Cherry Hill Mortgage Investment Corporation (CHMI) Q2 2020 Earnings Report, Transcript and Summary

Greetings. Welcome to the Cherry Hill Mortgage Investment Corporation Second Quarter 2020 Earnings Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to your host, Rory Rumore. You may begin.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's Second Quarter 2020 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. 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; Julian Evans, the Chief Investment Officer; and Michael Hutchby, the Chief Financial Officer. Now, I will turn the call over to Jay.

Thanks, Rory, and welcome to today's call. We hope you and your families are remaining safe and healthy, we appreciate you joining us this afternoon. I'd like to begin the call by thanking our entire team for their continued efforts to manage through what has been a most challenging environment these last five months. Their hard work and dedication impresses me every day. The team continues to work remotely with no disruption in productivity. The second quarter could be described as a rebuilding period, where we work to stabilize our portfolios and closely monitor our risk as the pandemic continued to greatly impact the economy in the country. The U.S. experienced record high unemployment numbers paired with record low GDP, keeping rates near historic lows throughout the second quarter, yet equities pushed higher in anticipation of COVID vaccines and better economic times. As we noted on our prior call, liquidity was of paramount importance as we navigated through these challenges, and we stayed focused on our core strategies and competencies throughout the second quarter. We remain committed to our portfolio as constructed with both RMBS and MSRs and believe the two asset classes provide investors with compelling returns and together effectively hedge book value, across multiple interest rate scenarios. In the midst of the pandemic, we overcame many challenges and I am pleased with our performance for the second quarter. We reduced the leverage on our aggregate portfolio from five times at the end of March to 4.4 times at the end of June, and ended the quarter with $94 million in unrestricted cash on the balance sheet. For the second quarter, we earned core income of $0.47 per share. From a book value per common share perspective, we finished the quarter at $13.41, as of June 30, a 2.3% reduction from where it stood on March 31. However, I want to emphasize that, the large majority of the reduction was the result of paying 50% of our first quarter common dividend in stock, during the worst of the crisis. Absent the stock dividend, book value for the second quarter was essentially flat. We accomplished all of this without having to dilute shareholders by taking on any additional financing. Year-to-date, our book value per common share is down a little less than 23%. As a hybrid REIT that invests in MSRs, which have been significantly affected by falling rates along with the unprecedented macroeconomic environment in recent months, we believe our overall book value performance thus far in 2020 stand up very well relative to other hybrid REITs that have seen greater deterioration in value since the outset of COVID. During the quarter, we made the decision to sell our Ginnie Mae MSRs. We had not grown that portfolio since the initial purchase several years ago. And given the current collateral characteristics and expected future performance, the sale was strategically appealing. We recognized a small gain versus the portfolio's fair value at June 30. Our remaining Fannie and Freddie MSRs continue to experience highly elevated prepayment fees, as expected, given the current interest rate environment. As of the end of July, active forbearance remained just shy of 8% with approximately 30% of borrowers having made all payments due through July. Going forward, we believe our bolstered liquidity position is sufficient to satisfy all of our servicing advance obligations over the foreseeable future. As we move into the second half of 2020, interest rates remain near historic lows, as markets await a vaccine. We are three months from a presidential election, which will undoubtedly heat up and there is still double-digit unemployment. The Fed has communicated that they are prepared to do whatever it takes to keep the economy strong. Housing remains a bright light, despite high forbearance statistics. We are content to keep our powder relatively dry as we seek further clarity on the pace of the recovery. We continue to believe MSRs look compelling at current levels. And if they meet our measured risk reward criteria, we will selectively invest through our full program. All in all, our team's efforts remain squarely focused on proactively managing our portfolio, keeping our balance sheet strong and preserving our book value to enable us to emerge from the pandemic to take advantage of the opportunities we believe will be present once the economy rebounds. With that, I'll turn the call over to Julian, who will cover more details regarding our investment portfolio and its performance over the second quarter

