Chimera Investment Corporation (CIM) Q1 2024 Earnings Call Transcript

Chimera Investment Corporation (NYSE:CIM) Q1 2024 Earnings Conference Call May 9, 2024 8:30 AM ET

Company Participants

Victor Falvo – Head of Capital Markets and Investor Relations
Phil Kardis – President and Chief Executive Officer
Subra Viswanathan – Chief Financial Officer
Dan Thakkar – Chief Investment Officer

Conference Call Participants

Doug Harter – UBS
Bose George – KBW
Trevor Cranston – Citizens JMP

Operator

Greetings and welcome to the Chimera Investments’ 2024 Earnings Conference.

I have here with me today are Victor Falvo and all participants are in a listen-only mode. At this time, a brief question-and-answer will follow the formal presentation. [Operator Instructions] And as a reminder this conference is being recorded.

It is now my pleasure to introduce your host Victor Falvo, you may begin.

Victor Falvo

Thank you, operator. And thank you, everyone, for participating in Chimera’s first 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 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 President and Chief Executive Officer, Phil Kardis.

Phil Kardis

Good morning, and welcome to Chimera Investment Corporation’s first 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.

The capital markets closed 2023 on a strong note, driven by investor expectations that the Federal Reserve would cut interest rates 7 times or 175 basis points during 2024, which was more than twice the number of the Federal Reserve had indicated through their quarterly dot plot. Throughout the quarter and during April, economic data reflecting strong employment and an increasing inflation rate caused the market on several occasions to reduce its expectations of interest rate cuts, triggering increased rate volatility and a backup in long-term interest rates. Today, market expectations are for 1 cuts to 2 cuts before year-end.

The four main themes that have emerged as we begin the second quarter are: inflation is still higher than the Federal Reserve’s desired rate; economic data continues to indicate a strong economy; long-term interest rates may not have peaked; and interest rates will experience increased volatility.

Despite the return of volatility, higher interest rates and reduced rate cut expectations, since the beginning of the year, we have acquired approximately $50 million in subordinated tranches of new issue mortgage securitizations backed by collateral that included reperforming residential mortgage loans and small balance commercial loans. These investments have a weighted average coupon of 10.5%, and inclusive of the purchase discount we anticipate earning low-teen unlevered returns.

In addition, we also settled on $78 million of residential transition loans. These loans have a weighted average coupon of 10.6%, and we expect to receive mid-teen levered returns. The unlevered securities will enable us to increase leverage over time and the residential transition loans generate superior returns, as compared to other short-duration investments, while providing a significant amount of free cash flow for reinvestment. We believe these investments will provide accretive returns to the portfolio, while preserving liquidity for future deployment.

On the liability side of the balance sheet, we continue to reduce some of our higher cost repo borrowings. We believe the actions taken this quarter on both sides of the balance sheet will benefit our interest — net interest income. And to further protect our liability cost against higher interest rates this quarter, we added an additional $500 million in 1×1 pay-fixed swaption at a rate of 3.45% to help protect the borrowing cost of the portfolio on a go-forward basis.

We continue to seek opportunities to finance our retained notes from securitizations with long-term limited or non-mark-to-market financing facilities. We currently have about 60% of our recourse financings with these facilities. To further manage our interest rate risk, we intend to continue to use financial derivatives such as interest rate swaps and swaptions to hedge against net interest margin compression.

Cash management is critical to our business. We monitor our ongoing needs for margin requirements, repo maturities, daily liquidity and new investments. Over time, we expect to continue to acquire and securitize mortgage loans, as well as further implement the company’s call optimization strategy on our securitizations.

With available funds, we plan to evaluate the merits of any new investments and compare them with the merits of reducing higher cost liabilities as they mature. Timing of these resecuritizations is impacted by many factors, including credit performance, prepayment speeds and interest rates. In the near-term, we are beginning to see some green shoots.

As I mentioned on our last call, we are closely monitoring several of our outstanding NR or non-REMIC eligible securitizations for potential resecuritization. With the spread tightening we have experienced this year, we believe our ability to resecuritize these loans in the second or third quarter has improved. Our ability to execute this strategy will free up additional cash to invest in new opportunities that we expect will be accretive to future earnings.

As we navigate current market conditions, we are focused on maintaining low recourse leverage and managing our liquidity with a proper balance of both cash and unencumbered assets. The credit performance of our portfolio continues to be within or better than our original investment expectations on mortgage delinquencies, default rates and recoveries.

We have fully deployed the proceeds from our capital raise last year and we continue to look to purchase new loan packages. We were successful in accomplishing our investment objectives this quarter, and we believe the increased rate volatility will enable us to continue to add accretive investments for the remainder of the year.

I’d like to now turn to Subra to give a more detailed overview of our financial results.

Subra Viswanathan

Thank you, Phil. I will review Chimera’s financial highlights for the first quarter 2024.

GAAP net income for the first quarter was $111 million or $0.45 per share. GAAP book value at the end of first quarter was $7.11 per share. The appreciation in value this quarter was mostly driven by a tightening of spreads on our reperforming loans.

For the first quarter, our economic return on GAAP book value was 7% based on the quarterly change in book value and the first quarter dividend per common share.

On an earnings available for distribution basis, net income for the fourth quarter was $31 million or $0.12 per share. Our economic net interest income for the fourth quarter was $68 million.

For the first quarter, the yield on average interest-earning assets was 5.8%. Our average cost of funds was 4.4%, and our net interest spread was 1.4%. Total leverage for the first quarter was 3.7:1, while recourse leverage ended the quarter at 0.9:1. For financing and liquidity, the company ended the quarter with $587 million in total cash and unencumbered assets.

