Chimera Investment Corporation (NYSE:CIM) Q3 2022 Earnings Conference Call November 3, 2022 8:30 AM ET
Company Participants
Victor Falvo – Head of Capital Markets
Mohit Marria – CEO and Chief Investment Officer
Subra Viswanathan – CFO
Conference Call Participants
Kenneth Lee – RBC Capital Markets
Trevor Cranston – JMP Securities
Mike Smyth – KBW
Operator
Good day, ladies and gentlemen, and welcome to the Chimera Investment’s Third Quarter 2022 Earnings Conference Call. All lines have been placed on a listen-only mode and the floor will be open for questions and comments following the presentation. [Operator Instructions].
At this time, it is my pleasure to turn the floor over to your host, Victor Falvo, Head of Capital Markets. Sir, the floor is yours.
Victor Falvo
Thank you, operator, and thank you, everyone, for participating in Chimera’s third quarter 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.
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 will 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
Good morning and welcome to the third quarter 2022 earnings call for Chimera Investment Corporation. Joining me on the call today are Choudhary Yarlagadda, our President and Chief Operating Officer; Subra Viswanathan, our Chief Financial Officer; and Vic Falvo, our Head of Capital Markets. After my remarks, Subra will review the financial results, and then we will open the call up for questions.
Before we begin, I would like to congratulate all the Chimera employees and members of our Board or Directors past and present, as we celebrate our 15th anniversary as a New York Stock Exchange listed company. I’m very proud of the team we have built and very much appreciate all their contributions to the company.
While elevated market volatility in the third quarter has led to higher rate and wider spreads, putting further pressure on our book value. We believe this has created several opportunities for Chimera on both sides of the balance sheet.
In particular, to the end of October, we’ve been able to increase our cash position, increase the amount of non-mark-to-market financing, and either added or committed to add new investments to our portfolio.
It has been a busy period for us, which I will discuss in more detail in a moment. But first let me describe the overall market and how that translates to our portfolio and expectations. The capital markets have been volatile this year, buffeted by global complex, higher inflation, a rapidly rising interest rate environment and a weakening U.S. economy.
Inflation which Federal Reserve officials have believed to be transitory in nature last year, has turned out to be persistent with the Consumer Price Index reaching 8.3% on a year-over-year basis in September. As a result, the Federal Reserve raised interest rates 75 basis points at each of their July and September meetings, bringing total tightening of short term interest rates to 300 basis points over the first nine months of this year.
The magnitude and velocity of the Fed tightening has put downward price pressure on all fixed income products, including treasuries, corporate bonds and mortgage backed securities. Higher rates across the capital markets have flowed through to the consumer for the rate of 30-year conforming mortgages rising to 7.04% at quarter end versus 3.18% one year ago.
Higher mortgage rates have substantially slowed down new home purchases and eliminated refinance activity. As reported in September sales of existing homes declined for eight consecutive months to the lowest level in the past decade. As a result, we believe this year’s mortgage rate shock to the consumer will have an impact toward slowing down the economy and ultimately lead to lower rates as many consumers will have less disposable income to spend.
Chimera’s portfolio of residential mortgage credit is unique and differentiated amongst our peers. It is well season and has experienced many interest rates and economic cycles. We have approximately $1.2 billion of non-agencies RMBs, which is largely comprised of opportunistic purchases made after the previous housing crisis. This portfolio has provided double digit returns for a long period of time for our portfolio, and we expect that to continue into the foreseeable future.
And since 2014, we have amassed an $11.8 billion portfolio of residential mortgage loans with substantially different characteristics than available through typical mortgage banking channels used by banks and traditional mortgage backed security investors. Our loan portfolio consists of 115,000 loans with an average loan balance of $102,000.
The loans are an average 15-year season, and an average loan to value add origination was 83%. Importantly, 88% of our loans were originated in 2007 or earlier, which means homeowners have been making mortgage payments on their homes for 15-years or more. And the portfolio is geographically diverse, there’s only three states having geographic concentrations above 5%.
Overall, this portfolio is different. A small loan size equates to low monthly mortgage payments, the eight of the loans as afforded many of the homeowners are reasonably long period of time to catch up home price appreciation, and or mortgage amortization. And there is a long and demonstrated history of monthly mortgage payments paid by the homeowner. All of these factors are very important features when evaluating a mortgage borrower’s paying ability.