Thank you, Jay. During the second quarter, spread sector markets improved as liquidity returned and spreads tightened on the heels of Fed policy. Those policy actions allowed us to continue to adjust our positioning to reduce leverage and maintain a high cash position. As the third quarter begins, continued Fed policy is the one constant. U.S. growth and unemployment remain uncertain, as the coronavirus weighs on the U. S. and global economies. A viable vaccine would aid consumer sentiment and confidence and would comfortably allow employees to return to work and improve growth prospects. The timing of such is unknown but we are hopeful that something materializes in the latter part of the year. Servicing-related investments comprised of full MSRs at a UPB of approximately $24 billion and a market value of approximately $177 million at quarter end. MSR investments represented approximately 37% of our equity capital and approximately 10% of our investable assets excluding cash. Meanwhile, our RMBS portfolio accounted for approximately 39% of our equity, a slight decline from the previous quarter. As a percentage of investable assets, RMBS represented approximately 90% excluding cash at quarter end. Our conventional and government MSRs, CPRs averaged approximately 38% and 28%, respectively for the second quarter. Speeds were elevated from the first quarter given historically low interest rates and mortgage rates. Similar to MSR speeds, the RMBS portfolio posted a weighted average three-month CPR of approximately 13.7% elevated from the prior quarter. Despite the decreased prepayments, the RMBS speeds remain better than Fannie Mae aggregate speeds for the quarter. As of June 30, the RMBS portfolio stood at approximately $1.5 billion. During the second quarter, we further repositioned and delevered our portfolio to maintain our liquidity position. Quarter-over-quarter the 30-year securities position of the RMBS portfolio grew to 95%, a slight increase from 93% as of March 31 and the remaining assets represented 5%. For the second quarter, we posted a 1.64% RMBS net interest spread versus a 1.25% net interest spread reported for the first quarter. The improvement in spread was due to significantly lower repo cost in the quarter and resetting our swap hedges to lower rates. During the quarter, our repo cost improved from 1.62% to 0.39%, as interest and mortgage rates remained at historically low levels. Mortgage prepayments will be the main driver of the net interest spread going forward. At quarter end, the aggregate portfolio operated with leverage of approximately 4.4 times down from 5 times the prior quarter. We ended the quarter with an aggregate portfolio duration gap of positive 0.19 years. We continue to evaluate and onto the portfolio as necessary as we move forward. I'll now turn the call over to Mike for our second quarter financial discussion.

Thank you, Julian. Our GAAP net loss applicable to common stockholders for the second quarter was $12.4 million or $0.73 per weighted average share outstanding during the quarter. While comprehensive income attributable to common stockholders, which includes the mark-to-market of our held-for-sale RMBS was $3.1 million or $0.18 per share. Our core earnings attributable to common stockholders were $7.9 million or $0.47 per share. As Jay mentioned, our book value per common share as of June 30, 2020 was $13.41, a reduction of $0.32 per share from March 31, 2020, net of the second quarter 2020 dividend. As we noted on our prior call, the accounting impact of paying half of our first quarter common dividend in shares of common stock was recognized in the second quarter and that encompassed the large majority of our book value reduction from March 31. Excluding that impact, book value was relatively comparable with the prior quarter. We use 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 TBAs and treasury futures all of which had a combined notional amount of $2.1 billion. Beginning with this quarter, we're providing more granularity with respect to our hedging strategy, which you can see in our 10-Q as well as in our second quarter presentation. For GAAP purposes, we've 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 $3.4 million for the quarter. On June 18th, we declared a dividend of $0.27 for the second quarter of 2020, which was paid in cash on July 28th, 2020. We also declared a dividend of $0.5125 per share on our 8.2% Series A cumulative redeemable preferred stock and a dividend of $0.515625 on our 8.25% Series B fixed to floating rate cumulative redeemable preferred stock, both of which were paid on July 15th, 2020. At this time, we will open up the call for up the call for questions. Operator? Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question is from Tim Hayes with B. Riley FBR. Please proceed with your question.

Hey guys. This is actually Mike on for Tim. Congrats on your quarter. So, my first question is that core EPS is well ahead of the dividend again. I guess just first question would you expect core earnings to exceed the dividend again in 3Q assuming there's no other major economic deterioration?

Hey, how are you, it's Jay. It's possible. But I think others -- as others have noted this quarter we use a variety of metrics to evaluate the earnings power of the company. Core is one, it's a big one, but we do look at other methods or things that we use to think about the true earnings power of things that we use to think about the true earnings power of the company. And today we're comfortable with where we are, but it's possible that core could exceed.

Got you, that's helpful. And then another question is that given where MBS spreads are and just the fact that it's become cheaper to hedge and your current amount of liquidity., I know you mentioned in your prepared remarks, Jay that you intend to maintain dry powder. I'm just wondering what would need to change for you guys to decide to get a little more offensive.

