Q3 2019 Earnings Call
Greetings, ladies and gentlemen, and welcome to the Cherry Hill third quarter 2019 earnings Conference call. At this time, all participants are no listen only mode.
And that's a session will follow the formal presentation.
Anyone require operator system during the conference. Please press Star Zero and your telephone keypad that my pleasure to introduce your host Workover. Thank you you may begin.
Thank you for joining us today for Cherry Hill mortgage investment Corporation third quarter 2019 conference.
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 Dot DHL My read dotcom.
On today's call management's prepared remarks in answer to your question 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.
Our future expected cash flows as well as prepayment and recapture rate 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 FCC and the definition of contained in the financial presentation available on the company's website.
It's conferences 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 today.
Thanks worry and welcome to the days call.
We remain diligent and proactive with respect to our hedging strategy and managing our portfolio and a third quarter. As we noted we would do on or prior call.
As a result, we're pleased to report an increase in book value and core earnings in line with our new quarterly dividend level.
We achieved these results as ongoing macroeconomic and U.S., China trade later concerns persisted.
Global economic data remain softer and recessionary fears collectively weighed on the rate environment.
The fed telegraphed and ultimately executed on to 25 basis point rate eases based on those global concerns at U.S. tenure yields declined to end the third quarter well below the 2% level at the close of the prior quarter.
As of September Thirtyth, our book value increased to $17 in one sense from $16, an 80 cents at the prior quarter end or a 1.3% gain net of the dividends.
As we communicated on our second quarter call, we anticipated that the board would adjust our common dividend.
In September as the board announced a quarterly common stock dividend of 40 cents per share.
Which we believe is a better representation of our expected near term earnings performance.
Even the increase in prepayments and lower yield environment for the reinvestment of capital.
The board also authorized to $10 million share repurchase program.
Given the significant relative valuation discount.
We remain confident in our portfolio composition in investment strategy to deliver shareholder value over the long term and we expect to be active in reposition purchasing shares as appropriate.
As we expected prepayment speeds rose significantly in the third quarter.
Adjusted by normal seasonality and the lowest mortgage interest rates since 2016.
Our hedging strategy mitigated the impact to both earnings and book value This quarter.
Our proactive management helped us achieve core earnings for the third quarter of 41 cents per common share.
Our MSR strategy remains a priority for us.
During the quarter, we made MSR portfolio acquisitions exclusively from work flow program as most spoke packages. We evaluated consisted of higher note rates, but did not fit our investment objectives.
Our desire is to own and MSR portfolio that is balanced and diversified.
Due to the significant growth at the portfolio last year, we're deliberately managing this growth to better position interest rate exposure.
At the end of the third quarter, the MSR portfolio comprised of approximately 36% of our equity capital.
Down from the prior quarter of 39% largely due to the lower market value of the portfolio quarter over quarter.
Looking ahead, we expect market volatility to persist as we enter an election year.
We expect interest rates to remain contain which will cause prepayments to remain elevated in the short term.
That said despite prepayment speeds still elevated through October .
We believe stabilization will occur later in the fourth quarter seasonality and recent moves higher and interest in mortgage rates eventually take hold.
In summary, we will continue to take a thoughtful and balanced approach in our portfolio construction.
Our management team employs a proactive and collaborative effort and managing our portfolio taking into account border market actions on dynamic sector specific data.
We believe we are positioned in hedge to protect shareholder equity.
And we remain diligent about actively managing our investment portfolio to generate attractive risk adjusted returns for shareholders.
We believe there's meaningful value to be realized as we execute going forward.
With that I'll turn the call over to Julien, who will cover more detailed highlights for investment portfolio and its performance over the quarter.
<unk>.
Thank you Jay.
The geopolitical themes that were present in the second quarter carried over to the third quarter.
Global interest rates rallied on manufacturing weakness geopolitical concerns and continue rising U.S., China trade touches.
These concerns increased volatility in lower global interest rates.
Despite increased volatility a majority of credit sector spreads move tighter and equity indices moved higher expectations of continued global Central Bank intervention group.
This is that did not disappoint and deliver to expect it eases eating most spread sector assets.
