Daniel Thakkar; Co-Chief Investment Officer; Chimera Investment Corp
Trevor Cranston; Analyst; JMP Securities LLC
Doug Harter; Analyst; UBS
Francesco Labetti; Analyst; KBW
Jake Katsikis; Analyst; BTIG
Presentation
Operator
Greetings, and welcome to the Chimera Investment Corporation third-quarter earnings call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce Victor Falvo, Head of Capital Markets. Thank you. You may begin.
Victor Falvo
Thank you, operator. And thank you, everyone, for participating in Chimera's third 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 for 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, Phillip Kardis.
Phillip Kardis
Thanks, Vic. Good morning, and welcome to the Chimera Investment Corporation's third-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 about the quarter, I will briefly discuss our recent acquisition announcement, and then turn -- and then Subra will review the financial results before opening the call for questions. After a prolonged period of rising rates and higher for longer, inflation abated to a point where the Federal Reserve is more concerned about a softening labor market. In September, the Fed cut the funds rate by 50 basis points, and provided guidance for another 50 basis point reduction by year end. The market reacted by pricing in a more rapid interest rate decrease than projected by the Fed. The yields on US treasury notes ended the quarter materially lower, with the yield difference showing a positive slope from the two years out to the 10 years for the first time since the middle of 2022. We believe achieving a lower short-term funding cost and a steeper yield curve environment will be beneficial for our future operating performance. Since the beginning of the fourth quarter, treasury yields have risen with the change in market sentiment mostly due to a stronger economic data and concerns over trade and the federal deficit. As the market has adjusted, we expect one more and maybe a second rate cut this year, but expect further Fed cuts to be in a smaller 25-basis-point increments. Housing fundamentals remain strong for residential mortgage credit. Home prices are higher by approximately 5% on a year-over-year basis, and delinquencies and default rates remain low. While existing home inventories have increased recently and are at their highest level in the past four years, they are in line with pre-pandemic levels. On a more macro level, the housing supply shortage should continue to support home prices, albeit at a slower pace moving forward. Investor demand for mortgage credit securities remains strong. Non-agency RMBS issuances for 2024 may reach $100 billion, which would be approximately 40% greater than in 2023. While credit spreads in the residential market have tightened significantly since the beginning of the year, they continue to remain attractive relative to the investment-grade and high-yield corporate bond markets. We believe market conditions align well with our residential credit strategy. In July, we sponsored CIM 2024-R1, a $468 million securitization of seasoned RPLs. We sold securities in a private placement with an aggregate balance of approximately $352 million or 75% of the capital structure. We retained approximately $116 million investment in subordinate bonds in certain IO securities. Our weighted average cost of the debt sold was 5.7%. In August, we issued $75 million of 9.25% unsecured notes due August 15, 2029, which are callable beginning in August of 2026. This was our second unsecured bond offer for the year, resulting in a combined total issuance of $140 million. While we continue to favor repurchase agreements and securitized debt as lower-cost source of financing for our loans, the ability to issue unsecured debt helps us to further diversify our capital structure and invest in new and accretive assets. Upon the issuance, we produced and settled on 430 -- excuse me, $543 million agency CMOs. We expect that the levered return on this investment will be accretive to earnings and more than exceed our cost of the debt. These investments provide attractive returns and a source of capital as we seek to make future investments in residential loans and credit securities. Over the course of the quarter, we purchased and settled on approximately $47 million of non-agency subordinate bonds from newly issued mortgage securitizations, backed by collateral that included RPLs and small balance commercial properties. We purchased these investments at a discount to their par values and expect to achieve mid-teen returns. This quarter, we also committed to purchase $118 million of residential transition loans, and we expect to close these loans during the fourth quarter. These loans have characteristics like residential transition loans we have purchased in the past. We will use leverage through our warehouse facilities for these loans and expect to achieve levered return in the mid to high teens. As we announced a couple of weeks ago, we signed a definitive agreement to acquire the Palisades Group, which is an alternative asset manager and residential mortgage credit based in Austin, Texas. Palisades provides asset management and servicer and vendor oversight services