Yes. Broadly speaking I think hybrid REITs are holding on to more cash than agency REITs in light of some of the investments that they hold. So, I would say that our desire to hold more cash is not a reflection of our view on any one specific asset, but a reflection of our ability to maintain a strong balance sheet still just a few months after what happened last time. Again I would also emphasize that we've significantly reduced the size of our non-agency position. So, today the position really comprises of agency RMBS which is very liquid and very transparent pricing-wise than MSRs. Given where we are with forbearance, we think our forbearance statistics are very good relative to what we thought might happen. So, as we get more clarity into what we think might happen going into the fall, I would expect that we could pare down that cash position. But it really isn't a function of a lack of desire anywhere to invest just more a function of trying to maintain a strong balance sheet.

That's helpful. Thank you. And then, one more just on speeds, so I guess high level with the outlook for the back half of the year, and then what would you expect to see in terms of speeds if the primary saw another 30 or 40 basis points to 2.5%? How do you think -- how sensitive do you think speeds would be to that decline?

Hi. This is Julian. I mean we're already pretty sensitive to that decline. We're already seeing things that were created three to four months ago already being refinanceable. Things that came out with a -- there were a 3% coupon mortgage with like a 3 and three quotes to 3.9 GWAC are refinanceable. So, I would say the current mortgage rate that we're kind of seeing out there right now is like 3, 3.8 right now. I mean you're talking about another potential 25 to 60 basis points. We easily -- the market would clearly be much more refinanceable. And on the RMBS side, I mean we've had good speeds, but I could easily see those increasing by 50%.

That's helpful. And then just one more for me. Could you provide an inter-quarter book value update us anything as a legacy at the end of July?

Sure. I would characterize it as down approximately 1% to 2%.

Thank you for taking my questions.

Our next question is from Steve DeLaney from JMP Securities. Please proceed with your question.

Hey, good evening, everyone.

Hey, Steve. How are you?

I’m good, Jay. Hope you are.

Yeah.

So look, I mean all-in-all, a lot to be thanked for both company-wise, personally everything else considering what we've been through this year so far. So, congrats on that as well. You mentioned liquidity about a dozen times in your remarks. And just thinking about the decision the Board made in June to cut the div from $0.40 to $0.27, pretty meaningful cut. And that decision mid-June, you had to know that you were going to make something north of $0.40 in core at that point. And all of us -- I didn't adjust my numbers until I guess after that. So I was below at 25%, but the high estimate of the four was 32%. So, we all -- I don't know whether we got head faked or we were just assuming more deleveraging or whatever. But, was a decision made just to protect liquidity in that -- I assume that was largely related to servicing advances as opposed to repo or anything like that. Could you just comment on kind of the why such a large cut in the dividend relative to what core came out to be? Thank you.

Yeah. Sure. So, I'm happy to. So, a couple of things. One, we definitely wanted to concentrate on a strong balance sheet given everything around forbearance. And at that time, we were in the very early stages of understanding, how many people would go into forbearance, how long they would stay there and how that would impact our ability to support that. And as a servicer, obviously, you have an obligation to support those borrowers. So, that was definitely a consideration. And as one of our peers mentioned on -- in their presentation, we do look at a few metrics. We look at core. We look at comprehensive. We look at taxable, and we look at the true earnings power of the company. And so, core income is one component of that and we had a feeling that core might exceed the dividend in the short-term. But as we looked at other components of thinking about our income those other metrics came into play and that was a consideration. The last thing, I would mention is as Julian mentioned look speeds are high. And at the time in June we -- you don't know how long. How long are these speeds going to persist? Is the 10-year really supposed to be at 50 points or 50 basis points when the S&P and the Dow are approaching all-time highs? Where's the disconnect? Is disconnect in rates? Is disconnect in equities? And so within the context of that if we're in this lower interest rate for longer environment, we do expect speeds to continue to be high and that should also have an -- or have a meaningful input to the core calculation as well. And my guess is that would be to the negative. So what we discussed with the Board was look what's sustainable? What are we sure that's sustainable? The last thing we want to do is to mess with the dividend to offer. So that…

You don't want to miss it.

Yeah. That's right. And so given what happened in March that was exactly true.

So I would – yeah, go ahead. Go ahead. I'm sorry. I didn't mean to cut you off Jay.

Could we revisit it? Sure. But we're still in the middle innings of all of this. So we do have the ability to raise it. But generically speaking or broadly speaking, I think what the Board decided was appropriate.

