Chimera Investment Q4 2022 Earnings Call Transcript

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February 15, 2023

Key Takeaways

  • Weighted average recourse borrowing costs surged to about 6.6% in 2022 from 2.3%, squeezing earnings available for distribution to $0.11 per share in Q4 (or $0.20 excluding one-offs).
  • Entered a $250 million fixed-rate non-mark-to-market financing and extended long-term debt through 2024+ to mitigate rate-rise risks, reduce hedging needs, and protect subordinate bond equity.
  • Acquired $463 million of prime jumbo loans under long-term fixed financing and reduced mortgage loan mark-to-market exposure by $100 million, lifting book value to $7.49 per share.
  • Committed approximately $700 million in reperforming loans, $365 million in business-purpose loans, and $200 million in non-QM loans in early 2023, targeting mid-teens ROEs on these accretive investments.
  • Reported a GAAP net loss of $587 million ($2.51 per share) for full-year 2022, with an economic return on GAAP book value down 27.3%.
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Earnings Conference Call
Chimera Investment Q4 2022
00:00 / 00:00

There are 7 speakers on the call.

Operator

Greetings and welcome to the Chimera Investment Corporation 4th Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Victor Falvo, Head of Capital Markets, thank you.

Operator

Please go ahead.

Speaker 1

Thank you, operator, and thank you, everyone, for participating in Chimera's 4th Quarter and Full Year 2022 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.

Speaker 1

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, Phil Curtis.

Speaker 2

Good morning, and welcome The Chimera Investment Corporation's 4th Quarter and Full Year 2022 Earnings Call. Joining me on the call are Chaudhry Mr. Laghada, our President and Chief Investment Officer Dan Thacker, our Co Chief Investment Officer Subra Viswanathan, our Chief Financial Officer and Vik Falvo, our Head of Capital Markets. After my remarks, Subra will review the financial results, and then we will open the call for questions. Let me begin by briefly introducing myself.

Speaker 2

As many of you may know, from our internalization in 2015 until I became CEO in December 2022, I served as the company's Chief Legal Officer and Corporate Secretary. Prior to that, I was a partner in a major law firm and among other things was The company's outside counsel from its IPO until I joined as Chief Legal Officer. What you may not know is that I have a broad range of experience before I became a partner in a law firm, from serving on Capitol Hill and the Executive Branch to a defense analyst at a think tank to To a Fortune 50 company to being a doctoral student in economics. My career as a lawyer was primarily structuring very complex financial transactions. That structuring experience carried over into my work at the company, where I've been heavily involved in all aspects of the company's business, including serving on the Investment and Valuation Committees as well as being involved in structuring its transactions.

Speaker 2

I'm not a regulatory attorney. I'm not a litigation attorney. My appointment as CEO was not the result of any regulatory or litigation issue at the company, but rather driven by my transactional and strategic experience. Also, let me note That while I have the transactional and strategic experience, I am not the Chief Investment Officer. We view the return to our past Where the roles of CEO and CIO were separate is critical to our success.

Speaker 2

Separating these roles will enable us to better focus on our long term vision, while staying keenly focused on investment opportunities and our portfolio. Now before turning to our vision, let me hit the highlights of the Q4 and of the year. As you know, 2022 was challenging for us, Great, from near 0 to a range of 4.25% to 4.5% by year end. As a student of economic history and being old enough to have lived through the late 1970s 1980s, The Fed falling behind inflation and rushing to catch up had a familiar ring. I remember when my wife and I purchased our first home in the late 1980s, We were happy with the rate around 9.5 percent because we had taken out an even more expensive second just to qualify for the first, We understood the value of that home as an asset.

Speaker 2

Not only was the story familiar, but the impact on the company was expected. We saw our weighted average recourse borrowing cost increase to about 6.6% by year end compared to about 2.3% for the prior year. We saw our earnings available for distribution decline to $1.08 for the year and to $0.11 for the 4th quarter, Due primarily to a one time hit for severance for our former CEO and a $250,000,000 fixed rate non mark to market financing, We entered into to enhance our liquidity while protecting us from the impact of increasing interest rates on those assets. Excluding those two events, our EAD for the quarter would have been approximately $0.20 During the latter half of the year, We entered several long term non mark to market facilities. We looked into the future and we believe the statements by the Fed that they were going higher for longer and decided to take the prudent action of extending some of our financing into 2024 and beyond To a point where we felt more comfortable that the Fed would be done raising and would begin cutting.