to third parties, as well as manages third-party funds and residential credit space. Like the team here at Chimera, the Palisades Group has a successful history of analyzing and investing in residential mortgage credit. We were particularly impressed by their ability to perform deep asset-level analysis, review borrower credits, and perform high-quality data validation and monitoring of loans. These capabilities overlap quite well and complement Chimera's existing business. Also, Palisades brings to us a proven suite of proprietary technologies, and when combined with our own in-house capabilities, will improve upon our strengths in both portfolio and credit risk management. Palisades acquisition is complementary and enables us to provide a new fee-based asset management service for third parties that would like to invest in residential mortgage credit. When completed, on a combined basis, Chimera and Palisades will have over $30 billion of notional value in loans and real estate owned, advised or managed. This benefits Chimera as it will increase the depth and breadth of our residential credit expertise, while adding strong partnerships with already established investment management and insurance companies. We're excited about this transaction and expect it to close in the fourth quarter. We believe we'll achieve accretive benefits from this acquisition in 2025. Finally, upon closing, Jack Macdowell, the Co-Founder and Chief Investment Officer of Palisades, will become Chimera's new Chief Investment Officer. So what does this mean for Chimera's shareholders? We feel good about our business. We're finding new opportunities, and we've increased the quarterly dividend by 12% over the past two quarters. And as we approach the end of 2024, the Federal Reserve has lowered short-term interest rates by 50 basis points, and as indicated, lower short-term rates may be on the horizon. Residential credit markets are robust, which aligns with our business strategy. We have established a new source of unsecured funding through the capital markets. And we believe the acquisition of Palisades will further strengthen and expand our existing business and provide additional opportunities for growth. Over the balance of the year, we'll work diligently to close this acquisition. The team at Chimera has a long and successful history of buying and securitizing residential credit assets. And with the acquisition of Palisades, we will increase and broaden our existing capabilities and add a new fee-based, third-party investment management business. We're working hard for our shareholders, and we'll continue to seek ways to position the company to achieve the best possible results over the long term. I will now turn the call over to Subra to review our quarterly financial results.
Subramaniam Viswanathan
Thank you, Phil. I will review Chimera's financial highlights for the third quarter of 2024. GAAP net income for the third quarter was $113.7 million or $1.39 per share. GAAP book value at the end of the third quarter was $22.35 per share. For the third quarter, our economic return on GAAP book value was 6.8% based on the quarterly change in book value and the third quarter dividend per common share. And year-to-date 2024, our economic return on GAAP book value was 15.6%. On an earnings available for distribution basis, net income for the third quarter was $29.9 million or $0.36 per share. Our economic net interest income for the third quarter was $71.5 million. For the third quarter, the yield on average interest-earning assets was 6.1%, our average cost of funds was 4.5%, and our net interest spread was 1.6%. Total leverage for the third quarter was 3.9 to 1, while recourse leverage ended the quarter at 1.2 to 1. For financing and liquidity, the company ended the quarter with $648 million in total cash and unencumbered assets. For hedging, we had $2.5 billion floating rate exposure on our outstanding repo liabilities. We had $1.5 billion pay interest rate swaps at a weighted average fixed pay rate of 3.56% as a hedge position for our floating rate liabilities. The company also has a long position in $500 million one-year swaption on a one-year pay fixed interest rate swap with a blended rate of 3.45%. We had $1.4 billion in either non or limited mark-to-market features on our outstanding repo agreements representing 43% of our secured recourse funding. As Phil mentioned, we closed our CIM 2024-R1 securitization during the third quarter. As part of our strategy to mitigate securitization execution risk on certain securitizations, we closed out $307 million of short five-year treasury futures contract position to protect the net interest spread of CIM 2024-R1. For the third quarter of 2024, our economic net interest income return on equity was 10.6%. Our GAAP return on average equity was 20.3%. Our EAD return on average equity was 6.8%. Also for the third quarter, the company increased the common stock dividend to $0.37 per share, up from $0.35 in Q2 and $0.33 in Q1. And lastly, for the third quarter 2024 expenses, excluding servicing fees and transaction expenses were $12.8 million, down modestly from the second quarter. That concludes our remarks. We will now open the call for questions.
