Cherry Hill Mortgage Investment Corporation (CHMI) Q1 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the Cherry Hill Mortgage First Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] I'd now like to turn the conference over to your host, Michael Hutchby, Controller for Cherry Hill Mortgage. Please go ahead, sir.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's first quarter 2015 conference call. In addition to this call, we have filed a press release that was distributed today and posted to the Investor Relations section of our website at www.chmireit.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ from those discussed today. Examples of forward-looking statements include those related to interest income, financial guidance, IRRs, future expected cash flows as well as prepayment and recapture rates, delinquencies, and non-GAAP financial measures such as core income. Forward-looking statements represent management's current estimates, and Cherry Hill assumes no obligation to update any forward-looking statements in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the company's filings with the SEC and the definitions contained in the financial presentations available on the company's website. Today's conference call is hosted by Jay Lown, President and Chief Investment Officer. Also present on the call today are, Marty Levine, the Chief Financial Officer; and Julian Evans, our Senior Portfolio Manager. And now, I will turn the call over to Jay.

Thanks, Mike, and thank you, everyone, for joining us today on our earnings conference call for the first quarter of 2015. As part of today's call, we've posted on our website presentation that we'll touch upon throughout the call, and we'll reference specific slides where appropriate. After our prepared remarks, we will open up the call for questions. The first quarter of 2015 would characterize by one of the more extreme interest rate environment we’ve experienced in awhile. The downward trend in interest rates prevailed as the U.S. 10-year treasury hit in inter quarter low of 1.64%. We had closed the quarter at 1.92%, down 25 basis points from Q4 2014. Adding to the quarterly volatility mortgage is struggled to key pace with treasuries throughout the quarter. As shown on Slide 5, RMBS prepayment fees increased quarter-over-quarter with a persistent decline in interest rates. Accordingly as we noted on the last call, a primary focus for our team has been and continuous to be minimizing the run off of our portfolio of Excess MSR. In our prepay speeds net of recapture demonstrate this effort. We remained focused on mortgage servicing rights as our primary investment strategy. As we believe this asset class offers attractive returns over the long-term, especially in arriving interest rate environment. We look forward beginning the ability to purchase full MSR’s in the coming months, which should broaden our investment options. Turning to our quarterly results as shown on Slide 6, our first quarter 2015 results were in large part inline with fourth quarter 2014 performance. A noteworthy addition to the performance data we report is the calculation of core earnings. We generated core earnings of $0.55 per share and dividend eligible earnings of $0.52 per share. We declared and subsequently distributed a $0.51 to our shareholders. Net interest spread for the RMBS portfolio for the quarter was 1.70% a slight increase from 1.67% in the previous quarter. Prepay speeds for the RMBS portfolio averaging approximately 5.4% for the quarter. Our RMBS portfolio once again, exhibited favorable prepayment characteristics versus generic and TBA cohort, which Julian will discuss in more detail shortly. Book value per share, as of March 31, 2015 is $20.78. The change from the prior quarter was primarily result of a reduction in the value of our investment and Excess MSR. Our aggregate leverage ratio at quarter end was approximately 2.4 times, up from approximately 2.3 times at the end of the fourth quarter, driven primarily by our reinvestment of principal and agency RMBS. In terms of our overall long-term strategy, in April we were pleased to enter into a loan agreement with NexBank, whereby Cherry Hill may borrow up to $25 million for general corporate purposes, including purchasing Excess MSR and whole MSR. We’re now very queue at any facilities exit for financing Excess MSR. We remain on track to close on our previously announced acquisition of Aurora Financial Group by the end of the second quarter, which will enable us to embark on a strategy of purchasing whole MSR. Turning to our investment portfolio, Slide 7 highlights our aggregate portfolio composition. At quarter-end, our Excess MSR investment represented approximately 56% of our equity capital and approximately 16% of our investable assets excluding cash. Our RMBS portfolio comprised approximately 38% of our equity and approximately 84% of our investable asset. At the aggregate portfolio level, given the sustained low interest rate environment, our duration gap remain negative during the quarter. And at quarter-end our duration gap was approximately negative 1.5 year. Our recapture effort continue to significantly reduced the volatility in this asset, and our net prepay speeds for the quarter reflect this as well. As shown on Slide 8 and 9, the Excess MSR portfolio performed well during the quarter given the ongoing downward trend in the interest rate. Current carrying value of the Excess MSR portfolio stood at approximately $85 million at quarter-end. Our recapture agreement resulted in approximately $1.1 billion of loans being recaptured during the quarter. And we continue to set new high for our recapture rate with Pool 2 posting at 77% recapture rate. Pool 1 also posted a new high with the 45% recapture rate. The FHA mortgage insurance premium reductions implemented in January had a finance impact on projected prepayment speeds to Pool 1. Overall we believe we’ve done an excellent job protecting our book value in this volatile environment and we’re looking forward to expanding our opportunities in the residential mortgage market in the coming months. I’ll now turn the presentation over to Julian who will provide some detailed information on the agency RMBS portfolio and its performance over the quarter.

