Cherry Hill Mortgage Investment Corporation (CHMI) Q4 2017 Earnings Report, Transcript and Summary

Greetings, and welcome to the Cherry Hill Mortgage Investment Corporation Fourth Quarter and Full Year 2017 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Michael Hutchby, Controller and Head of Investor Relations. Thank you. You may begin.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's Fourth 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'll turn the call over to Jay.

Thanks, Mike, and thank you, everyone, for joining us on this call. 2017 was a transformative year for Cherry Hill. We began the year by completing the transition out of Excess MSR assets and the full MSRs. And then completed both the common equity follow-on offering and a preferred stock offering. We established 2 new subservicing relationships and entered into a flow agreement for MSRs to complement our bulk acquisition strategy. At the same time, we continued to preserve book value, maintain our dividend and execute on our strategy of opportunistically deploying capital into MSRs. By the end of 2017, we had materially enhanced our ability to take advantage of investment opportunities within these strategies. Overall, for the fourth quarter, strong performance from our RMBS portfolio along with a growing MSR portfolio helped produce core earnings per share of $0.57. We closed the quarter with a book value of $20.44, an increase of 1.9% from the prior quarter. We continue to focus on preserving book value through actively managing a portfolio of assets that we believe accomplishes that goal across multiple interest rate environments. During the quarter, our subsidiary, Aurora, purchased over $2 billion in MSRs under our flow purchase agreement with RoundPoint, increasing the size of our MSR portfolio to nearly $12 billion in unpaid principal balance as of December 31. We've been very pleased with our relationship with RoundPoint and it's paying significant dividends for our company. As a reminder, the monthly $250,000 yield maintenance payments we have been receiving from Freedom Mortgage ended in the fourth quarter. As we noted previously, while there are many variables that will affect our core EPS going forward, particularly with the pace and amount of MSR purchases, all things being equal, we expect our revenues in 2018 will be lower than in recent prior quarters due to the expiration of the payments. Overall, our performance in 2017 and the current economic environment has reinforced our conviction that our MSR strategy is the proper course of action for Cherry Hill. We are continuing to put our capital to use in a prudent manner, using our investment experience to make MSR acquisitions at appropriate valuations, and thus, positioning us well for the months and years ahead. At the same time, we will continue to leverage the relationships we've established to augment our sourcing, servicing and subservicing capabilities. And as always, we continue to keep a close eye on ensuring our strategy is aligned with preserving book value. As you will hear from Julian shortly, 2018 has been eventful, to say the least. Domestic and global data have been strong. Our Fed has become increasingly comfortable with the country's macroeconomic performance, and the Trump administration remains active in its policymaking. As a result, we have witnessed a significant increase in interest rates year-to-date. All those have commented on how this has affected their book values quarter-to-date. We are happy to report that as of the February month-end, our book value has remained fairly consistent with where it stood at year-end. The composition of our portfolio has continued to protect our investors from rising rates. And as we add more servicing-related assets, we believe the company will be able to withstand further Fed tightening over the near term. It's our expectation that our MSR portfolio will exceed $15 billion at the end of the first quarter through both bulk and flow purchases. I have high expectations for 2018 and as we look to build new relationships and capitalize on existing ones. We are excited to continue building shareholder value and growing Cherry Hill. 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. At quarter-end, our servicing-related investments, comprised solely of full MSRs, represented approximately 26% of our equity capital and approximately 6% of our investable assets, excluding cash. Our aggregate investment portfolio composition is shown on Slide 5. Servicing-related assets as a percentage of equity increased to 26% from 20% due to the additional deployment of cash into select MSR investments during the quarter. As a result, our RMBS portfolio accounted for approximately 68% of our equity and approximately 94% of our investable assets, excluding cash at quarter-end. As of December 31, we held MSRs with a UPB of $11.7 billion and a market value of approximately $122.8 million, as shown on Slide 6. The total MSR portfolio prepayment speeds continued to decline during the quarter, despite a pickup in delinquencies due to hurricane-related impacts. Life-to-date, our conventional MSR CPRs have averaged approximately 10.1%, while our government MSRs CPRs averaged approximately 10.4%. As of December 31, the RMBS portfolio stood at approximately $1.9 billion, as shown on Slide 7. Opportunistically, we expect to redeploy a portion of the RMBS funds into MSRs. At quarter-end, the 30-year securities position of our RMBS portfolio stood at 73%, while the 20-year and 15-year fixed-rate pools, as well as shorter-duration assets, represented the balance of the RMBS portfolio. In the fourth quarter, the RMBS portfolio posted a weighted average 3-month CPR of approximately 6.45%, up from 5.95% posted in the previous quarter, as shown on Slide 8. Overall, the portfolio continued to benefit from its collateral composition and continued to vest Fannie Mae aggregate prepayment speeds during the quarter. For the fourth quarter, we posted a 1.27% RMBS NIM versus 1.26% for the third quarter. The slim increase in NIM was driven by the portfolio of collateral composition and reduced swap costs, which helped offset increased repo costs. At quarter-end, repo cost averaged 147 basis points versus 137 basis points in the third quarter. The higher costs were partially offset by increased 3-month LIBOR, which benefited the receiving portion of our swap hedges. The received portion of our swap hedges rose to 144 basis points versus 131 basis points posted in the third quarter due to LIBOR resets. In the near term, we expect our NIM to fluctuate on increased repo cost. During the quarter, the aggregate portfolio operated with leverage of 5.3x in a negative duration gap. As shown on Slide 9, we ended the quarter with an aggregate portfolio duration gap of minus 0.91 years. During the first quarter of 2018, we've proactively managed our hedges, as asset durations have extended in the portfolio due to rising interest rates. We have increased our swap hedge ratio as well as added additional swaptions and treasury feature hedges to the portfolio. We expect to continue to evaluate and alter the portfolio as the year progresses. I'll now turn the call over to Marty for our fourth quarter financial discussion.