Hi, thanks. You talked a lot about some of the opportunities you guys are seeing on the loan side. One thing we've heard from some of the non-bank originators recently is a focus on trying to grow home equity lending. I was wondering if you could talk about kind of what you guys are seeing there and if you think that's a potential opportunity for Chimera to participate in in the future? Thanks.
Phillip Kardis
Listen, yes, we are looking at that space and, it actually is an area that Palisades has got some experience in. And it's an area that we are looking at, pretty closely. It just hasn't worked for us right now, but we've heard the same things and we're seeing things that are interesting. We just haven't found something yet to pull the trigger on.
Trevor Cranston
Okay, got it. And then in terms of the overall, interest rate exposure or net duration of the portfolio, could you say where that was at September 30? And also, maybe provide an update on book value given the move in rates in the fourth quarter so far? Thanks.
Phillip Kardis
So I'm going to -- on the book value, I'm going to turn that over here in just a second to Dan Thakkar. But on the other part, it's something that, we haven't traditionally made public. But let me let Vic address kind of where we think book value has gone since the end of the quarter -- I mean, excuse me, Dan --
Daniel Thakkar
Yes. So -- yes, so the sell-off in the rates market getting more pronounced the same as we all saw, like the intermediate treasuries that we raised all gains that they, gained in the quarter plus some. So I would say versus quarter end, we are flat this morning, Trevor.
Trevor Cranston
Okay, great. Thank you.
Operator
Thank you. Our next questions come from the line of Doug Harter with UBS. Please proceed with your questions.
Doug Harter
Thanks. Just to follow up on that. When you say you're flat from the end of the quarter, I guess what are you comparing that time frame to? Just to make sure we're on the same page.
Daniel Thakkar
So the book value as of end of 9/30 versus the move today. That's what we're looking at.
Doug Harter
Okay.
Daniel Thakkar
Yes.
Doug Harter
Great. And can you just talk about with the acquisition of Palisades, kind of how you think about kind of growth in, kind of like broadly defined AUM, how you would think about whether you want that to kind of be on balance sheet for Chimera versus kind of third-party funds and how you would look to balance that?
Phillip Kardis
Sure. So right before I answer, I just want to make sure to clarify. I think what we meant to say on the book value is we've given up, most or nearly all of the gains that we showed at the end of the third quarter prior -- relative to the end of the second quarter. So most of that increase --
Doug Harter
So that would be more flat with the second --
Phillip Kardis
That's correct.
Doug Harter
(multiple speakers) June?
Phillip Kardis
Yes.
Doug Harter
Okay, that makes sense. Thank you.
Phillip Kardis
Okay, yes. Okay, on Palisades, that is something, we are working through in terms of how we're going to think about third-party asset management in the fund business. We will develop a pretty detailed allocation policy that will be -- that will work well for Chimera's shareholders and any limited partners and any future funds that we create through that. That's kind of an early-stage business for them and we'll look to grow that, but we'll look to grow it in a way that's beneficial for all parties. And then, as I said, their third-party asset management is an interesting business and to the extent we'll look to grow that as well and they have, capabilities, both investment and collateral management that we'll find useful on our own portfolio.
Doug Harter
I appreciate that. And then just one more on interest rate exposure. How do you think about your kind of earnings EAD exposure to the short end? I know you updated your swap positions, but, just how to think about your -- kind of your net interest spread or earnings sensitivity to lower short-term rates or a steeper curve?