Speaker 2

Such financing is of course more expensive in short term financing, but it reduces our need for hedges to protect against margin calls, which frees up cash for other purposes. Also, we know that we are building up significant equity in our securitizations, as my wife and I were with our first home, And protecting our retained subordinate bonds with such financing is in the long term best interest of our shareholders, even at the expense of higher rates. But there were many positives during the Q4. In addition to lengthening the term of our financings, we We acquired approximately $463,000,000 of prime jumbo loans into a long term financing facility, which is effectively fixed rate And non mark to market. We believe the returns on this investment are accretive to our shareholders.

Speaker 2

We We were able to reduce our mortgage loan mark to market exposure by approximately $100,000,000 by sponsoring the SIM 2022 NR1 seconduritization. Also, our book value per common share increased to $7.49 At the end of the Q4, the good news continued during January as we were able to access the securitization market And terminated 4 of our securitizations and issued 2 new securitizations, reducing recourse borrowing by approximately 139,000,000 and releasing approximately $90,000,000 in equity. We also committed to purchase approximately $700,000,000 of reperforming loans, which we intend to settle into securitizations and believe the returns on these investments are accretive to our shareholders. We We were also able to purchase additional business purpose loans ending in January with $365,000,000 in cash. Finally, so far in February, we have committed to purchase approximately $200,000,000 of non QM loans, which again, we believe will be accretive to our shareholders.

Speaker 2

So where do we go from here? Our mission is simple, to deliver attractive risk adjusted returns to our shareholders By being the best in class credit mortgage REIT. We believe our assets are very strong. We still have approximately $900,000,000 of You'll see non agency RMBS on our balance sheet that continues to generate double digit yields for our portfolio. As of year end, we had approximately $11,400,000,000 fair value of mortgage loans, including RPLs held for investment.

Speaker 2

These loans serve as the cornerstone of our business. The largest component of our loan portfolio is reperforming loans. These loans are very seasoned and since purchase have demonstrated consistent to improving metrics regarding both Credit performance and prepayment histories. We have successfully securitized and re securitized these loans throughout the years. Over time, these securitizations delever and have historically provided opportunities for Chimera to release equity.

Speaker 2

Chimera uses this equity for either redeployment into new assets, retirement of debt or distributions to shareholders through dividends. We view this ability to extract equity from our investments as a key differentiator for Chimera amongst its peers and can be a significant source of capital for deployment. We continue to see interesting and accretive opportunities in RPLs, Non QM, BPLs and jumbo prime mortgages. While our focus During the past few years has been on RPLs, we expect to continue to diversify our loan purchases. In addition, we historically have had robust portfolios of Agency RMBS and Agency CMBS.

Speaker 2

We intend to rebuild these portfolios over time, both for the returns and for the liquidity to support our credit portfolio. Since REITs can't retain earnings, we often find ourselves able to raise equity during periods where the returns on credit assets are not attractive. Likewise, when the opportunities in credit are attractive as they are now, it can be challenging to raise capital. We see these agency portfolios as a way for us to balance out these periods. We can grow our agency and use the increased liquidity to purchase credit assets when attractive or to support our financing of our Credit assets during more challenged markets.

Speaker 2

While these portfolios will support our core business, we will manage these portfolios with the appropriate leverage And hedging to generate current income and to maintain book value to support both our dividend and our investment in credit assets. This is not a new strategy for us. We successfully used it from internalization until the pandemic. During that period, our combined agency RMBS and CMBS portfolio range from a low of about $4,000,000,000 to a high of Slightly more than $12,000,000,000 depending on the opportunities to invest in credit assets. Now we do think 2023 presents challenges.

Speaker 2

We saw a lot of positives in January and believe there are still positive trends. Nevertheless, we also see some dark clouds. Getting inflation down to 2%, if possible, is going to take some time. According to a recent Wall Street Journal article, the service industries, healthcare, hospitality and so forth, Account for 36% of all private sector payrolls. By the same token, the tech heavy information sector accounts for only 2%.

Speaker 2

These service industries have accounted for approximately 63% of all private sector job gains over the past 6 months And the labor demand in these industries remains strong. Accordingly, we believe the Fed when it says Rates will go higher for longer, and we believe we have positioned ourselves to handle that outcome. We're also mindful of the 2nd cloud, liquidity volatility arising from debt ceiling shenanigans. We're keeping our eye on our financing and roll dates with respect to this cloud. Finally, there is the known unknown of geopolitical turmoil.

