Cherry Hill Mortgage Investment Corporation (CHMI) Q2 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Cherry Hill Mortgage Investment Corporation Second Quarter 2017 Earnings Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Michael Hutchby, Controller for Cherry Hill Mortgage Investment Corporation. Mr. Hutchby, you may begin.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's Second Quarter 2017 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 core and comprehensive 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 CEO of Cherry Hill. Also present on the call today are Julian Evans, our Chief Investment Officer; and Marty Levine, our Chief Financial Officer. And now I will turn the call over to Jay.

Thanks, Mike, and thank you, everyone, for joining us on today's call. On our last call, I had noted that our increased financial strength after our follow-on offerings should assist us in creating relationships that would be accretive to our business. Thanks to the groundwork we laid in the second quarter, we were pleased to announce last week our MSR flow purchase arrangement with RoundPoint Mortgage Servicing Corporation. Working with RoundPoint, we will be able to purchase on a monthly basis up to $2 billion of conventional MSRs that are acquired through RoundPoint's co-issue program. The MSRs we purchased through this agreement will be subserviced for us by RoundPoint. The agreement neatly fits into our long-term strategy as it provides us with an alternative to the bid and comp process to deploy our capital and further grow our portfolio. It also diversifies our subservicing options. We're excited about the overall partnership and working closely with the RoundPoint team. In addition to the RoundPoint agreement, post our capital raise, we acquired approximately $2 billion of conventional MSRs from 3 unaffiliated parties, which raises the total unpaid principal balance of our MSR portfolio to over $9 billion. During the second quarter, we further strengthened our capital position by entering into a $20 million MSR term facility secured by the pledge of Aurora's Ginnie Mae MSRs. And as we have said multiple times, we regularly identify and evaluate all MSR opportunities that meet our investment criteria. Looking at our second quarter results. Solid performance from our RMBS portfolio helped produce core earnings per share of $0.53. We did see a $0.03 positive impact from our EPO protection on the Ginnie Mae MSR portfolio, which expired in the second quarter, and thus we expect more normalized earnings from this portfolio going forward. We closed the quarter with a book value of $19.94, down 0.8% from March 31. The decrease in book value was attributable primarily to the reduction in the value of the MSRs given the lower interest rate environment. The second quarter was the dawn of a new era for Cherry Hill. The additional capital greatly increased the company's liquidity and presence in the markets in which we transact. We're using our significantly stronger financial position and our deep expertise to invest in assets we believe will set up Cherry Hill for long-term success and further value creation. With that, I'll turn the call over to Julian who will cover some more detailed highlights of our investment portfolio and its performance over the quarter.

Thank you, Jay. Despite a dysfunctional government with respect to large items, such as health care, infrastructure, and tax reform, the U.S. economy continues to move forward at a slow and steady pace. The Fed raised rates as expected in June, marking a second consecutive 25 basis point hike. Yet with those expectations already baked in, interest rates actually moved lower for most of the second quarter as compared to where they stood on March 31 due to suboptimal inflation. We remain biased to an additional hike prior to year-end, most likely in December. This assumes the U.S. economy stays on its current pace and absent any shocks to the financial markets or global economy as well as assuming the markets digest the Fed's initial reduction of their balance sheet. Moving forward, Slide 5 highlights our aggregate investment portfolio composition. At quarter end, our servicing-related investments comprised solely of full MSRs, represented approximately 16% of our equity capital and approximately 5% of our investable assets, excluding cash. Servicing-related assets as a percentage of total assets declined due to the temporary deployment of additional cash proceeds from our first quarter follow-on offering into the RMBS portfolio. As a result, our RMBS portfolio accounted for approximately 75% of our equity and approximately 95% of our investable assets, excluding cash at quarter end. As shown on Slide 6, as of June 30, we held MSRs with a UPB of approximately $7.6 billion and a market value of approximately $74 million. With interest rates at lower levels for most of the second quarter, our conventional and government speeds increased modestly. Life to date, our conventional MSR speeds are averaging approximately 11%, while our government MSR speeds are averaging 9%. As of June 30, the RMBS portfolios stood at approximately $1.36 billion as shown on Slide 7, an increase from approximately $1.1 billion as of March 31. The increase was driven by the deployment of the proceeds from the follow-on offering from the previous quarter. During the quarter, we increased our 30-year securities position of our RMBS portfolio to 71% versus 68% from the previous quarter. 20-year and 15-year fixed rate pools as well as shorter-duration assets represented 29% of the RMBS portfolio at quarter end. In the second quarter, the RMBS portfolio posted a weighted average 3-month CPR of approximately 5.2%, an improvement from 5.5% posted in the previous quarter as shown on Slide 8. Overall, the portfolio continued to contribute from collateral compositions during the quarter despite lower interest rate as compared to the first quarter. For the second quarter, we posted a 1.78% RMBS NIM versus a 1.42% NIM for the first quarter. The improved NIM benefited from the portfolio's collateral composition and price amortization that was driven by favorable prepayment speeds during the quarter. Similar to other REITs, repo cost rose during the second quarter. Repo cost averaged 119 basis points versus 104 basis points in the first quarter. The higher costs were partially offset by increased 3-month LIBOR, which benefited the receiving portion of our swap hedges. Based on these factors, we continue to expect our NIM to fluctuate as we move forward. During the quarter, the aggregate portfolio operated with leverage of 4.8x and a negative duration gap. As shown on Slide 9, we ended the quarter with an aggregate portfolio duration gap of minus 0.54 years. I'll now turn the call over to Marty for our second quarter financial discussion.