Our seasoned re-performing portfolio is a cornerstone of our business. And we believe our portfolio of seasoned re performing loans will continue to outperform the market. We believe market conditions with higher interest rates and wider mortgage spreads presents new accretive investment opportunities.
Since the beginning of the year, we have been scaling into new investments. We believe our patients and investment discipline throughout this year will benefit our shareholders over the long term.
Now I will take you through a recent activity. During the third quarter of 2022, we committed to purchase $687 million residential mortgage loans, $211 of this total settled in October. We expect to close $476 million loans into a long-term non-mark-to-market structure, which we anticipate will generate double digit returns.
Due to the delay in settlement, we expect to see the full benefit of these loans in 2023. Additionally, we purchased and settled down $66 million of business purpose loans during the third quarter of 2022. As we have mentioned in the past, we like our loan characteristics associated with business purpose loans. They have short duration and provide good spread income for the portfolio. In total, we committed to purchase $753 million loans in the third quarter.
As of the end of the quarter 96% of our capital was allocated to residential credit assets. Securitizations remain the primary source of financing of our loans. In September, we sponsored CIM 2022-R3. A rated securitization of season reperforming residential mortgage loans, with a principal balance of $370 million.
Securities issued by CIM 2022-R3 with an aggregate balance of approximately $284 million were sold in a private placement to institutional investors. These senior securities represented approximately 77% of the capital structure. We’ve retained subordinate notes and certain interest only securities with an aggregate balance of approximately $86 million.
We also retained an option to call the securitized mortgage loans at any time beginning in September of 2027. Our average cost of debt for this securitization is 5.80%. As of the end of the quarter securitized debt represented 72% of our total financing, with an average cost of 2.7% and 98% of our securitized debt is fixed rate. Largely because of securitization this quarter we reduced our overall recourse financing by $328 million.
On the remaining 28% of our financing, we have kept a portion of our secured credit financing and either none or limited mark-to-market facilities. This quarter, we extended a maturing $489 million non-mark-to-market facility by an additional 29 months to February of 2025.
We continue to believe these facilities are valuable components of our liability structure.
Third quarter experienced a significant increase in interest rate volatility. Given the market outlook for higher rates for an extended period, we entered a $500 million two-year and a $385 million five-year interest rate swap. These swaps complement the $1 billion swaps we entered in Q2, so that we may partially hedge our borrowing costs over a longer period.
We expect to manage our derivative hedge position in conjunction with our asset and liability framework. In total, during the third quarter we entered into $885 million pay fixed interest rate swaps.
On post quarter end, we ended October was approximately $350 million of cash on our balance sheet. Entered an additional $1.1 billion of pay fixed interest rate swaps. Entered a new two-year non-mark-to-market secured financing facility for $250 million to finance retained securities from our securitization, and sponsored $145 million CIM 2022-NR1 with existing loans from our warehouse. These transactions are further strengthened Chimera’s liability and liquidity position since quarter end.
Throughout 2022, we have managed our balance sheet to lock in long term funding. While seeking opportunities to have higher yielding mortgage assets to our portfolio.
We have maintained to low recourse leverage and stick to our discipline of carrying none or limited mark-to-market financings for many of our subordinate credit assets. And while markets have been challenging, since the beginning of the year, we have closed or committed to acquire $1.6 billion of loans completed five securitizations totaling $1.6 billion. Repurchased $50 million of our common stock, enters nearly $3 billion hedge transactions to protect against further increases in interest rates. And expect to add new credit financing partners bring in a none and limited mark-to-market facilities to nearly 50% of secured financing.
We believe our credit portfolio is strong and will continue to outperform other mortgage assets in the marketplace.
Chimera is a strong believer in securitization that provides us with stable non-recourse long term financing. We’ve taken many steps to bolster our balance sheet so that we can weather the current economic storm.
We believe we are well positioned to take advantage of the new market opportunities and that our patience and investment discipline benefit our shareholders over the long term.
I will now turn the call over to Subra to review the financial results for the quarter.
Subra Viswanathan
Thank you, Mohit. I will review Chimera’s financial highlights for the third quarter of 2022. GAAP book value at the end of third quarter was $7.44 per share. And our economic return on GAAP book value was negative 13% based on the quarterly change in book value, and a third quarter dividend per common share.
