Cherry Hill Mortgage Investment Corporation (CHMI) Q4 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the Cherry Hill Mortgage Fourth Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Mike Hutchby. Thank you, Mr. Hutchby. You may begin.

We like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation’s fourth quarter 2015 conference call. In addition to this call, we have filed a press release that was distributed earlier this afternoon 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, President and Chief Investment Officer. Also present on the call today are Marty Levine, our 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 earnings conference call for the fourth quarter of 2015. As part of today’s call, we posted a presentation on our website that we will touch upon periodically and we will reference specific slides where appropriate. After our prepared remarks, we’ll open up the call for questions. 2015 was a challenging year for the residential mortgage REIT industry. And based on the last few months, we expect this could continue in 2016. In December, after months of speculation, we finally saw our first interest rate hike in over 10-years. At that time, the Fed projected they might raise four times in 2016. However, as a result of the volatility in the global marketplace this year, the probability of that happening is now lower. In fact, during the first quarter, the 10-year treasury fell as much as 61 basis points from year-end, well below where it stood pre-rate-hike as markets have digested a global economy that remains fragile. There is now considerable uncertainty as to when the Fed will further tighten this year. The fourth quarter was plagued by a flattening yield curve and higher short-term borrowing rates, which weighed on REIT performance. Most credit spread sectors, underperformed treasuries and interest rate swaps, which put pressure on book values. Given the composition of our portfolio, this impact was muted, which help to mitigate book value erosion for Cherry Hill. For the fourth quarter, our book value was essentially flat quarter over quarter rolling $0.05 or 0.2% to $20.13. We recognize we are not impervious to the volatility and rates, and the effects it has in our portfolio. But we believe we have navigated the storm well and have created a portfolio that to-date has preserved shareholder wealth. Market volatility has persisted in 2016, and investors have found solace in swaps in U.S. treasuries. As we navigate an ever-changing global macroeconomic environment, we continue to execute on our MSR strategy. During the fourth quarter, we acquired a $1.4 billion bulk Fannie Freddie MSR portfolio. And subsequent to year-end, we closed on an additional acquisition of $460 million Fannie MSR portfolio, both of which are being subserviced by Freedom. As many of you know in January, the FHFA issued a final regulation requiring the FHLB to terminate the memberships of their captive insurance company members. And the membership of CHMI Insurance will be terminated by early 2017. We will continue to look for additional sources of liquidity to mitigate any impact from the loss of FHLB membership. But we note, that we have only liquid agency RMBS currently financed with FHLB and expect we can unwind our membership without causing any hiccups to our normal operations. Overall, our strategy remains unchanged, as we maintain a bias towards being a more operational business. When we find quality investments, we will continue to emphasize preservation of capital and we continue to believe we are positioned appropriately to pursue additional opportunities to generate sustainable attractive risk-adjusted returns. Turning to our quarterly results, as shown on Slide 5, fourth quarter core earnings were $0.49 per share, while dividend eligible earnings were $0.48 per share. The definition of core earnings backs out the effect of a catch-up of premium amortization on our excess MSR portfolio. While core earnings were above dividend eligible earnings this past quarter, we maintain our position that as we grow our servicing portfolio we expect core earnings will be impacted by acquisition expenses. Depending on the amount and timing of these expenses, we would expect core earnings to typically trend at least a few cents lower than our dividend eligible income each quarter. With that said, we still expect our current dividend level to be sustainable in the near-term. For the fourth quarter, we distributed a $0.49 per share dividend to our shareholders, and recently declared a $0.49 dividend for the first quarter 2016. Slide 6 highlights our aggregate investment portfolio composition. At quarter-end, our servicing related investments, which include MSRs and excess MSRs, represented approximately 49% of our equity capital and approximately 16% of our investible assets excluding cash. Serving related assets, as a percentage of total equity, have increased slight 8 percentage points quarter-over-quarter, which is attributable to the MSR acquisition we closed in October. Our RMBS portfolio at quarter-end comprised approximately 46% of our equity and approximately 84% of our investible assets, again, excluding cash. As shown on Slide 7 through 9, the current carrying value of our servicing related assets stood at approximately $98 million at quarter-end. Our recapture on loans underlying or excess MSRs continues to help stabilize prepayments speeds with approximately $328 million of loans being recaptured during the quarter, with Pool 1 posting a 34% recapture rate and Pool 2 posting a 54% recapture rate. Our total excess MSR portfolio performed in line with expectations with combined CPR of 11%. Now I’d like to turn the presentation over to Julian, who will provide additional information on the investment portfolio and its performance over the quarter.