Thank you, Julian. Our GAAP net loss applicable to common stockholders for the second quarter was $1.5 million or $0.12 per weighted average share outstanding during the quarter; while our comprehensive income attributable to common stockholders, which includes the mark-to-market of our held-for-sale RMBS, was $4.3 million or $0.33 per share. Our core earnings, as detailed on Slide 18, were $6.7 million or $0.53 per share. As Jay noted earlier, core earnings in the quarter saw a $0.03 positive impact from EPO, or early payoff protection on the Ginnie Mae MSR portfolio we acquired in the first quarter. That EPO expired at the end of May, and thus we would expect core earnings to be more normalized in the third quarter. As detailed on Slide 21, we used a variety of derivative instruments to mitigate the effects of increases in interest rates on a portion of our future repurchased borrowings. At the end of the second quarter, we held interest rate swaps, swaptions and TBAs with a combined notional amount of $864 million. And 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 $2.2 million for the quarter, of which approximately $472,000 was related to our taxable REIT subsidiary. On June 15, 2017, we declared a dividend of $0.49 per share, which was paid on July 25, 2017. Our goal remains to distribute regular quarterly dividends of all -- substantially all of our taxable income to holders of our common stock and to the extent authorized by our Board of Directors. We continue to believe our current quarterly dividend level will remain sustainable in the near term. Now I'd like to turn the call back to Jay.

Thanks, Marty. At this time, we'll open up the call for questions. Operator?

[Operator Instructions]. Our first question comes from the line of Steve Delaney from JMP Securities.

Congratulations not just on a strong quarter, but also pretty nice recovery in the stock of about 17% since the offering, so nice to see. Want to start off with the new term loan, Jay, the $20 million. Was that with the new lender? Can you -- are you seeing any ability to tap new sources for borrowing?

We tapped into the same lender.

Same lender, okay.

Than the previous one.

Than we do with -- yes.

Than we do with the [indiscernible], the other MSRs.

That's right.

Okay. Okay. Got it. Are you seeing any -- I don't know whether the RoundPoint relationship helps in this regard in any way. But looking at the market, are you seeing any widening of the number of banks that are willing to provide financing for MSRs? And especially, I guess, what we've seen is it seems like Ginnie Maes are easier. And maybe if you want to comment on that, but just -- I'd like to just kind of see here kind of how you're seeing this whole leveraging financing of MSRs, how you see the kind of the waterfront there.

Sure. So I would say that I think we find Fannies easier than Ginnies.

Oh, really? Okay.

As a general statement just based on the acknowledgment agreement, et cetera. And from that perspective, we have had less partners that are willing to work with us on the Ginnie Mae front than on the Fannie Mae front. But with respect to that Fannie front conventional, I think we have a fair amount of runway. We have a strong counterparty who's able to grow with us and also syndicate out, and And as we grow, we also have the ability to look at the Street once we fulfill as high as they're willing to go with us. But today, I think we're very comfortable with the amount of runway we have with our existing counterparties on the conventional side.

Right. And the reason I mentioned Ginnie Mae and tied this into your comment about the Street, we noticed the secured notes that PFSI was able to do earlier this year, and they made the point to us that Ginnie Mae was invaluable in that process. It wouldn't have gotten done. So forgive me, that's where that bias towards Ginnie came from. But I mean...

Yes, we accept that the securitization route for that is an option. We have a long way to go before we even think about that.