Mortgages performance fluctuated during the quarter and ended the quarter softer as lower mortgage rates brought heightened prepayment and increased supply figures.
As shown on slide five servicing related investments comprised of full MSR is represented approximately 36% of our equity capital and approximately 9% where investable assets, excluding cast a quarter it.
Servicing assets declined as a percentage of equity from the previous quarter is MSR valuations declined alongside with interest rates.
Meanwhile, our RMBS portfolio accounted for approximately 62% of our equity 5% higher than the previous quarter due to a combination of additional purchases and rising market value during the quarter.
As a percentage of investable assets RMBS represented approximately 91% excluding cash at quarter end.
As of September Thirtyth, we held MSR is whether you PB of approximately 20 billion in a market value of approximately 256 million.
As we noted last quarter, given the falling interest rate environment, we made the prudent decision to slow the rate of additional MSR purchases.
As the availability of near par collateral dwindled into the rally.
In the third quarter prepayment speeds remained elevated as interest rates in mortgage rates moved lower our conventional and government MSR CPR is averaged approximately 24 and 17%.
Respectively for the third quarter conventional MSR speeds were up 12% from the prior quarter, while the government MSR rose from 14% CPR posted during the same timeframe.
As of September Thirtyth, the RMBS portfolio stood at approximately 2.7 billion.
Definitely 17% higher from the previous quarter as shown on slide seven.
Quarter over quarter, the RMBS portfolios composition shifted as capital was deployed.
The 30 year securities position of the portfolio grew to 85% up from 80% as of June Thirtyth and the remaining assets represented 15%.
In the third quarter, the collateral composition of the RMBS portfolio posted a weighted average three months CPR of approximately 11% as a prepayment speeds accelerated further based on lower mortgage interest rates.
Subsequent to the third quarter. The recent rise in interest rates may have dampened the effect of future mortgage prepayments, especially in the latter part of the fourth quarter and into the new year, assuming interest in mortgage rates can maintain the recent high levels.
For the third quarter, we posted a 0.87 RMBS NIM burst is a point before NIM for the second quarter.
The Nims modest increase was due to the repositioning of RMBS portfolio and resetting some of our payer swaps to lower rates.
Which was partially offset by the increased RMBS amortization.
We continue to expect the NIM to fluctuate near term.
As we move forward, we would expect the NIM to maintain or improved due to improvements in acid financing levels, a better entry point for asset yields and slower prepayments. The transition may take several months, but we may be on the cost.
At quarter end, the aggregate portfolio operate with leverage of approximately 5.9 times and a positive duration gap. We ended the quarter with an aggregate portfolio duration gap of a positive 0.24 years.
As we move forward, we will continue evaluating all to the portfolio is necessary.
I'll now turn the call over to Mike for our third quarter financial discussion.
Thank you Julien.
Our GAAP net loss applicable to common stockholders for the third quarter was $5.4 million or 32 cents per weighted average share outstanding during the quarter.
Well comprehensive income attributable to common stockholders, which includes the mark to market of our held for sale RMBS was $9.9 million or 59 cents per share.
Our core earnings were $7 million or 41 cents per share.
As Jay mentioned.
Our book value as of September Thirtyth was $17 and once that an increase of 21 cents per share from June thirtyth or 1.3% net of the third quarter dividend.
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 third quarter, we held the interest rate swaps and Swaptions TV A's and Treasury futures all of which had a combined to notional amount of $3.1 billion.
[noise] 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 the component of the net gain or loss on interest rate derivatives.
Operating expenses.
Were $3.2 million for the quarter of which approximately 598000 was related to our taxable REIT subsidiary.
I want to briefly mention and adjustment when we made to our core EPS accounting methodology this quarter.
As our portfolio composition has evolved over the past few years, we believed it was necessary to refine the MSR amortization calculation, we use in determining the amount of realized and unrealized gains or losses on our MSR investments.
Beginning with this past quarter, we've adjusted the MSR amortization method used for the calculation of core earnings to better reflect how carry on our MSR investments will vary with changing prepayment conditions. We believe this refinement more precisely reflects the earnings power and returns expected of Rms.
