Cherry Hill Mortgage Investment Corporation (CHMI) Q2 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the Cherry Hill Mortgage Second Quarter 2015 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. [Operator Instructions] It is now my pleasure to introduce your host, Mr. Michael Hutchby, Controller of Cherry Hill Mortgage. Thank you sir. You may begin.

We’d like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation’s second quarter 2015 conference call. In addition to this call, we have filed a press release that was distributed yesterday 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 comprehensive income and core earnings. 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, our 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 thanks everyone for joining us today on our second quarter 2015 earnings conference call. As part of today’s call, we’ve posted on our website a 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 second quarter was a noteworthy one for Cherry Hill on several fronts. First, I want to highlight the outstanding quality of the underlying assets we own. In a quarter where much of the industry saw their book value per share shrink, our book value per share increased quarter-over-quarter by 0.9% after giving effect to the payment of our dividend. The increase was almost entirely organic. Even without the assets we purchased in our acquisition of Aurora, we would have generated book value growth of 0.7%. This was the seventh consecutive quarter of stabilizing and preserving our book value and is a testament to the quality of the overall portfolio we have assembled since going public in late 2013. During the quarter, we took significant strides toward being able to execute on our long-term MSR strategy. In April, we obtained a $25 million loan facility that is secured by pledge of our existing portfolio of Excess MSRs. We drew down $7.5 million in May and we used the majority of the proceeds to help finance the acquisition of Aurora. The Aurora acquisition positions us to start purchasing full MSRs and we’re now actively evaluating and bidding on portfolios that meet our investment criteria. Also noteworthy, at the end of the quarter, our wholly owned captive subsidiary, CHMI Insurance Company, was admitted as a member of the Federal Home Loan Bank of Indianapolis. As a member of the Federal Home Loan Bank of Indi, we have access to a variety of additional financing options and services that will allow us to fund the acquisition of prime whole loans and RMBS. We’ve been clear since we first became a public company that we saw an attractive investment opportunity in MSRs, especially in a rising interest rate environment. As we have said consistently, our approach is based on a long-term investment strategy. We have also demonstrated that we are focused on investing in a prudent manner that emphasizes preservation of capital and quality of investments. We continue to hold fast to this approach. And we believe we have the foundation in place to pursue additional opportunities to generate sustainable, attractive and risk adjusted returns. Moving on, the second quarter was characterized by improved domestic economic data, ongoing uncertainty about the timing of a Fed rate hike and concerns about global growth and inflation. The U.S. 10-year treasury closed the quarter at 2.35%, up 43 basis points from the end of Q1 2015. Despite healthy upward moving rates in the second quarter, the interest rate rally in the first quarter resulted in elevated prepayment fees; they carried into Q2 as loans were fair way to origination pipelines. In addition the absolute level of the interest rate sale off in the second quarter was not enough to shutdown the origination refinance engine. Turning to our quarterly results. As shown on slide five, our second quarter earnings were down slightly from the first quarter 2015 earnings. While it was a difficult decision, we reduced our quarterly dividend in June by $0.02. Our goal was to set a dividend that we believe will be sustainable in light of the composition of our current portfolio and previously discussed strategic plans. For the quarter, we generated core earnings $0.48 a share and dividend eligible earnings of $0.49 per share. We declared subsequently distributed $0.49 per share dividend to our shareholders. Net interest spread for the RMBS portfolio for the quarter was 1.46% and prepaid fees averaged approximately 8.2% CPR. Book value per share as of June 30, 2015 was $20.96, again a 0.9% increase from the prior quarter. Our aggregate leverage ratio at quarter-end was approximately 2.5 times. Slide six highlights our aggregate investment portfolio composition. At quarter-end, our servicing related investments which include MSRs and Excess MSRs represented approximately 55% of our equity capital and approximately 18% of our investible assets excluding cash. Our RMBS portfolio comprised approximately 39% of equity and approximately 82% of our investible assets. As shown on slide seven through nine, our servicing related investments performed well during the second quarter, given the rise in interest rates. The current carrying value of our portfolio stood at approximately $93 million at quarter-end. Our recapture agreement resulted in approximately $900 million of loans being recaptured during the quarter with Pool 1 posting of 44% recapture rate and Pool 2 posting a 57% recapture rate. As we mentioned last quarter, the FHA mortgage insurance premium reduction implemented in January had a pronounced impact on projected prepayments fees for Pool 1 and we did see an increase in the actual prepaid fees in that portfolio during the second quarter. The Aurora acquisition represents our initial foray into the conventional servicing space, and this portfolio performed well in its first month, posting a June CPR of 7%. This represents what we believe will be the beginning of a shift to a more operational centric business. I’ll now turn the presentation over to Julian who will provide some detailed information on the investment portfolio and its performance over the quarter.