GAAP net loss for the third quarter was $205 million or $0.88 per share. Our earnings available for distribution basis, net income for the third quarter was $63 million or $0.27 cents per share.
Our economic net interest income for the third quarter was $104 million. For the third quarter, the yield on average interest earning assets was 5.5%. Our average cost of funds was 3% and our net interest spread was 2.5%.
Total leverage for the third quarter was 3.9:1, while recourse leverage ended the quarter at 1.1:1. For the quarter, our annualized economic net interest return on average equity was 14.8%, and our annualized GAAP return on average equity was negative 26.5%.
And lastly, our third quarter expenses, excluding servicing fees and transaction expenses were $15 million, consistent with previous quarter.
That concludes our remarks, we will now open the call for questions.
Question-and-Answer Session
Operator
[Operator Instructions] And our first question comes from Kenneth Lee from RBC Capital Market. Go ahead, Kenneth.
Kenneth Lee
Hey, good morning, and thanks for taking my question.
Lot going on in terms of the financing side between the extending the non-mark-to-market and the rate swaps, you’ve been entering into. Just wondering if you could talk a little bit about how you think funding costs could trend over the near term given all these changes? And importantly, how responsive would funding costs be to rising rates? Thanks.
Mohit Marria
Good morning, Ken. This is Mohit, that’s a good question. As we enter 2022, the expectations of the Fed from where it started to where it was going to end was the magnitude of about three to four rate hikes, obviously, as we mentioned in the opening remarks, that have gone much further, and yesterday went an additional 75 basis points for the Fed funds rate to be at 4%. And as a result of how quickly the expectations were, the Feds going to change is why we started laddering into swaps and hedges to protect our financing cost over the last two quarters and even post quarter round.
So, the vast majority of our recourse borrowings are floating rate nature. So any adjustments in the index on the Fed funds rate translates into an increase in financing costs. But these hedges will lock in over the next two, three years of locked in rate with the spread that is finance on. But from a spread perspective, in terms of the asset, we’re looking to finance, there is still ample cash at those spreads to finance those assets. So it’s more the benchmark rate as opposed to the spread. That’s a bigger concern for us.
Kenneth Lee
Got you. Very helpful there. And appreciate — just one follow up, if I may appreciate the discussion on the RPLs and realizing that much the residential are very seasoned. But one of the things is talk about the potential impact of a slowing housing market and potential home price declines in terms of resi loan valuations or non-agency valuations. Thanks.
Mohit Marria
Sure. So, the big differentiator for us on our loan portfolio is the vast seasoning that the portfolio has the origination and LTV was 83%. So if you assume that 85% of the portfolio was originated prior to 2007, there’s been 15 years of natural amortization, coupled with some pretty strong HPA. So we think the updated or HPI adjusted amortized adjusted LTV on the portfolio is closer to 50%. So from a credit performance standpoint, that gives you a lot of equity to play with.
And if you look at the average loan balance of $102,000, the monthly mortgage payment is sub $800 a month. And if you just compare that to the change in mortgage rate from the start of the year to now, for a $400,000 mortgage, that mortgage payment adjustment would be $900. So these borrowers have gone through different interest rate cycle different credit events. So we think, you know, there’s going to be really not a material change, given the lack of housing alternatives that these borrowers have.
Kenneth Lee
Got you. Very helpful there. Thanks again.
Operator
And our next question comes from Trevor Cranston from JMP Securities. Go ahead, Trevor.
Trevor Cranston
Hey, thanks. Good morning. Can you guys talk a little bit about how the high level of volatility in the rates markets has impacted your investment appetite, just given the risks that there could be a big move in rates and spreads, between the time period when you acquire loans and when securitization takes place?
Mohit Marria
Hey, Trevor. Again, a good question and one we’ve addressed on sort of other calls as well. Like our approach is not to necessarily aggregate loans in many bulk size that we buy bulk production and warehousing them to transfer servicing and ultimately to securitize. So the period of time from committing to a trade to funding a trade securitization. We sort of look at it from a 60 to 90-day basis from a tournament perspective. So we try to limit how much exposure we have to spreads and rates adjusting now this year has been unique given how quickly rates have moved in Q3, the two year moved 130 basis points, the five year moved 100 basis points and the 10 year moved 90ish basis points.
