Chimera Investment Corporation
Q1 2008 Earnings Call Transcript

Published: 4 Jun 2008

[Operator:]

Good morning and welcome ladies and gentlemen to the first quarter earnings call for Chimera Investment Corporation. (Operator instructions) This earnings call may contain certain forward-looking statements within the meaning of the Section 27A and the Securities Act of 1933 and in Section 21E of the Securities & Exchange Act of 1934. Forward-looking statements are based on various assumptions, some of which are beyond our control, may be identified by reference to a future period or by the use of forward-looking statements terminology, such as

[Matthew Lambiase:]

Good morning and welcome to the first quarter earnings call for Chimera Investment Corporation. I’m Matt Lambiase the CEO and President of Chimera and joining me on the call today are members of our senior management team, our CFO Alex Denahan, our Head of Investments Chris Woschenko, our Head of Underwriting Bill Dyer and also joining me today are Wellington Denahan-Norris, the Chief Investment Officer for FIDAC, J. Diamond a Managing Director at FIDAC and a Director of Chimera. We’ll all here to review the results of the first quarter and answer any questions that you may have. I’d like to make a few general comments and then have Alex review the quarter. As you all know, Chimera is in the business to evaluate and manage credit risk in the residential mortgage market. As a long term business model it’s tried and true. At the time of our IPO in November 2007, there were dislocations in the market resulting in investment opportunities not seen in over a decade. We made progress toward achieving our ramp up in return objectives in the first full quarter of operation and the dividend we declared reflects that progress. We followed our plan to acquire attractively priced and stable cash flows on triple-A non-agency RMBS and recently originated, well-underwritten loans acquired from bank channels and other high quality lenders. We put hedges in place to minimize interest rate risk and operating income was strong during the quarter. As we all know now, market conditions in the first quarter of 2008 only got more volatile. We saw a flurry of liquidations from CDOs and SIVs to start the year and that kept pressure on credit spreads. Investors stayed on the sidelines and waited for more supply to hit the street as well as expected downgrades from the rating agencies. Dealer inventories are quite heavy and they begin to sell paper rather than provide much needed liquidity to the sector. The non-agency cost basis relative to agency collateral continued to deteriorate and traded at historically wide levels during the quarter. The opportunities we discussed in our road show and the subsequent discussions with investors and analysts have only increased and the manner in which we realize these opportunities will naturally adjust to the new operating environment. While our relatively recent entry to the market has been fortunate, nevertheless, the market value of our assets has declined. But while we may have been early on price, we were not early on the credit work on our assets. In any event, no participant was immune from the market conditions in the first quarter. We took a number of steps to protect investor’s capital from a rationalize risk assessment. Although we are running leverage on a relatively low level, no higher than 4

[Alex Denahan:]

Thank you Matt. Chimera reported core earnings for the quarter ended March 31, 2008 of $10.1 million or $0.27 per average share available to common shareholders. Core earnings is a close approximation for taxable earnings out of which we pay our dividend. We declared a dividend for the period of $0.26 per share producing an annualized dividend yield of 8.46% based on the March 31 closing price of $12.30. Our book value at March 31 was $11.11. As opposed to core earnings, we reported a GAAP loss for the quarter of $54.9 million or $1.46 per share comprised of an unrealized loss of $31.5 million on $1.6 billion notional of interest rate swaps and $32.8 million realized loss on $394.2 million of investments tolled. At March 31, Chimera was levered 3.4

[Operator:]

(Operator instructions) Your first question comes from Steve Delaney – JMP Securities.

[Steve Delaney:]

I noticed when you gave your spot spread at the end of the quarter that your weighted average cost of repo borrowings at the end of the quarter was actually about 40 basis points above the average for the quarter. So I was just curious, as part of the chaos in the month of March, that would imply that maybe the lenders raised their pricing relative to LIBOR in the second half of March. Was that the case?

[Alex Denahan:]

It’s largely related to the swaps. Swaps are as you know, the floating leg is tied to LIBOR. And although our rate of repo financing has come down as you would expect during the quarter and would expect in relation to the Fed activity, the swaps are adjusting to LIBOR. And so that has not leveled out as yet and this is a snapshot at the quarter end. So I would expect movement in that number as rates move around.

[Steve Delaney:]

In terms of the repo financing on the triple-As, I mean are you finding that that financing is available in the repo market on sort of an ad hoc basis outside of your two established lines of credit or are you pretty much just using the two lenders that you’ve disclosed for your triple-A repo?

[Matthew Lambiase:]

Well actually the two warehouse binds that we disclosed are for the purchase of [Polum]. We have several repo agreements on it. We have 12 repo agreements for securities and we’re using about half of them.

[Steve Delaney:]

Your securitization that you were able to do in April, is that a new shelf that Chimera created or did you borrow a shelf for that transaction?