As of June 30th, the RMBS portfolio stood at approximately $433 million excluding net TBAs, as shown on slide 10, up modestly from $430 million at the end of the first quarter. At quarter-end the RMBS portfolio’s leverage stood at 6.28 times with the portfolio evenly split between 30-year fixed whole-pools and a position comprised of 20-year and 15-year fixed rate whole pools as well as shorter duration assets. During the quarter, we utilized the proceeds from 30-year position sales and principal runoff to increase our 20-year, 15-year position as well as other assets. As shown on slide 11, the RMBS portfolio’s collateral composition remained primarily composed of loan balance collateral at quarter-end. The portfolio posted weighted average three-month CPR of approximately 8.2%, as Jay previously mentioned; and a weighted average six-month CPR of approximately 6.8%. Our portfolio’s prepayment fees continued to outperform Fannie aggregate prepayments fees. However, we experienced 285-basis-point increase from the previous quarter as originators made increased efforts to finance, as many home owners as possible as interest rate rose during the quarter. At quarter-end, the aggregate portfolio continues to be managed conservatively. During the quarter, the aggregate portfolio operated with modest leverage of 2.5 times and a negative duration gap. As shown on slide 12, we ended the quarter with an aggregate portfolio duration gap of minus 1.18 years. Following a few hundred basis-point instantaneous move according to our model, our aggregate duration gap would move from minus 1.18 years to a positive 0.15 years. The portfolio’s gap is driven by the composition of the RMBS portfolio, associated hedges, and the fact that 55% of the portfolio’s equity was comprised of servicing related assets including excess MSR and full MSRs, during the second quarter of 2015. I will now turn the call over to Marty Levine. He will review our second quarter financial highlights in more detail. Marty?

Thank you, Julian. Net interest income for the quarter was $4.9 million. In combination our Excess MSRs, whole MSRs, RMBS and derivatives produced a net increase in asset value of approximately $1.5 million for this quarter, after paying our quarterly dividend. Our GAAP net income applicable to common shareholders for the second quarter was $11.2 million or $1.49 per share. Our core earnings, as detailed on slide 24, was $3.6 million or $0.48 per share while our dividend eligible income was $0.49 per share. For the second quarter, our comprehensive income which includes the mark to market of our held for sale RMBS was $5.1 million or $0.68 per share. As detailed in slide 27, we used a variety of derivative instruments to mitigate the effects of increases in interest rates on a portion of our future repurchase borrowings. At the end of the second quarter, we held interest rate swaps, swaptions and TBAs with a combined notional value of $367 million. For GAAP purposes, we have now elected to apply hedge accounting for our interest rate derivatives. And as a result, we recorded the change in estimated fair value as a component of the net gain or loss on interest rate derivatives. Operating expenses were $1.3 million for the quarter of which approximately $60,000 was related to our licensing efforts and other infrastructure costs relating to CHMI Solutions, our taxable REIT subsidiary. For the quarter, our total operating expense ratio as a percentage of average equity was 3.4%. On June 18, 2015, we declared a dividend of $0.49 per share for the second quarter, which was paid on July 28th. 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’d like to turn the call back to Jay for closing remarks.

Thanks, Marty. We are pleased with where we are with respect to our long-term strategy. We now have access to additional sources of financing and we’re actively attempting to acquire full MSRs. We believe we are well-positioned to grow and diversify our business over multiple economic and interest rate environments, and deliver consistent attractive returns for shareholders. We’ll now open the call for questions. Operator?

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Steve DeLaney with JMP Securities. Please go ahead with your question.

Jay, way I’d like to start is maybe just digging a little bit into the sequential decline in core. This quarter’s all been about higher speeds and for everybody other than yourself, pretty much lower book values. But just digging into your statement of cash flows, looks like that premium amortization on RMBS went up about 160-some thousand, looks like $0.02 a share to me and probably one of the main culprits in your core dropping from $0.50 to $0.48 temporarily. Just curious if you guys attribute the bulk of the sequential decline to premium amortization as these numbers would indicate?

I’m going to let Julian handle that one for me.

There is no doubt that we did have an increase in prepayments fees over the quarter. I would say it was basically through throughout the portfolio. There wasn’t anything that was kind of significant that I could highlight and say that that was what was targeted. It just seem the entire portfolio with target is almost as rates were rising, services and originators trying to gobble up what they could as a last effort for rising rates in the second quarter. But that definitely had an impact in terms of our NIM in the second quarter.

Looking at the Fannie data, I’m trying to get a feel for what you would expect looking out to 3Q and 4Q in terms of the speeds here? And I’m sure others will be asking about speeds on the servicing related assets but I was just focusing currently on the agency. It’s look like we got with looking at the Fannie Mae 30-year universe, looks like we got a slight pickup in speeds generally in July. But I just looked at the August speeds and they crashed. I mean it was almost 12% drop in the Fannie 30-year cohort. Just curious, I know you’ve got spec pools and a lot of prepay protected stuff, so you won’t see that kind of delta. But just curious how you feel about the probability of speeds. Looking forward to the end of the year, are we going to see something more in the 6%, 7% kind of CPR range that you’ve shown up until the second quarter?