So, it made it a bit challenging environment on top of the amount of issuance in the new issue market. But again, we do take warehousing risk, and use that as much as possible. But the quick turnaround that I just mentioned.
Trevor Cranston
Okay, got it. And then in the post quarter update, you mentioned the $476 million of loans. I think you call that they were going to be placed into a long term non-mark-to-market structure. Can you explain exactly what that is? And why you are used to utilizing that person’s securitization?
Mohit Marria
Sure, so as you just touched upon and I have just mentioned to the prior question, given the challenges within the new issued market currently, like we acquire these loans, where we have also locked in a five-year tenure financing arrangement, which will be on a non-mark-to-market basis, achieving a similar advanced rate that you would get via securitization. So we thought this was a better outcome to produce better returns for the company.
Trevor Cranston
Okay. And our structures like that something that you think could be, more available in the near term, new issue market doesn’t necessarily look as attractive?
Mohit Marria
Yes, I mean, I think, again, given the challenges, the new issue market is facing these structures could become more commonplace. And if — and when the market returns on the securitization front, we will sort of balance that out on a go forward basis.
Trevor Cranston
Okay, got it. And last thing. Can you provide an update on book value quarter today?
Mohit Marria
Sure. I mean, again, we’ve had this question the last two quarters. And each time we’ve sort of presented it, it’s been various vastly different by like five quarters ended. Since the end of the quarter, rates have moved about 30 basis points parallel across the curve. Spreads are marginally wider. I would suspect book value to be down between 2% to 3% since quarter end.
Trevor Cranston
Okay. Thank you.
Operator
[Operator Instructions] And our next question comes from Bose George from KBW. Go ahead.
Mike Smyth
Hey, guys, it’s actually Mike Smith on for Bose. My first question is, can you provide an update on your asset acquisition pipeline and kind of the overall level of competition in the space? Wondering if any of your loan origination partners have stepped away kind of given the uptick in volatility?
And then as a follow up, can you just remind us how many loan origination partners you have? And then, if any are shutting doors for or facing solvency issues, just kind of given the moving rates? Thank you.
Mohit Marria
Sure, Mike. As far as sourcing assets, it’s not a problem. I think, as we’ve sort of highlighted, we’ve been defensive, trying to maintain low leverage while adding accretive assets. Since the start of the year, we required $1.6 billion of loans, and obviously, we’ve also done five securitizations to fund a lot of those transactions.
We are going to bid loans to where the securitization exit is, and or where we can find other long term sources of financing for those loans.
We don’t have a full agreement with anybody we buy, to what makes the most economic sense from an ROE perspective for the company. So again, we have no commitment with any particular originators in terms of sourcing on a flow basis, any assets. We have, everybody at our beck and call to sort of pick and choose the collateral that we like. So hopefully that answers your question.
Mike Smyth
Yes, that’s helpful. Thank you. And then maybe just one more. Can you talk a little bit about where levered ROEs are on new investments? And then kind of, how you’re thinking about the balancing act between going on offense buying back stock and maintaining a strong liquidity position?
Mohit Marria
Sure, so let me start with the ROE question. And as we mentioned, on the loans that are looking to settle here in Q4, the $476 million, we mentioned double digit returns on that investment. I think the vast majority of the mortgage ecosystem can produce pretty attractive, levered returns. But given the backdrop of higher rates, still, beating inflation, and Fed being active, we’re going maintain a pretty disciplined approach to deploying capital. I think maintaining liquidity is the biggest focus here. As we have done throughout the year, we started the year with 1.0 turns of recourse leverage. We’re at 1.1 now, and rates have moved to the tune of 300 to 400 basis points across the curve.
But at the same time, we want to be justice in deploying accretive capital, given how attractive some investments look. But on the aggregate, leverage returns should be in the mid-teens, at least for us to sort of deploy capital. And we see plenty of opportunities there as it stands now.
Mike Smyth
Great, thanks a lot for taking the questions.
Operator
And there appear to be no further questions. At this time. I would now like to turn it over to management for any closing remarks.
Mohit Marria
Thank you, operator. And thank you everyone for joining us on our call today. We look forward to speaking to you next year.
Operator
Thank you, this does conclude today’s conference. We thank you for your participation. You may disconnect your lines at this time and have a wonderful day.
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