Thank you, Jay. As of March 31, the RMBS portfolio stood at approximately $430 million, as shown on Slide 10, up from approximately $416 million at the end of the fourth quarter. At quarter-end, our RMBS portfolios leverage stood at 6.22 times with 55% of the portfolios composition represented by 30-year fixed rate whole-pools and 45% of the portfolio comprised with 20-year and 15-year fixed rate whole pools, as well as shorter duration asset. As shown on Slide 11, the RMBS portfolios collateral composition was primarily comprised of loan balance collateral at quarter-end. As Jay noted during the first quarter, the portfolio continue to exhibit same book prepayment speeds despite lower interest rates and mortgage rates. The portfolio posted a weighted average three months CPR of approximately 5.4% and weighted average six months CPR of approximately 6.1%. Over the past year, our portfolios prepayment speeds have out performed to manage the aggregate prepayment speeds. In the future, we may see prepayment speeds drive given the portfolio collateral composition an originated time of loan. Throughout the quarter, the treasury curve continue to rally as weakening global growth and across sense of deflation increased investor concern. To minimize the effect of the continuous fall in rate, we adjusted the portfolios assets as well as liabilities. Despite the RMBS portfolio changes the aggregate portfolio continues to be managed conservatively. During the quarter, the aggregate portfolio operated with a moderate leverage of 2.39 times and a negative duration gap. As shown on Slide 12, we ended the quarter with an aggregate portfolio duration gap of a minus 1.48 years. Following a 200 basis point instantaneous move according to our model, our aggregate duration gap would move from a minus 1.48 years to a positive 0.25 years. The portfolios gap is driven by the composition of the RMBS portfolio, associated hedges, and the fact that 56% of the portfolios equity was composed of Excess MSRs during the first quarter 2015. I will now turn the call over to Marty Levine, who will review our first quarter financial results in more detail. Marty?

Thank you, Julian. Net interest income was approximately $5.2 million for the first quarter of 2015. However, our Excess MSRs, RMBS and derivatives produced a combined net decreased in asset value of approximately $3.7 million for the quarter. Our GAAP net loss for the first quarter was $2.4 million or $0.32 per share. Our core earnings as detailed on Slide 23 was $3.8 million or $0.50 per share, while our dividend eligible income was $0.52 per share. For the first quarter, our comprehensive income, which includes the mark-to-market of our held-for-sale RMBS was approximately $50,000. As detailed in Slide 26, we used a variety of derivative instruments to mitigate the effect of increases in interest rates on a portion of our future repurchase borrowings. At the end of the first quarter, we held interest rate swaps and swaptions with the combined notional amount of $342 million. For GAAP purposes, we have not elected to apply hedge accounting for our interest rate derivatives. And as a result, we record the change in estimated fair value as a component of the net gain or loss on interest rate derivatives. Operating expenses were approximately $1.4 million for the quarter, of which approximately $90,000 was related to our licensing efforts and other infrastructure cost, relating to CHMI Solutions, our taxable REIT subsidiary. For the quarter, our total operating expense ratio as a percentage of various equity was $3.5 million. On March 5, 2015, we declared a dividend of $0.51 per share for the first quarter, which was paid on April 28. Our goal remains to distribute regular, quarterly dividends of all or substantially all of our taxable income to holders of our common stock and to the extent authorized by our Board of Directors. Now, I would like to turn the call back to Jay for closing remarks.

Thanks, Marty. Our primary goal at Cherry Hill has been and continues to be aimed at delivering consistent attractive returns for shareholders. While the interest rate environment has been difficult with the past few months, we believe we’ve done a good job expecting our book value and are well position within pending Aurora acquisition and the NexBank loan to grow and diversify our business over multiple economic and interest rate environment. We'll now open up the call up for questions. Operator?

At this time, we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jeremy Campbell from Barclays.

Hey, thanks guys. Can you just talk a little bit about book value quarter and dates, have you guys were traced the decline given the rates are so far in the quarter?

Jeremy, I’m not sure, I could answer that question, but we are clearly in a slightly different industry environment I think that what we could tell you the changes within the MSR market related more through one time regulatory of asset happened in January around easing the MIP premium associated with FHA loan. And we think we have that narrow down. But I think we were pretty clear in the presentation, while the interest rate environment definitely on downward trend much of the changing book value that you saw that is also an expected increase in prepay activity around the FHA loans which comprised about 40% of Pool 1 and 25% of the aggregate if you recall Pool 2 is specifically VA. We see a more is kind of one off, if you remember over the last 15 months as of 10 years, we are chase down over a 100 basis points virtually has delinquent on the book value given the lot of the recapture efforts that you see. So this is somewhat of a regulatory events that, we’re trying to capture and we think we had factored in.

Got it. Then we feel some other mortgages out there that were granted FHLBA membership this past quarter, can you guys commented on where you guys maybe in the process or in the queue.

Sure, we feel good about that process. It has been less than 90 days officially with them. We’re in constant dialog with them on our application and we had no reason to believe that there is anything that would prohibited, but we’re in that queue and we feel as though that is moving along as fine.