It’s clearly going to be interest rate dependent. So, if we’re too wise in terms of rate, I would expect overall not just our portfolio but everyone in the industry’s prepayment fees to slowdown. And if we try to reverse course back down to 2%, it’s just going to make everyone’s portfolios much more refinancable. So, given the volatility that we’re having, not necessarily what’s going on in the U.S. but globally here, the backend where rates are could be anchored somewhat for a little bit while even though the Fed is trying to raise rates. I think in the first quarter this year, we benefited a lot from what our speeds were, exactly as where everybody’s speeds were rising, ours actually declined in the first quarter but just look over everyone in the sector. And in the second quarter here I think we played a little bit of catch up in the sector, obviously with rising rates. We weren’t the only REIT that had rising rates; I think majority of them had it. But I would probably say that it will probably fluctuate somewhere between 7 CPR and 8 CPR and will kind of see where we go from there. But it will be rate dependent.

And we’ll have to obviously watch rates very closely here, meaning especially the 10-year. And then one final quick thing, leverage on the agency book is stayed just slightly over six times. You now have the Home Loan Bank. And while we think of the Home Loan Bank is being primarily a great source of financing for whole-loans, we have heard some commentary by other agency and MBS PMs [ph] that in terms of some term type funding that it’s looking pretty attractive to them. And I’m just curious if -- two-part question, are you looking at the Home Loan Bank to provide any incremental financing for the agency book? And given that sort of the durability and stability that relationship, would that entice you to take your leverage up to any degree on the agency portfolio? And I’ll leave it at that.

I think the two-part question; one, having the Federal Home Loan Bank, I don’t think changes our perspective on risk. I think from our perspective, it creates another counterparty that we think is accretive to the business. With respect to the FHLB on its own merits, we’re trading cautiously today. Obviously I think everybody has shared their views with you guys and we’re one of the last to go. So, I am sure it won’t be a surprise for you to hear that we remain cautiously optimistic about the regulations around the FHFA and whether or not we get to stay in the system. So, we’re making an effort to be very prudent about how we utilize that financing. And we watch and monitor the situation every day, both on our own and with all of our peers through the MBA.

Our next question comes from the line of Jeremy Campbell with Barclays. Please go ahead with your question.

How much dry powder you think you guys have to go look for full MSRs in the marketplace right now?

Sure. So, if you took into account the fact that MSRs only account for only about 55% of total equity today, plus we currently have access to additional debt with NexBank, that gives us approximately 15ish million with NexBank and probably another 15 million to 20 million in equity around taking positions out of the MBS and move them to sourcing related.

And then can you just remind us again about your optimal leverage on the full MSRs? I think before when we talked about this, it looked quite a bit different than what you got on the excess side?

I think it is very different. We are currently evaluating leverage opportunities around MSRs. But typically what we see being offered in terms of leverage in the MSR space is advanced rates anywhere between 50% and 60% and that’s pretty much what we see out there.

Thank you. [Operator Instructions]. Our next question comes from the line of Michael Kaye with Citigroup. Please go ahead with your question.

I recall you needed some more licenses in order to acquire MSRs on a national basis even after Aurora. It sounds like -- I don’t know if you’ve got them already but it sounds like you’re going ahead to buy MSRs now. So, did you basically get all the licenses you need at this point?

I’ll let Marty handle that one.

We have all the paperwork and we’ve gotten all but three and I don’t want to insult any states but I’ll call the minor states left to get. And we are actively bidding on the MSRs to transact in the fourth quarter.

I know last quarter you talked about what your thought was on return profile for full MSRs. I think you’re thinking not conforming high single digits, Ginnie Mae low double digits; is that still consistent with what you’re seeing in the market now?

It’s really unchanged from where we were in Q1. For the most part the market is kind of in a state right now that it hasn’t really been moved to one side or another.

Just one final question, just again on the dividend, just to make sure I am perfectly clear, in terms of your trajectory of the dividend going forward. Do you think given your desire to add more MSRs, just keeping the relative yield of MSRs versus agency MBS. Do you think the current dividend level of $0.49 to be maintained and if you add more MSRs?

We try to be pretty descriptive in the speech and given the current composition of the portfolio married with our strategic plans which include MSRs, we do today think that what the level of the dividend that we said is sustainable.

Thank you. Ladies and gentlemen, there are no further questions at this time. I would like to turn the floor back over to Mr. Lown for closing remarks.

Thanks very much. Thank you for joining us today on our call. And we look forward to updating you on our progress on our third quarter 2015 earnings call. Have a great day.

Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.