[Matthew Lambiase:]

We borrowed Deutsche’s A shelf and [BHHMC’s] ticker.

[Steve Delaney:]

And that was a public deal so we’ll be able to get the terms on that?

[Matthew Lambiase:]

Yes.

[Operator:]

Your next question comes from Bose George – KBW.

[Bose George:]

I had a question on the assets you guys sold in the quarter, the $394 million. Your leverage seemed very low throughout the quarter, so just wondering what caused you to sell those assets.

[Matthew Lambiase:]

I think the turmoil that was happening in the credit markets was pretty severe in March, especially after March 17. You know Bear Stearns looked like it was going down the second week in March and certainly March 17 you saw Lehman Brothers, looked like Lehman and Merrill Lynch, both their stocks took a huge hit in the marketplace and I think there was widespread panic in the lending market. We thought it was the prudent thing to do is to take down some leverage and to prepare ourselves for what we expected to be higher margin requirements going forward. And I think you saw a lot of people during the period, at least the prudent managers do the same thing.

[Bose George:]

On the subject of leverage, the leverage guidelines you guys gave in November, given what’s happened in the market, do you think those need to be revised? How do you view the whole issue of leverage?

[Matthew Lambiase:]

I think we told people 8

[Operator:]

Your next question comes from Peter Homans – Parkmans.

[Peter Homans:]

Do you have any anecdotal or personal commentary on the announcement by Fannie this morning on a $6 billion financing and the articles which suggest that they may need to do additional financing. What is your feeling on the opinions in those articles? And then secondly from a factual standpoint, so far you’ve invested all in non-agency triple-As, have you or will you begin to do anything in the alt-A or subprime market?

[J. Diamond:]

The Fannie Mae news wasn’t actually all that new, I think the market pretty much expected that there would be some mark to market losses and some higher provisioning. If anything, though, I think several positives came out of the release this morning. Number one, that they are going to take steps to bolster their capital position. Again I would rather be a long the guarantee and a creditor of Fannie Mae than a shareholder. But the fact that they are going to take steps by reducing their dividend and raising additional capital is positive. In addition, they are going to have their excess capital charge reduced as long as they raise this capital from 20% to 15%. And in the release it said if they continue to play nicely, they could have it reduced to a 10% surcharge which again just gives more buying power into the marketplace which should help to stabilize and improve market values for the types of assets that Chimera owns.

[Matthew Lambiase:]

I think there’s just an unbelievable opportunity right now in alt-A and jumbo prime and just along about every aspect of the mortgage market is completely re-priced, I think providing great opportunities to use a moderate amount of leverage or even in some cases no leverage at all. I would say the one caveat is that I don’t believe and I don’t think we’re going to make investments in the subprime assets along any kind of credit category. We’d still like to avoid those assets.

[Peter Homans:]

Everybody thinks about or asks the question of themselves and analysts and everybody else, sort of where are we if you consider the credit crisis to have been a storm, are we through the eye and into the trailing edge or are we, I think [Michael Ferrell] on the Annaly call said that it was his opinion that the credit crisis was quote, passed or something to that effect. And now we’re into the economic crisis, do you all share that?

[Matthew Lambiase:]

I think we’re starting to see the stabilization and the recovery of the non-agency mortgage market. I think it’s in its early stages. I think a lot of the recovery is starting to happen because of the actions by the Fed. They’ve pumped an awful lot of liquidity into the market and really been hands on in making sure that the market gets back on track to trade again. Since the quarter end, we’ve seen investor sentiment change I think pretty dramatically in almost all credit products. Investment grade corporate index, the commercial mortgage index and even the triple-A part of the ABX index have all had sizable increases since quarter end. You know I think the recapitalization of the banks and the broker dealers and their ability to hold onto assets in here is great. The technicals I think for bonds themselves look pretty good, especially in the mortgage market. You know we’re seeing a lot more trading in alt-A and prime assets in the marketplace. And if you think what’s happening is the bonds are shifting from weak hands to stronger players and that’s a very good technical for the market. And there’s absolutely no supply coming on to the market, there’s nothing new. And in the mortgage market, normal amortization and pay downs reduces the outstanding balance of the mortgage market every month. So all those things put together I think are adding to stability and I think people’s sentiment are definitely changing around. And again it goes back to the Fed, the Fed by expanding their lending operations has pretty much made it impossible to have another Bear Stearns type of failure happen in the marketplace and I think that’s probably the paramount reason why we’re coming back to normal.

[Operator:]

Your next question comes from Douglas Harter – Credit Suisse.

[Douglas Harter:]

I was wondering if you could talk about how much capital you freed up by doing this securitization relative to where it was funded on the repo lines.

[Alex Denahan:]

Typically we’re not going to address financial data that’s in the forward quarter. But the securitization went well and we’re happy that we were able to securitize that, we got into that market a little bit earlier than we were expecting. So we’re not really prepared to discuss the financial aspects of that until the next quarter ends.