Yeah. And you still have plenty of time to deal with any REIT minimum distribution requirements between now and end of the year, so that can be dealt separately.

Yeah. You'll see that in our -- you'll see that once you go through the financials. That's not an issue.

Okay. So look, first, the correlation between stocks and bonds are completely broken. I mean, we have to throw out all our textbooks, I guess, or our notes from economics and everything else. I mean, it just does feel broken. But won't -- that's not relevant. What is interesting for a company that is focused on agency MBS and Agency MSRs given where we are today, is there anywhere Julian that you go? Where can you -- I mean, pay-up is the obvious answer, but they've got run-up so much. So where -- if that's your investment menu, where do you go right now and get any -- some kind of protection from speeds?

Disney World.

Disney? Yeah. Okay.

I'm getting a little bit more detail of an answer. Look I think you can buy securities that -- where you don't have to pay an exorbitant price premium on those bonds and still get some type of protection. You may not hold them as long as you would like to hold the better quality type of product that you are paying, a higher price premium for, but you can still get some protection. I mean on the RMBS side, we still are seeing low to double-digit type of returns even with paying for a higher price premium. And even on MSR on the leverage side, we're still seeing on the low double-digit type side. So we do think the combination does offer an attractive return. Currently, we like, some of our peers are rolling a portion of our bonds. So we are taking advantage of the dollar roll market that's out there. It's never been a major strategy for us. We have been a firm that likes to pick bonds go to the collateral and try to have collateralized stories. But we also will take advantage of the specialists when it's that attractive. So we are doing that coupled with picking selectively, picking some bonds as well.

Got it.

And I would add to that Steve that, look the Fed has indicated that they are going to continue going to continue to be involved in buying MBS. And as long as that holds true prepays and mortgage bond pricing will be remain elevated. And we remain very in tune in touch with that as a determinant in how we think about deploying capital. And for those who are highly invested in lower coupon MBS today which have done have done well from a price perspective. The day the Fed decides that they're no longer going to support that market and size, you're going to see some meaningful hits. And so we're very in tune to that and try to maintain a balanced mortgage-backed securities portfolio relative to coupon.

Right. Right. I'll never forget June of 2013 that Wednesday and the taper tantrum. I'm sure you guys remember that too. Listen, thanks. Thanks everyone.

Sure.

Thanks, Steve.

Our next question is from Kevin Barker with Piper Sandler. Please proceed with your question.

So I just wanted to follow-up on the Ginnie Mae MSR sale. Could you just walk through some of the rationale behind the sale and then some of the direct impacts you may see? I'm assuming it's going to cause a significant decline in servicing costs especially with elevated forbearance that's going on right now?

Well, remember it was only -- hey, Kevin how are you? It's good to hear from you. Remember it was only 10% of our overall servicing portfolio. So relative to the overall portfolio of servicing, the impacts aren't going to be significantly meaningful. But I think as you pointed out, the delinquencies on the portfolio were getting high and we weren't adding to the portfolio. So it's a static portfolio that's only getting worse. And so, obviously, when you think about how the regulators might think about that, that's probably not a positive discussion. So given our current and short-term views on that part of the sector and given that our strategic partner is much better at handling that recapturing refinancing that we are, they were interested in the portfolio. They saw based on recent recapture results that a lot of that portfolio had potential for them. They had an interest in the portfolio. And we both looked at it together and we said to ourselves look if we're not planning on making any investments in the short-term in this portfolio, and we think that forbearance, et cetera might increase or grow relative to composition of that portfolio tonight -- today might be the right time to kind of divest to that. And you should never be married to any specific portfolio, right? I think it was -- it's a great fact pattern that we can actually trade that asset instead of held for investment are held to maturity. So from my perspective, it's always good to be able to show transactions on both sides of the coin. And given that we haven't added any assets that and in the short-term hadn't planned on growing that part of the portfolio, it made sense to us. So hopefully that helps with respect to your question.

Yes. It makes sense. Totally understandable just given the size of it and the fact that you weren't adding to it. And then also could you just talk about like some other opportunities that you may see out there, just maybe in other asset classes? And you still have healthy amount of cash and obviously you’re being conservative with it. So I’m just thinking, like, there has been quite a bit of market disruption and continues to be the case. But are you seeing any other ideas or maybe some other diversification or possibilities?