Thank you, Julian. Our GAAP net income applicable to common stockholders for the fourth quarter was $18.7 million or $1.47 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 $11.2 million or $0.88 per share. Our core earnings, as detailed on Slide 18, was $7.3 million or $0.57 per share. As Jay mentioned, our book value as of December 31 was $20.44, an increase of $0.39 per share or 1.9% from September 30. 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 repurchase borrowings. At the end of the fourth quarter, we held interest rate swaps, swaptions and TBAs with a combined notional amount of $1.25 billion. 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 $277,000 was related to our taxable REIT subsidiary. On December 7, 2017, we declared a dividend of $0.49 per common share for the fourth quarter of 2017, which was paid on January 30, 2018, as well as a dividend of $0.5125 per share on our 8.2% Series A cumulative redeemable preferred stock, which was paid on January 16, 2018. Our goal remains to distribute regular quarterly dividends of all or substantially all 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.

Thanks, Mike. At this time, we will open up the call for questions. Operator?

[Operator Instructions] Our first question comes from the line of Tim Hayes with B. Riley FBR.

Jay, you mentioned that you see the MSR portfolio reaching about $15 billion at the end of the quarter. Does that reflect any bulk acquisitions or just flow? And with the quarter nearly done, is it safe to assume you've closed the majority of that growth you've indicated?

Hey, Tim. That is a function of both bulk and flow. And I can't really give you a lot of details around what's closed or what hasn't, but it is a combination of both.

Okay. And then your -- the equity allocation of servicing assets increased a bit in the -- quarter-over-quarter and so does your overall leverage and your swap position as a percentage of repos. So how should we think about leverage and your hedges as you approach your optimal capital allocation mix?

Sure. I'll let Julian talk about the leverage ratio.

