevor Cranston, Analyst (JMP Securities)

On your legacy non-agency portfolio, do you have a number handy for how many of those deals you think are callable at this point? Is it most of them?

Mohit Marria, CEO and Chief Investment Officer

I don't have an exact number handy, but I'd ballpark it at around north of 80%. If you look at the legacy securities we hold, many were issued back in 2006, 2007, and 2008 and most of those deals had cleanup calls or provisions in the 10% to 20% range. Given we are now over a decade past issuance, a lot of those have factored down to levels where they could be callable today. On an aggregate portfolio basis, I'd estimate around 80% of our legacy assets are probably callable.

Operator, Operator

We will take our next question from Stephen Laws with Raymond James. Your line is now open.

Stephen Laws, Analyst (Raymond James)

Hi, good morning Mohit.

Mohit Marria, CEO and Chief Investment Officer

Morning.

Stephen Laws, Analyst (Raymond James)

The portfolio is a little smaller. There's a lot of competition out there. We've discussed the call activity that seems likely to take place. Can you talk about any other asset classes you're watching that seem to fit the investment mandate you like from a credit standpoint? Are you likely to continue a narrow focus or do you see expanding beyond the same lines of assets you've historically focused on?

Mohit Marria, CEO and Chief Investment Officer

From an investment standpoint, we look across the full gamut of assets available in both residential and commercial. We've participated in the seasoned reperforming space, we've done prime jumbo deals, we've done agency-eligible investor deals, and we're focused on growing the business-purpose loan portfolio. Where we see the best relative-value opportunities is where we want to deploy capital. The space has gotten crowded at times and we've been patient, picking up small pools here and there. In addition to the seasoned reperforming loans, we have done three jumbo deals. The jumbo market is interesting because at times there's a great ability to securitize and at other times spreads widen, creating a challenging environment to issue securities. But given how we've structured the business, we want to be involved and repeatable, as shown with the deals we've done. Going forward, we're still optimistic about acquiring loans and continuing to use securitization to finance those vehicles.

Stephen Laws, Analyst (Raymond James)

Thanks. A follow-up on LTVs. If you take older vintage reperforming loans and look at mark-to-market LTVs based on home price appreciation, what does that math look like given current home prices?

Mohit Marria, CEO and Chief Investment Officer

We have looked at that. As mentioned, we called 12 legacy deals totaling $5.6 billion and re-securitized those loans. Those prior securitizations, issued in 2016 and 2017, had LTVs in the mid-80s at acquisition. When we refreshed BPOs for the new securitizations, the updated LTVs based on amortization over the last four years and home price appreciation were in the low 60s. So it's been a meaningful drop in LTVs due to both amortization and home price appreciation. If you translate that trend to the rest of the assets that we own, we would expect to see a similar decline in LTVs.

Stephen Laws, Analyst (Raymond James)

One quick follow-up: you mentioned expenses were down about $3 million sequentially. Was that due to seasonality around some stock vesting in Q1 or another impact for the sequential decline?

Mohit Marria, CEO and Chief Investment Officer

It was all comp-related, just a correction from Q1 due to stock vesting that didn't reoccur in Q2.

Operator, Operator

I will now turn the program back over to Mohit for any additional or closing remarks.

Mohit Marria, CEO and Chief Investment Officer

Thank you, and thanks everyone for joining us on our call. We look forward to speaking to you on our Q3 earnings call.

Operator, Operator

This does conclude today's program. Thank you for your participation. You may disconnect at any time and have a wonderful day.