Yes, scale, right, I mean, just in terms of what you would have to have in fair value. Okay. Great.

That's right. Crédit Suisse, it's clearly an option for that.

Yes, okay. And we spoke to -- we now have -- the nice thing we have your strategy, which I would describe as MBS/MSRs held in tandem. We now have 2 public companies that are pretty cleanly and clearly defined that that's where they're going, and we spoke to your larger peer today and in terms of the current opportunity, their statement to us was low-to-mid-double-digit investment returns, obviously, from pre-expense. Just curious how you and your team currently see the market on both sides of that. And in fact, Jay, do you look at the blended return of the 2 held in tandem the way that I was suggesting?

We look at them both ways. We look at them separately and then together, and we evaluate the portfolio in total to understand the total returns that we're expecting to get for the portfolio in aggregate. But I would agree. So it's interesting that, that other company, what I read in the transcripts, what you're saying seem to be consistent. I would say that we also target portfolios in the low-to-mid teens, and that also depends on whether it's conventional or Ginnie and that's on a levered basis. I think they also said, and we would agree that pricing has gone up. Portfolios have gotten a little bit richer, so to speak, in terms of the servicing space. And we do -- we're very careful about how we model, and we stick to our models with respect to how we evaluate these portfolios. And some, we will fight for aggressively because they meet our collateral characteristics, expectations, and return expectations, and some we just don't get very excited about.

Understood. You’ve got to have a frame of reference, right? So nice to have that model to work from. My last question, I'll address to Julian. And you guys got to forgive me when you were at the end of the earnings cycle here, we've done a lot of these calls, so a lot of my questions relate -- may come from what I've heard from other guys over the last week or so. So I talked to somebody else today, Julian who was whining because hybrids blew out 20 basis points in OAS and MBS were benign, as you reported, kind of not much change there. But apparently, hybrids, because of increased supply, hybrid ARMs had a really poor performance from a fair value mark standpoint. I'm just curious. I know you don't have a lot of hybrids, but you at least -- you have 5%, so you least look at it. I'm just curious whether that caught your eye and whether you're seeing any value in sort of recent vintage 5171s.

Look, we really don't have any hybrid in the portfolio. I know we have something called ARM CMO. That's really kind of where -- our placeholder where we've held some staggered cash [ph] securities.

Oh, I see. I didn't realize they weren't, traditional. My bad there.

That's okay. But in terms of hybrids, yes, I would say we noted the technicals. So I think that, yes, there was a repricing that went on in the hybrid market. We do evaluate hybrid versus some of the other securities that we currently look at. I would say that I find limited value in hybrids at this point in time, and I'll leave it at that.

Our next question comes from the line of Jessica Levi-Ribner from FBR.

In terms of the RoundPoint agreement, you mentioned that it would be a $2 billion -- it could be up to $2 billion per month. What kind of -- I guess, in 2 parts. How much of that do you think you could take down? And then what's your capacity for whole MSRs on the balance sheet?

Jess, we have a lot of capacity for MSRs right now. With 17 -- I think post the quarter, it's risen. But at the end of the second quarter, we had 79% of our equity in that asset class 15, 17. And we've said, I think, a few times on previous calls that we could easily get into the 60s in terms of percentage of equity. So I think we have way more capacity than we could ever fill with RoundPoint alone. And so what we'd like about RoundPoint is, is it's a consistent source on a regular basis for us to be able to continue to build that portfolio. But we also feel we have plenty of powder to buy in the bulk space as well.

And then just in terms of the economics around the flow sale with RoundPoint, how will that work? And can we assume the same net servicing fee as the rest of the portfolio?

Yes, I would assume the same net servicing fee. And with respect to economics, not sure I totally understand what you just asked.

In terms of the cost of -- just the cost of the MSRs.

I would expect that we would be able to acquire the flow at or better yields than the bulk.

Than the bulk, okay. And then my last one is just around the characteristics of the MSRs that RoundPoint has versus the existing portfolio and how we can think about that.

Sure. They have a very large nationwide co-issue program that we think is a good mix on the conventional side from us. I would expect that the large majority of this would be conventional inconsistent with what we currently own in terms of collateral composition. The beauty about the co-issue program is you can price aggressively to what you like and you can back away from what you don't like.

That is all the time we have for questions. I'd like to turn the call back over to Jay Lown for closing comments.

Thanks. Thank you, everyone, for joining us in today's call, and we look forward to updating you soon on our third quarter results.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and a wonderful day.