Speaker 2

Russia, China, Iran and North Korea in particular. The impact of such turmoil is unknown, but between our long term financing, About our future. We have a great team, outstanding assets and a clear vision. I would now like to turn to Subra

Speaker 3

Thank you, Phil. I will review Chimera's financial highlights for the 4th quarter And full year 2022. GAAP book value at the end of the 4th quarter was $7.49 per share And our economic return on GAAP book value was 3.8% based on the quarterly change in book value and the 4th quarter dividend per common share. Our economic return for the full year was negative 27.3%. GAAP net income for the Q4 was $79,000,000 or $0.34 per share and GAAP net loss for the full year was $587,000,000 or $2.51 per share.

Speaker 3

On an earnings available for distribution basis, Net income in the Q4 of approximately $0.11 per diluted common share and $0.16 per diluted common share After excluding a one time severance expense related to the separation of our former CEO And for the full year, earnings available for distribution was $256,000,000 or $1.08 per share. Our economic net interest income for the 4th quarter was $77,000,000 $436,000,000 for the full year. For the Q4, the yield on average interest earning assets was 5.5%. Our average cost of funds was 3.9% And our net interest spread was 1.6%. Total leverage for the 4th quarter was 4 times to 1, While Reco's leverage at the end of the quarter was 1.3:one.

Speaker 3

For the year, Our economic net interest return on equity was 14.7% and our GAAP return on average equity was negative 16.7%. And lastly, our full year 2022 expenses, excluding servicing fees and transaction expenses, were $72,000,000 modestly up from the previous year. That concludes our remarks. We will now open the call for questions.

Operator

Thank you. Ladies and gentlemen, the floor is now open for questions. The first question is coming from Bose George of KBW. Please go ahead.

Speaker 4

Hey, guys. This is actually Mike Smith on for Bose. So you mentioned that you intend to rebuild the agent CMBS and CMBS portfolios. Just wondering how big do you envision this kind of getting as a percentage of capital and then what's the timeline for getting there?

Speaker 2

Hi, this is Phil. Thanks for the question. There isn't a specific timeline. We'll look at the opportunities in the market for both And depending on kind of relative value, we'll start moving into those assets. As to the size, I think what we'll be looking at is A minimum of which we think is a minimum size of portfolio to be effective in this space or to be efficient, But the actual size will depend on kind of the size of our credit portfolio and where we see the future going In terms of possible investments.

Speaker 2

So we're not going to peg it to 10% or 25%. We're going to look at it in more holistically at the time.

Speaker 4

Great. Thanks. And then on the loan purchases, I was wondering, are you able to purchase the loans and kind of securitize it roughly at the same time to kind of avoid the risk of Holding those loans on balance sheet and funding it with repo?

Speaker 2

That's correct. That is our intent there. It could be the case that we Because of timing that we end up warehousing for a week or so, but the intent of when we purchase these is to settle right into securitizations.

Speaker 4

Great. And then maybe just one more. You noted that the purchases would be accretive. Can you just kind of walk through what's the expected ROE and kind of what does this Assume in terms of structural leverage and does it assume any repo leverage on the retained pieces?

Speaker 2

Yes. We think it's we're talking about something in the mid teens for returns and that would include leverage on the retained pieces.

Speaker 5

Great. Thanks a

Speaker 4

lot for taking the questions.

Speaker 5

You

Operator

bet. Thank you. The next question is coming from Trevor Cranston of JMP Securities. Please go ahead.

Speaker 5

Hey, thanks. Good morning. You guys talked about broadening out the types of Purchases you're going to be making more so beyond the traditional RPLs as we go forward. Between the new categories of non QM and BPL, for example, can you talk about Where do you see a bigger opportunity in terms of how much supply of loans is available and the type of returns that you think you can get on those investments? Thanks.

Speaker 2

Well, firstly, we really like BPLs. We think the returns are very good and we like the short duration. At times, it can be challenging to acquire that in size, but we're always for opportunities there. And so but in the non QM, it's something that we traditionally haven't played in, but in terms of some forms of Investor loans and the like in that category, we're now finding to be attractive and opportunities are coming our way and we're we think we'll be buying more of that on a go forward

Speaker 5

Okay, got it. And then the question on the dividend, I mean, the 4th quarter earnings, excluding the one time stuff, seemed to have still trended Downwards as cost of funds has increased. Can you maybe just talk about how you guys are thinking about the dividend given that trend and Maybe any other considerations that the Board takes into account beyond just the EAD metric when you guys are setting the dividend? Thanks.

Speaker 2

Sure. Thanks. EAD is one of the metrics. It's not the only metric. And at times, It's a good measure for certain aspects, but not 100% foolproof.