For hedging, during first quarter, the company exercised its two swaption contracts for $1 billion notional and entered into two separate one year swaps for a total of $1 billion notional at a weighted average 3.46% fixed pay rate. We added a new swaption contract with $500 million notional for the option to pay-fixed at 3.45% for one year beginning in January 2025.

We had $1.7 billion floating rate exposure on our outstanding repo liabilities. We had $2 billion pay-fixed interest rate swaps at a weighted average fixed pay rate of 3.36% as a hedge position for our floating rate liabilities. $1 billion of these swaps matured in May and $1 billion pay-fixed swaps remain with 3.46% weighted average fixed pay rate.

We had $1.4 billion of either non or limited mark-to-market features on our outstanding repo agreements, representing 60% of our total recourse funding. For the first quarter of 2024, our economic net interest income return on equity was 10.5%, our GAAP return on average equity was 19.9%, and our EAD return on average equity was 7.3%.

And lastly, for the first quarter 2024 expenses, excluding servicing fees and transaction expenses, were $15 million, down $1.3 million from same period last year, a reduction of 8%.

That concludes our remarks. We will now open the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Doug Harter with UBS. Please proceed.

Doug Harter

Good morning. You mentioned that you’re getting closer on calling some of your deals. Can you just talk about how you — what type of capital you think you might be able to free up in the coming quarters? And how you would view the relative return on redeploying that capital versus kind of what you’re calling?

Phil Kardis

Doug, this is Phil. So yes, I mean, I think we believe we’re getting closer. We’re not there yet. We’re looking at a variety of factors. Partly, that comes down to issues like how much are we actually going to get. We think it’s significant enough that we’re willing to really look at this seriously. But the actual amount will be — again, will depend on factors, and we look at kind of what the hurdle rates are and the like.

And so I think we can say that there’s a fair amount of opportunities out there for kind of low to mid-teen returns, and it currently looks like we can beat the hurdle for reinvestment. That’s why I mentioned it. I mentioned on the prior call that we thought that was possible. We think it’s now, given where the spreads have gone, that it’s more possible. But we need some further improvement before we’re there. But we are hopeful that we get something done in the next period or so.

Doug Harter

Great. And I was hoping you could give us an update as to how book value has trended so far in the second quarter?

Phil Kardis

Yes. So far in the second quarter — so I’m going to turn this over to Dan Thakkar, our Chief Investment Officer.

Dan Thakkar

Yes. Yes. So Doug, so this quarter we have had a sell-up in rates in the range of 25 to 30 basis points. Spreads have tightened a bit more, especially post the FOMC and the soft payroll last week. So our estimate at this point is that we are lower by close to 1.5% to 2%.

Doug Harter

Great. I appreciate that. Thank you, guys.

Operator

Our next question comes from Bose George from KBW. Please proceed.

Bose George

Hey, guys. Good morning. Just a follow-up to the book value question. The — just in terms of the improvement this quarter, can you just walk through the drivers?

Dan Thakkar

Yes. So Bose, so look, I think as Subra said, we had positive mark-to-market changes in the investment portfolio, which was primarily driven by the tightening in the loan portfolio. Look, spreads tightened a fair bit commensurate with the tightening in the non-agency subs in the last quarter. We saw roughly $3 billion to $4 billion trading in loans. Fannie Mae sold $500 million in early February. That traded pretty well. There is another list out today that’s expected to trade even better than that.

So in addition, there was a fair amount of issuance in the securitization market, close to $5 billion. So we saw that spread tightening as far as the trading is concerned in the markets and what we saw in the supply. So that’s how we tighten our loan portfolio.

Bose George

Okay. Makes sense. Thanks. And then if the forward curve is right and we’re in the higher for longer, can you just talk about the outlook for EAD? And just talk about the path to a double-digit ROE if we’re remaining higher for longer.

Subra Viswanathan

Bose, this is Subra. EAD, at this point, based on the hedges we have and the forward rate projections, we are expecting EAD to be consistent along where we have reported. If you actually look at our E&D trend the last three or four quarters, we have remained very stable, and we expect that to continue. Obviously, if you add more assets and if you raise more capital and add more assets, that could change the scenario a little bit, but the trend so far is that we’re maintaining consistent EAD.

Bose George

And the second part, yes…

Subra Viswanathan

Sorry, say that again, your second part.

Bose George

The second part was really if we remain in higher for longer, what’s the path to a double-digit ROE.

Subra Viswanathan

Okay. So the — if you think about the ROE today, in my prepared statement, I said that average return on equity was 10.9%. Now that’s before the expenses. So we are generating double-digit ROEs today. And obviously, how we manage our hedges and additional investments that we make on capital raise would contribute further on top of that.

Bose George

Yes. Okay, great. Thanks.

Operator

Our next question comes from Trevor Cranston with Citizens JMP. Please proceed.

Trevor Cranston

Hey, thanks. Good morning. Can you talk about how you guys are evaluating the potential to buy back shares versus making other new types of loan investments given where the stock is trading relative to book value? Thanks.

Phil Kardis

Sure. I mean, I think as we said in the past, we look at all those factors. Right now, I think we view acquiring assets in this environment as a better long-term investment for our shareholders.

Trevor Cranston

Okay. Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the floor back over to Phillip Kardis for closing comments.

Phil Kardis

I would like to thank everyone for participating in our first quarter earnings call, and we look forward to speaking to you at the end of next quarter.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.