And then assuming your service licenses comes through late in the quarter, can you remind us are you looking the source for MSRs outside of the treating complex or just to work nearly exclusively with them.

I think one of the great things about having licenses with the ability to take advantage of buying MSRs in within the total market. So while we would love to have a relationship with Freedom on that front we thing that the overall market around that asset class is the most compelling thing and we’re looking forward being able to transact with multiple counterparties, not just Freedom.

And then finally, what kind of returns are you guys seeing both levered and unlevered in the kind of whole market or the whole MSR market opportunities these days?

So in the confirming stage, I’ll let Jay answer that, but we will probably on the conforming side and on the Ginnie side.

Sure, so in the confirming space, we’re really looking at mid-high single digit unlevered basis and Ginnie Mae would be a little bit higher we’re talking low double-digit they will call 10 to 12. But Ginnie had some additional concerns around there. So we’re probably looked to supply mostly in the GSE space.

Got it. Thanks a lot guys.

Thank you. Our next question comes from Steve DeLaney from JMP Securities.

Hey, good evening, everyone, and thanks very much for the new core EPS metrics we’re adding simplify things dramatically for all of us. I want to be just suggest on the Excess MSRs, but Jay taking your comments about the regulatory change, we noted that the fair value mark overall on all the Excess MSRs was about $2.8 million would it be reasonable for us to assume based on your comments that the majority of that mark was it associated with Pool 1.

Yes, actually in the queue that will comment later you will see that Pool 1 actually was the majority of that, it was around $3 million there was a small around offset which got just $2.7.

Got it.

So it was all on Pool 1 has the FHA majority.

Got it. Okay, that’s helpful, thank you very much. And look talking about you’re the loan agreement by NexBank, we found at the Dallas, Texas Bank about $2 billion just curious I mean that’s a fairly asset credit loan, is there a relationship there between Freedom and NexBank that led to that?

It’s a combination of that as well as a former FBR banker that we had relationship with we’ve been trying to think about along within the context of Excess MSRs but quite a long time so. But we left FBR once NexBank and given the relationship that Freedom have with NexBank and they are comfort with resourcing asset, its came in natural fit and its something that we’re really excited pretty well at MSR.

So congratulation on the small world and relationship makes things big things happen. You suggested that the – I’m sorry.

No.

You suggested in the press release Jay that the $25 million loan was back by the Excess MSRs I’m just curious are the entire $87 million of Ex-MSRs split on the $25 million, or is there…

Its in the general but there is not pledges its like Excess MSRs at all with this line.

They are not, okay. So and then my follow-up would be the $325 million in your mind represents is the maximum leverage that you would speak to obtain against the current Excess MSR book.

We only have some negative components around the Excess MSR, so theoretically we could get more than the $25 million, everything is fine – and we will do it also.

Interesting, okay, thanks for the comments guys.

Thank you. Our next question comes from Michael Kaye from Citigroup.

Hi, with a start still trading in a well below book value, could you just give some updating capital rising thoughts here, I mean does that still only loan agreement give you in that by our power for now?

Hey Mike, how are you? I would tell you that the first quarter was fairly interesting quarter respect to just managing the portfolio and the stock has not hit a level that we would like it to be at today. But I think we posted this quarter we’ve been less focused on that actual aspect of rising capital as we navigated the first quarter and more about finishing some of the things we’ve been talking to how you post about over the last year, now the similar things we’re in place we’re hopeful that we get an opportunity to execute on the strategy and hopefully, the market thinks that the positive events. And we’ll be able to think about the rising capital at some point in time.

Could you want to comment on your comfort on the sustainability at that $0.51 dividend as you got that pretty high Pool 2 IRR it’s about 19% running of?

Yes, Pool 2 has been performing terrifically, if that is Q1 hybrid RMBS portfolio and Freedoms in extremely successful moving a lot of those loans in to 30-year fixed rate loan. And that portfolio was really securing its job we – with respect to the its dividend its hard for me to comment going forward with respect to the first quarter, we were confident that we were able to pay $0.51 dividend eligible was actually slightly north of that so we feel pretty good about that. You obviously nowhere rates are today I think our average borrowings cost for the quarter was somewhere around 39 basis points, which was not very high and so, we have not done anything substantially different so far this quarter. So I would tell you that we feel good about the business today, but its pretty hard to comment about with respect to sustainable that is going forward.

Great. And then last question, just comment on any thoughts about potentially moving to monthly dividend.

We’ve recognized something perhaps, we had conversations about internally. We know some investors are interested in it, some of which were thought, we continue to give some thoughts, we’ve actually socialized it with the board, so we have not made any decisions yet with respect to moving down that road. If you do it will be one of the first we looking that.

All right, great. Thank you.

Thank you. [Operator Instructions] We appear that no further questions. I will turn the call back over to our speakers for closing comments.

Perfect, thanks, thank you. Thank you for joining us on the first quarter 2015 Investor Call. We look forward to having additional conversations and have a great day.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.