No that's actually a great question. Yes. Right after March I think a lot of us wanted to focus on the strategies that were kind of within your DNA. And, for us, at that time that was agency MBS and servicing. What happened in credit, look, everybody was down on rates going into this. But rates aren't going to kill you; credit’s going to kill you. Just -- I can tell you firsthand. And from that perspective, over the last three months we've really just kind of stuck to our core competencies. And to your point in the back of my mind, I'm thinking, okay, what's the next leg of the stool supposed be given that, to your point, there's been a fair amount of dislocation. Are there any opportunities in the market relative to our core competencies and when and where should we invest in those. And those are great discussions that we have here with the Board. But over the last couple of months my personal view was, look, as we exit out of this, our view is we did a good job coming out of this. Don't get too crazy getting into an asset class that you may have wanted to get into going into the crisis, just because you think it might look cheap. And I think that there are some asset classes that continue to look interesting and appealing on the loan space to us. And given the recent opening of credit, relative to kind of non-agency/non-QM, that could be something. But I would say that that is probably more of a fourth quarter question than a third quarter question or second quarter question.

Yes. Okay. That’s fair. I mean there’s still a lot of things that need be figured out here over the next several months or even years. Okay. And then, you've guys held up relatively well compared to your peers on book value holding up and portfolio is fairly stable, leverage is low cash is high. But your stock is not reflecting the strength of the balance sheet. Would you consider being a little bit more aggressive in buying back stock? Obviously, liquidity concerns there. But would you look at that? You have had a history of doing that here and there. So I was just wondering if you're looking at it just given where the stock is trading there.

So, that's definitely a conversation we would have with the Board. And should the Board decide that that would be appropriate, I would tell you that we would act on that.

Okay. All right. Thank you for taking my questions.

Thanks, Kevin.

[Operator Instructions] Our next question is from Henry Coffey with Wedbush. Please proceed with your question.

Yeah. Good afternoon and thanks for taking my question. In listening to the conversation that there are small pockets, it sounds like there are small pockets where you'd like to deploy capital, but there aren't any large places to put the money. Is that a fair...?

I think that's right. Yes. I think that's right, Henry.

And now your servicing costs, I'm just looking at my model really quickly, I mean, they're still around $6 million. Do they start to come down now that you've sold these assets? Or is this at $6.6 million that we're looking at a more likely number, for the rest of the year?

So broadly speaking, I would say, Ginnie is the most expensive to service …

Right.

… especially given level delinquencies and the high touch of the nature of the product versus conventional. So, on a pure relative basis, definitely, on an absolute basis, given the small percentage of the portfolio in that asset class maybe not as much as you would think. But I'm happy to kind of get that out with you on the side.

So everyone we talked to is looking at a $3 trillion, mortgage market or so?

Yeah.

And some people brought that up in February. And the expectations for next year are pretty rich. I would forecast your...

I would say [Indiscernible]…

The forecast aren't there yet. But every company we talk to thinks these spills over. So that means speeds stay high and the attraction of your two primary asset classes remains low. You can talk to the Board about buying back stock. Or just sitting here generating the kind of returns that you have, growing book value, is that the worst possible thing you could do with the next nine months?

After, what we just witnessed over the last five months? No.

I mean just -- I know it's a lot more conservative than my colleagues are talking about. But from a point of view of a current investor, if I bought, this -- I'm not talking about person who bought the stock six months ago. But in terms of writing checks today that's the best profile for just buying the stock and letting things kind of chill.

Yeah. Look, I would say -- we're looking to play offense. And we're looking to figure out where we're supposed to play offense. And within the context of what would another round of an increase in COVID cases, due to the market our sectors specifically and the equity markets relative to the REIT sector, we think that there is room to play offense. But do it in a responsible way. And we're not a straight agency route. We're not going back to 10 times leverage. We're going to let those guys do that. And if they do a good job great and we're a hybrid REIT. We haven't been shy about that. And to the extent that we find something -- and I think, you're right to your point, it's probably on a smaller scale than the other two asset classes we own. Then we'll think about investing in it. But the last four months would best be described as back to basics.

Great. Thank you.

Sure.

And we have reached the end of the question-and-answer session. And I will now turn the call over to, Jay Lown for closing remarks.

Thanks so much. Everybody thank you for joining us in today's call. And we look forward to updating you soon, on our third quarter results. And we hope you remain safe and healthy. Have a great night.

And this concludes today's conference. And you may disconnect your lines, at this time. Thank you for your participation.