Thank you, Jay. Before I discuss our portfolio, I’ll make a few comments on mortgage performance. The fourth quarter was a continuation of the volatile and choppy markets experienced in the third quarter as Jay mentioned. For the first three quarter of 2015, RMBS underperformed treasury and swap hedges similar to other spread sector assets regardless of the directionality of rates. The belief that the Fed would raise rates for the first time in over 10 years weighed on the financial markets for an entire year. During the fourth quarter, mortgage performance was slightly better depending on hedges. Drivers of mortgage performance were primarily tighter spreads carry and a decline in volatility according to Barclays. The early scenes of 2016 are reminiscent of the worst parts of 2015; global banks under pressure, credit spreads widening, and limited market liquidity. The combination has moved investors to the sidelines or positioned themselves in the comfort of treasuries. For the start of 2016, mortgages have fared better than most other credits spread sectors. But nonetheless, the sector’s performance is weaker versus treasuries and interest rate swaps. As of December 31, the RMBS portfolio stood at approximately $508 million, as shown on Slide 10, down from $580 million at the end of the third quarter. The RMBS portfolio’s reduction from the third quarter was necessary to fund the acquisition of additional servicing related assets in late October. As you may recall, we temporarily deployed debt proceeds into RMBS in the third quarter, pending settlements of the MSR acquisition. At quarter end, 56% of the RMBS portfolio was comprised of 30-year fixed rate whole-pools and 44% was comprised of 20-year and 15-year fixed rate whole-pools as well as shorter duration assets. As shown on Slide 11, the RMBS portfolio’s collateral composition remained primarily comprised of loan balanced collateral at quarter-end. For the quarter, the portfolio posted a weighted average three-month CPR of approximately 6.3% and a weighted average six-month CPR of approximately 7%. Our portfolio’s prepayments speeds continue to outperform Fannie’s aggregate prepayment speeds. The quarter-over-quarter decline in CPR was driven by the higher interest and mortgage rates coupled with seasonality throughout the fourth quarter. In addition, the primary and secondary spread for mortgages widened during the quarter as originators attempted to protect against increased volatility and hedging related to the Fed. For the quarter, we posted a 1.46% net interest margin versus a 1.31% NIM for the third quarter. The NIM improvement was a normalization from the third quarter. In the third quarter, the NIM was depressed, as term debt facility proceeds were temporarily deployed into RMBS until the MSR acquisition settled in October. During the quarter, the aggregate portfolio operated with a leverage of 3.1 times and a negative duration gap. As shown on Slide 12, we ended the quarter with an aggregate portfolio duration gap of minus 1.08 years. The portfolio’s gap was driven by the composition of the RMBS portfolio, associated hedges and the fact that 49% of the company’s equity was invested in servicing related assets, including excess MSR and full MSR, during the fourth quarter of 2015. And I’ll now turn the call over to Marty, for our fourth quarter financial discussion.

Thank you, Julian. Net interest income for the quarter was $6.2 million. Our GAAP net income applicable to common stockholders for the fourth quarter was $9.5 million or $1.27 per share. Our core earnings were $3.7 million or $0.49 per share, while our dividend eligible income per share was $0.48 for the quarter and $1.97 for the year. Our core earning eliminates the effects of the catch-up premium benefit, so as to present a more accurate picture of our core earnings. As Jay discussed earlier, we expect to generate enough dividend eligible income to allow us to sustain our dividend in the near-term. For the fourth quarter, our comprehensive income, which includes mark-to-market of our held-for-sale RMBS was $3.4 million or $0.45 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 fourth quarter, we held interest rate swaps and swaptions with a combined notional amount of approximately $385 million. For GAAP purposes, we have now 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 $1 million for the quarter, of which approximately $270,000 was related to our taxable REIT subsidiary and expenses for the proposed capital-raise in December. For the quarter, our operating expense ratio as a percentage of average equity was 4.6%. On December 10, 2015, we declared a dividend of $0.49 per share for the fourth quarter of 2015, which was paid on January 26, 2016. All of our dividends paid in 2015 were taxable as ordinary income. Our goal remains to distribute regular quarterly dividends of all or substantially all of our taxable income to holders of our common stock to the extent authorized by our Board of Directors. Now, I’d like to turn the call back to Jay for closing remarks.

Thanks you, Marty. We are optimistic about the opportunities that lie ahead this year and believe our long-term investment strategy remains very much on pace. We look forward to updating you soon on our results for the first quarter of 2016. We’ll now open up the call for questions. Operator?

Thank you. [Operator Instructions] Our first question comes from Steve DeLaney with JMP Securities. Please state your question.

Thank you. Good evening, everyone. Jay, I apologize, I missed your opening remarks, if you commented on this. You have this new credit facility that you put in place. Could you just discuss the any - what capacity you have under that facility for any additional liquidity that you have to continue to purchase MSR assets? Thanks.

Hey, Steve, how are you?

Good.

Sounds like you not have. If you’re talking about the NexBank facility, that’s been fully deployed.

Okay. And that was the facility that allowed you to - the MSRs that closed in October that was the incremental capacity for that purchase?

We had a slight amount left based on the 1.4, but as of today that facility is been used up.

Okay. And I think, Julian mentioned that 49% of your equity was now in MSRs. I know you got to manage very closely the 40 Act. Now how much capacity do you have there or are you - can that 49% go higher from where it stood at December 31?

Hey, Steve, it’s Jay. So we do have some room. I believe our current position is somewhere in the 70s, so we have some room and we valuate that on a regular basis in terms of how to allocate that to make sure that we are within the context of the 40 Act test.

Okay, great. I appreciate the comments, Jay. Thank you.

No sweat. No problem.

There are no further questions. I’d like to turn the call back to Jay Lown for closing comments.

Thanks very much. Thank you, everyone, for joining us on today’s call. We look forward to updating you on our progress on our first quarter 2016 earnings call.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.