Subramaniam Viswanathan
Hi, Doug. This is Subra. Thanks for the question. We -- I mean, the way to think about it is EAD will react both positively and significantly. So if you think about our floating rate liabilities at the end of the quarter, that was about $2.5 billion. So that will continue to see some benefit, right? Now hedging those floating rate liabilities, we have $1.5 billion of swaps. And we have those at a rate of 3.56%. So some of the ops -- the benefits we receive from the floating rate liabilities going down will be offset by these swaps losing some of that benefit. However, as the rates go below 3.56%, we will continue to see benefit. Now also, I will remind you that the swaps, most of them mature by the end of the second quarter of 2025. So we'll have to readjust and evaluate our hedging strategy there. Outside of that, we have about $525 million of preferred dividend -- preferred dividends, which are again floating rate. And so those, we'll continue to see benefit right away because of the floating rate changes. Okay. And then, separately, we obviously have some longer dated limited mark-to-market liability -- sorry, non-mark-to-market or limited mark-to-market facilities that would be maturing early in 2025, about $115 million. So as those get restructured, we will see some benefit there. And then obviously, as paydowns happen and we reinvest, we should hopefully be able to reinvest the paydowns in higher-yielding assets. So that's kind of like the summary of how to think about the interest rate sensitivity and how it will affect EAD.
Doug Harter
I appreciate that, Subra. Very helpful.
Operator
(Operator Instructions) Bose George, KBW.
Francesco Labetti
Hi, good morning. This is Frankie Labetti on for Bose. I just wanted to touch on the fact that your EAD seems to be run-rating around the $0.36 to $0.37 range. Can you just discuss some of the drivers that can get you from here to a double-digit net ROE after expenses, please?
Subramaniam Viswanathan
I mean, I just explained some of the, EAD growth that we could expect. But the -- as the rates go down, obviously, we will continue to go up. But I would say -- I mean, in my prepared remarks, I did say that the return on our economic net interest, net interest income return on EAD is about 10.6%. So we are, on an economic, perspective, getting the 10.6%. And as rates continue to go down and our interest expense go down, we will see some additional benefits. The one other thing that I will say is there are some investments that still don't go through EAD like our investment in a -- LP investment in an RIA. But some of those, we will get it. But even though it doesn't go through EAD, it's really from an economic net interest income perspective, we are seeing growth and we will continue to see growth.
Francesco Labetti
Thank you. And then just a follow-up. Given like the current environment, where do you see the best opportunities for investing incremental capital going forward? Thanks.
Daniel Thakkar
Yes. So, we did the RPL deal, right? So just like the deal, we expect to make, low to double-digit returns in there. And in addition, like Phil also talked about in his prepared remarks that we found attractive pockets of relative value on non-agency subs and deployed capital there. So those are the things that we are targeting in addition to RTLs. That's where we deployed or committed to buy approximately $118 million. That's going to get mid to high double-digit returns. So those are the areas that we are focusing on, in addition to looking at every sector which, kind of meets our return bogeys in non-QM as well as, home equity stuff that we just mentioned.
Francesco Labetti
Thank you.
Operator
Eric Hagen, BTIG.
Jake Katsikis
Hi, good morning. This is Jake Katsikis on for Eric. Thanks for taking my question. Just wondering if you could walk through the opportunity you have to potentially raise the dividend further or more quickly if you're able to resecuritize the callable debt. Thank you.
Phillip Kardis
Okay, so I'll start with that. So just like as when we raised capital and we're able to invest it accretively, I think that adds to the earnings power of the portfolio. We've held off on the relevering of some of the existing deals, in part because we could raise capital with a lower hurdle than we could in terms of collapsing those deals at the time. But they've now paid down further and rates have come down. So we are looking, more aggressively and given where the securitization market is to begin to look for opportunities to relever and pull cash out. And we think there's opportunities to reinvest that money accretively, which will be a driver to enhance the returns on the portfolio.
Jake Katsikis
Great. Appreciate that color. Thank you.
Operator
Thank you. There are no further questions at this time. I'd now like to hand the call back over to Phil Kardis for any closing comments.
Phillip Kardis
Thank you, everyone, for participating in our third-quarter earnings call, and we look forward to speaking to you next year when we give our fourth quarter and fiscal year 2024 report. Thank you very much.
Operator
Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.