Yes. I mean, it's true that the leverage is marginally higher. We've also noted that Jay has mentioned that we are looking at putting some bulk as well as flow to work during this quarter. The assessment would be that as we purchase the various MSRs, it will reduce our RMBS position. With that being said, I would expect the overall leverage for the firm to come down marginally based off of that. In terms of the hedging of the portfolio, what you've seen obviously at the end of the fourth quarter, I would say hedges have increased in the first quarter. I would expect those hedges to kind of remain as we migrate towards a 3% tenure. But on a going-forward basis, I think the overall leverage, obviously, as we reduce the RMBS portion of the portfolio should come down commensurate with that.

Okay. That's helpful. And then can you give us just an update on any discussions you've had with counterparties over securing additional MSR financing?

Say that again?

Can you just give us -- have there been any developments with your -- with counterparties over securing additional MSR financing?

Sure. We continue to work with counterparties to ensure that we have sufficient financing to grow that portfolio, and we feel very confident that as we grow that portfolio that we'll have financing in place to be able to support it.

Okay. And are you seeing a stronger appetite from banks to lend against servicing assets? And if so, is it tailored more towards Agencies or Ginnies? Are you seeing anything worth noting?

We've had success on both fronts. I can tell you that we continue to work with the regional banks. I don't think we're large enough to deal with some of the new residential/PennyMac structured financings that you've seen recently. But we're very happy with our counterparties and their ability and willingness to continue to grow with us.

Our next question comes from the line of Steve Delaney with JMP Securities.

Congratulations on the book value gained in the fourth quarter, and moreover, the stability that you've seen year-to-date. Jay, I'm curious the RoundPoint seems to be up and running pretty well with the -- I assume, the entire $2 billion -- I think you alluded the $2 billion increase in UPB was -- of MSRs was all from RoundPoint. Did I hear that correctly?

Over the fourth quarter, that's true.

Yes. Okay. Good, that's what I was asking. And I guess, on the -- as far as that opportunity, are there other potential strategic partners out there that you are in dialogue with? Is there anything about the RoundPoint agreement that precludes you from adding other sources of flow MSRs?

So the short answer to that is yes. But we're very happy with the RoundPoint relationship and our desire to grow that relationship and add counterparties to the RoundPoint JV that we have. Should we find anything that's interesting outside of that, obviously we will think hard about that. But my preference is to continue to grow the way we have done with RoundPoint because we like the way it's structured. And just to clarify, I was -- I did mistake -- about the bulking. We did have 2 small bulk purchases in the fourth quarter, the majority of it -- that was RoundPoint.

Okay. That's helpful. And Marty, I guess, this is -- I'll direct this one to you. I'm focused on the core earnings reconciliation for the fourth quarter. The 2 items in there that I'd like you -- could maybe give us a little color on the -- first, the catch-up premium amortization. I assume that's just your MBS premium that gets tweaked when rates move higher, that would be the $2.2 million adjust -- positive adjustment, am I correct on that?

No, that relates to the Excess.

The estimated catch-up $2.2 million relates to Excess MSRs?

Yes.

Okay. Got it. The number below though, the negative number of $4.9 million changes due to realization of expected cash flows. Help me understand which assets the cash flows you're referring to there?

That is -- I don't know off-hand. I will have to get back to you with that one.

Okay. So it's a pretty good-sized number. I just -- I think it's just the terminology. We can follow up on that one off-line. And I guess, the -- just if you could comment, guys, obviously, you delayed your call. We got a number of questions from investors. We pointed them to the book value figure and it led us to the conclusion that possibly the issue you were describing about methodology of amortization that maybe it was not a GAAP issue, but maybe just had an impact on how you arrive at core. Is there any color that you can give us about the short delay and more kind of what the issue was that caused you to push the call off a couple days?

The audit process revealed a discrepancy between the premium amortization of the RMBS portfolio calculated by us and the auditors. We reconciled and -- our calculations and methods and it resulted in no change to the reported results. That's it.

Okay. So just -- typical Agency RMBS at premium amortization was -- okay. That's what I'm hearing?

That's right.

[Operator Instructions] There are no further questions at this time. I would like to turn the call back over to Mr. Lown for any closing remarks.

Thank you for joining us on today's call. And we look forward to updating you soon on our first quarter results. Have a good day.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.