Speaker 2

So I think the Board looks at a variety Factors, including kind of the total cash that the portfolio is generating, some of which just has not Captured in kind of the EAD metric. We also bear in mind, as I mentioned, that we have equity in our securitizations. And Depending on the timing and what our needs are, we may tap that from time to time. So we have All those factors go into it when we think about or when the Board thinks about the dividend. And so they were given where the portfolio is, they were comfortable with Declaring the Q1 dividend at 23 despite kind of where EAD is at the present moment.

Speaker 5

Okay. Appreciate the comments. Thank you.

Speaker 2

Sure. No problem.

Operator

The next question is coming from Lee Cooperman of Omega Family Office. Please go ahead.

Speaker 6

Thank you very much. I'll Just make an observation. You said you're a student of history. Any student of history would know interest rates were going up. Why weren't you not hedged earlier than now?

Speaker 2

That is something that in hindsight though, the company should have done. I mean that We're right now, Lee, looking kind of on a go forward basis. I mean, we have had a change in leadership. We do have a vision of where we're going. We do have a structure and a strategy with respect to hedging versus our longer term financing.

Speaker 2

And That's where we are. I am a student of history, but to be frank, it's that is in our past and what we're focusing on is fixing it and moving forward.

Speaker 6

Hi. So, it was a question that was previously asked, but you talked around the way you want to run the company, What is a reasonable return on equity for us to generate on our $7.49 of book value?

Speaker 2

It's really our dividend return, 10% to 12% ish range.

Speaker 6

Well, 10% return on equity wouldn't do it. 10% return on equity would be a $0.75 dividend that would imply a cut.

Speaker 2

Jump in, Tumor.

Speaker 3

Haley, this is Subrah. Historically, the dividend yields Our stock has been around 10% to 12%, and that's where we expect our dividend to That our investments are currently yielding and that's where we see the dividends to be as a return on capital to be expected from the stock.

Speaker 6

So what are you saying? The return on equity determines the distributable income, which will determine the dividend. So You're saying that the return on equity should be 10% to 12%?

Speaker 3

Yes.

Speaker 6

Right. Okay. That would imply the dividend is kind of iffy at this level that should we assume as shareholders that there's a good chance the dividend might be In the next 12 months, what do you think the dividend is likely maintained?

Speaker 2

No, I think right now we feel where the dividend where our Our portfolio is in terms of throwing off cash and the new investments we're making. It's hard to predict where the future is in terms The markets and potential dark clouds that we talked about, but right now we feel good about that $0.23 dividend.

Speaker 6

Thank you. And I assume given the balance sheet, you have plenty of capital to run the business. You don't need new additional capital?

Speaker 2

Yes, we have plenty of capital to run the business as it's currently constructed. But as we mentioned In terms of growing the other portfolios and investment opportunities, I'll just be straight, we're not going to shy away from raising money if That money is raised at a rate that's appropriate for us to reinvest in the asset. So if we see a positive return to that capital, we will Won't shy away from raising additional thoughts.

Speaker 6

Equity, would you consider equity financing at these levels?

Speaker 2

I would consider equity financing depending on The investment opportunities at the time that we could access the market, yes.

Speaker 6

So you would sell stock at a discount to book value?

Speaker 2

No, I didn't say that.

Speaker 6

I said that we won't ask capital. I'm asking. Look, let me tell you what my view is. Wall Street has created a lot of companies in this BDC, The MLP REIT space, they only work when stocks sell at a premium to NAV, because what happens is You sell stock, you buy assets, you raise a dividend. You sell stock, you buy assets, you raise a dividend.

Speaker 6

When you go to a discount to NAV, it's game over. It's only the smart guys that basically either merge to become more efficient to generate synergies or basically buy back stock at discount. The idea of selling stock at a discount to book value makes absolutely no sense and we should consider winding up the affairs of the company and giving back to 1,000,000 to shareholders. And so we made a mistake. Stock has been a disaster.

Speaker 2

Yes. I mean, we don't disagree with that. I mean, our intent would be to raise at book. I mean, the reason I would pause for a second, it depends in terms of what the opportunity is. And if we feel That is massively accretive, we would at least consider it, but that's not our going in position.

Speaker 6

Very good. Thank you. Good luck.

Speaker 2

Thank you. Thank you. At this

Operator

time, I would like to turn the floor back over to Mr.

Speaker 2

Kartas for closing comments. I I'd like to thank everybody for joining our earnings call and frankly my first earnings call. It's been a pleasure To have the opportunity to speak to you and I look forward to doing so in the future. Thank you.

Operator

Ladies and gentlemen, thank you for your participation. This concludes Today's event, you may disconnect your lines or lock off the webcast at this time and enjoy the rest of your day.

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