Chimera Investment - Q2 2024

Transcript

Operator (participant)

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 (Head of Capital Markets and Investor Relations)

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 Thakkar, 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. Most importantly, for our shareholders, we raised the 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. 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 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 in 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 our mortgage credit portfolio. The proceeds from the debt raise 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.

Lastly, this quarter, we committed to purchase reperforming loans that settled simultaneously in July into CIM 2024-R1, a rated securitization. Securities issued by the securitization had an aggregate principal balance of approximately $352 million and 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-month seasoned on average. Following on CIM 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 resecuritizations 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 creative 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. 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 review Chimera's financial highlights for the second quarter 2024. GAAP net income for the second quarter was $33.9 million or $0.41 per share. GAAP book value at the end of second quarter was $21.27 per share. For the second quarter, our economic return on GAAP book value was 1.4% based on the quarterly change in book value and the second quarter dividend per common share. Year-to-date 2024, our economic return on book value was 8.4%. On an earnings-available-for-distribution basis, net income for second quarter was $30.3 million or $0.37 per share. Our economic net interest income for the second quarter was $73 million. For the second quarter, the yield on average interest-earning assets was 5.9%. Our average cost of funds was 4.2%, and our net interest spread was 1.7%.

Total leverage for the second quarter was 3.8 to 1, while recourse leverage ended the quarter one to one. For financing and liquidity, the company ended the quarter with $649 million in total cash and unencumbered assets. For hedging, as mentioned on the last earnings call, we had $1 billion pay-fixed interest rate swaps mature in May. This quarter, the company exercised one swaption contract for $500 million notional and entered into a one-year swap for $500 million notional at a 3.76% pay-fixed rate. We had $2 billion floating-rate exposure on our outstanding repo liabilities. We had $1.5 billion pay-fixed interest rate swaps at a weighted average fixed pay rate of 3.56% as a hedge position for our floating-rate liabilities. We had $1.4 billion of either non- or limited mark-to-market features on our outstanding repo agreements, representing 52% of our secured recourse funding.

During the quarter, the company hedged the interest rate execution risk on our 2024 R1 securitization with a short position of approximately $308 million Treasury futures contracts. The hedge was closed prior to settlement of the R1 securitization. For the second quarter of 2024, our 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 was 7.1%. This quarter, the company implemented a 1-for-3 reverse stock split with the objective of reducing Chimera's number of shares of common stock outstanding for companies of a similar market capitalization. We believe the reverse stock split will make the common stock more attractive to a broad range of investors, which has the potential to reduce share price volatility over time.

And lastly, for the second quarter 2024, expenses excluding servicing fees and transaction expenses were $13.3 million, down $1.6 million from first quarter, a reduction of 11%. That concludes our remarks. We will now open the call for questions.

Operator (participant)

If you would like to ask a question at this time, please press star, then the number one on your telephone keypad now. You will be placed into the queue in the order received. Please be prepared to ask your question when prompted. Once again, if you have a question, please press star, then the number one on your telephone keypad now. Your first question comes from Doug Harter with UBS. Your line is open.

Doug Harter (Equity Research Analyst)

Thanks. Good morning. Hoping 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 Kardis. I'm going to turn this over to Dan.

Dan Thakkar (Co-CIO)

Yep, yep. Hi, Doug. So good morning. So 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 20-30 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 50-60 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 its footing as we speak. If you would have asked this question yesterday or the day before, we would have given a very different answer.

Doug Harter (Equity Research 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 2 years from now, 3 years from now, our ability to either call that debt or refinance it. So keeping it appropriately sized is given our size is what we're looking for.

Doug Harter (Equity Research Analyst)

Great. Thank you.

Operator (participant)

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

Bose George (Managing Director)

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. Said we'll reprice 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, yeah, 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 this 3.56%, we will begin to pick up additional sort of 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 $175 million piece, I believe, which is in preferreds, which 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 $200 million piece.

Bose George (Managing Director)

Okay. Okay. Great. Great.

Phil Kardis (CEO)

Okay. And then.

Bose George (Managing Director)

Sorry. Go ahead.

Phil Kardis (CEO)

Sorry. Didn't mean to interrupt. Go ahead, Subra.

Subra Viswanathan (CFO)

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

Phil Kardis (CEO)

Oh, yeah. I did. Yeah. So I should have said that. Thanks. Actually,

Bose George (Managing Director)

just switching over then to book value sensitivity. I mean, you answered Doug's question on the book value. 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?

Dan Thakkar (Co-CIO)

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

Bose George (Managing Director)

Okay. Great. Thanks.

Operator (participant)

Once again, to ask a question at this time, please press star, then the number one on your telephone keypad. Your next question comes from Stephen Laws with Raymond James. Your line is open.

Stephen Laws (Head of Real Estate Finance)

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

Phil Kardis (CEO)

Yes. This is Phil. As we've mentioned on prior calls about maybe the first ones we would look to do is our NR deals because we think there are loans that are performing in there and there's an opportunity to lower the overall cost of the financing on those. We've looked at feedback. We've looked at a lot of those nominal factors, but also this past period, given where the hurdle rate was, 9% on the debt was a more effective way for us to raise capital. Now we're looking at potential Fed rate cuts. We're looking at the timing of that will only improve with those rate cuts. I think that's how we're looking at it. We were very close to thinking about the NR deals, and I think those economics are going to improve once the Fed starts cutting.

And so given that we were able to access the market at a 9%, that was what we did first, and we're going to be still monitoring the resecuritizations. And as far as other non-NRs, obviously, as rates continue to drop, they'll start to come into play as well. So hopefully that's helpful for you as we're thinking about it.

Stephen Laws (Head of Real Estate Finance)

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 resecuritizations, 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 relevers 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 is really hard for me to be much more specific other than things are moving in the right direction. And when we do do it, we'll do it when it's going to be a material benefit to the company.

Stephen Laws (Head of Real Estate Finance)

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 problem loans? I mean, it seems typically as long as pool season, you see increased delinquencies. But I thought 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 2020. 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 kind of a pre-pandemic level given the seasoning of our portfolio.

Stephen Laws (Head of Real Estate Finance)

Great. Appreciate the comments this morning. Thank you.

Operator (participant)

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

Jake Katsikas (Equity Reseach Associate)

Good morning. This is Jake Katsikas on for Eric. Thanks for taking my questions. I wanted 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 (Co-CIO)

I think obviously it's too early to call that. But if you look at our RPL portfolio, that has ranged from close to 6 CPR to low to mid double digits. If we come to the point where mortgage rates meaningfully go down from here, we could expect to see our RPL prepayments go back to, I would say, low to mid double digits.

Jake Katsikas (Equity Reseach Associate)

Great. Thank you so much.

Operator (participant)

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 (participant)

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