[Matthew Lambiase:]

And I would say that the securitization went very well. You know part of the stabilization of the mortgage market, we saw an opportunity that there was no good collateral, recently originated collateral out in the marketplace and we were able to price our bonds, our term financing, I think at pretty attractive levels and really set the benchmark for new issues going forward.

[Douglas Harter:]

Is that a market that you think remains open and is something you’ll continue to use in the coming quarters?

[Matthew Lambiase:]

Absolutely, this is part of our business plan. It certainly helps our liquidity and it’s definitely part of our business model going forward. This was a [grant door] trust rather than a REMIC and it’s a financing on our balance sheet.

[Operator:]

Your next question comes from Stephen Laws – Deutsche Bank.

[Stephen Laws:]

As we think about the whole loans and what you’re looking to purchase in the jumbo and alt-A markets there, can you talk about any trends you’re seeing, any products you’re avoiding, any products you’re partial to at this point and then talk overall about pricing in the market and what you’re seeing there.

[Bill Dyer:]

What we’re seeing on recently originated prime is outstanding excellent quality. We’re seeing loan to values in the vicinity of the low 70% LTV, credit scores at the 760 level. And loans that I would deem as being pristine type quality. We are certainly concerned about certain geographic areas such as Las Vegas, Florida, California. We underwrite every appraisal on a loan amount of $1 million or more and we do an AVM in each one of the areas where we have a geographic concern. The quality has been excellent what we’ve seen.

[Matthew Lambiase:]

And I think from a loan underwriting, we still like the prime jumbo market, especially the recently originated paper, we think there’s a lot of value there. From a security point of view, I think we’re still kind of negative on things like option, pay option ARMs, I don’t think we’ll ever buy them no matter how much subordination is involved in that and we don’t like subprime assets. So the great thing about this market in the way its re-priced is that there’s a tremendous opportunity we believe in the higher quality paper right now.

[Stephen Laws:]

So it sounds like things have remained on track from your initial thoughts in November when you launched the deal?

[Matthew Lambiase:]

Yes.

[Stephen Laws:]

Can you just talk to the loan loss provision that you recorded. I know it was a small one in the partial quarter and another amount even with no non-performing loans, can you talk about your reserve policy, what rates you’re doing that at?

[Alex Denahan:]

Sure, the loan loss provision as you know is based on historical experience. And we have a limited historical experience so in order for me to calculate that provision I am using the experience ratings of the originators of the types of assets that we hold in our loan portfolio. And as you saw between the fourth quarter and the first quarter, it ticked up a bit and I have a full quarter’s provision now, my asset base on my loans has certainly increased as well. But it is historically based on originator experience. All of our loans in the portfolio are performing, they’re all accruing income, I don’t have any delinquencies greater than 60 days. So I’m not expecting any charge offs anytime in the near future on these loans.

[Stephen Laws:]

How should we think about the securitization changing the leverage target for the company as we move forward? I know when we initially kind of got to an 8 times blended leverage it was really kind of 10 times on the jumbo, 8 times on the alt-A and about 5 times on the triple-A non-agency RMBS. You know can you update that with kind of a target now that we’re utilizing securitization financing?

[Matthew Lambiase:]

I think we were always anticipating using securitization in our business model. I think the important thing to take away here is that we’re limiting our recourse lending. You know we’re terming out the structure. So I think I view it as a very big positive, especially in a volatile market that you’re able to term out your financing on your loan portfolio. And as regard to where our leverage is going to be going forward, like I explained to Bose, I think we just want to let some time pass and let the dust settle before we make any tweaks to our business model.

[Operator:]

Your final question Joe Plevelich – Schneider Capital Management.

[Joe Plevelich:]

I was wondering if you could talk about what net spread will look like in the second quarter in comparison to first quarter and what will happen to cost of funds and if you could give a current estimate for what book value is?

[Alex Denahan:]

We can’t give an estimate of what book value will be. Book value is a snapshot in time and I can only tell you what that is at 6/30 when I get there.

[Matthew Lambiase:]

Yes I would say there that the market has improved. We just want to be very careful, not telling people that the book value has changed and give guidance on that and then in a very volatile market, have things change. So I think being prudent, obviously the market has improved, we feel a lot better about prices and I think spreads remain wide and I think the operating environment is pretty positive going forward.

[Operator:]

This concludes our Q&A session.

[Matthew Lambiase:]

The first quarter of 2008 has been historic and we witnessed a liquidity crunch that took out Bear Stearns, I think one of the savviest players in the mortgage market and forced the Fed to take drastic action to restore order to the market. Taking actions we haven’t seen since the great depression. This dislocation has created I think a great opportunity. Chimera has persevered through this tough time and I believe we are now uniquely positioned to take advantage of the dislocation going forward. Thank you all for taking the time for this call and we look forward to speaking with you at the end of the second quarter.