Our portfolio.
On September 4th 2019, we declared a dividend of 40 cents per common share for the third quarter of 2019, which was paid on October 29 2019.
On September 13, we declared a dividend of 51.25 cents per share on our 8.2% series a cumulative redeemable preferred stock.
And a dividend of 51.56 to five cents on our 8.25% series B fixed to floating rate cumulative redeemable preferred stock both of which were paid on October 15 2019.
At this time, we will open up the call for questions operator.
Thank you, ladies and gentlemen, if he'd like to ask a question. Please press star one on your telephone keypad confirmation total indicate your line is no question Q you if I start to if you'd like to remove your question from the Q for participants he thinks speaker equipment. It may be necessary to pick up the handset before passing on Starkey is one moment. Please so we pull for questions.
Our first question comes from the line of Steve Delaney with JMP Securities. Please proceed with your question.
Hi, Thanks for taking my other question guys look I know third quarter was such challenging for for everyone. In the agency MBS MSR world, but congratulations on the on the book value being a positive figure and it's nice to see the stock come back here in the last month or so.
Obviously, a different rate environment on a couple of fronts. The tenure of course, but also you know we've seen three month LIBOR floor come down pretty sharply here now.
Since our even even just since September and I'm curious based on what you're seeing in the repo market if that.
You know what did become a negative spread between what you're paying on your one month repo versus what you're receiving on three month LIBOR or.
I Wonder if you could just comment on all that may have been proved here in north and the last month or so.
Hey, Steve It's a it's Julian how are you.
I wouldn't say in general you are right libraries, obviously come down a repo has come down pretty significantly I would say post quarter end, even after what Weve reported here on the third quarter I believe in terms of our repo rate, we're posting like a 236 I would say we're currently seeing something.
Think about let's say 194, three month repo. So we do see somebody.
Trip improvements that will help improve the NIM in terms of the negative part in terms of three month repo coming down for our swapped positioning we've continued to adjust some of our old payer swaps into new payer swaps to kind of keep that receive versus what we're paying out on the positive side.
Got it got it okay. That's helpful and just thinking.
Thinking about the.
The tenure the decline in where your pre pay outlook today versus maybe your pre pay outlook in August or September whenever the lows, where I think they were after labor day.
Almost 50 basis points, My guess 40 47 basis points from sub 150 to 190, something how would how does that alone you know kind of setting to repos side, and and <unk> and that that.
40, or 50 basis points, you made I think Oh wise decision to.
Take the dividend down meaningfully, but as you sit here today with close to a 2% 10 year. Yeah can you comment on what that means to your earnings potential relative to being at 150, which is where the world was.
Yeah, I can try to talk to that Steve So I.
Extra.
One thing to note was that mortgage rates were pretty sticky on the way down relative to the tenure so I think.
You know they pretty much underperformed a on the way down and outperformed some extent on the way back up.
And so you know to that.
Fact, I don't think you're going to see as huge I pick up you know in terms of speeds dropping meaningfully over the short term relative to.
No. What you may have seen in late summer early fall, but yeah, we're hopeful that going into you know the winter months with you know what.
Prepay speeds naturally are coming down as well as you know the absolute uptick in rates that we'll get a breather Oh jeez I think you know we tried to convey that you know and that's in the speech, saying I think through October we saw that speeds remained elevated.
You know, but we are hopeful that as we get to the latter part of the fourth quarter that you know we get a breather.
Yep, Okay. So maybe so maybe it's really more of the combination a winner and rates and Marvel first first quarter, saying been so much or a fourth quarter staying in terms of.
The magnitude of of any improvement and at the right like fourth early first yeah.
Yep, Okay. Thank you and just one quick thing be.
The disclosure you made with respect to freedom and you know the Subservicing agreement has all that servicing since been transferred to one of your other partners at this point.
[noise], which which they have any referring to well. This was in your proxy and your proxy you had made a statement and it said that you did that.
They they had given notice of termination of the Subservicing agreement and that.
The transfer the servicing you would be transferring subservicing from freedom to other servicers and they said it would likely be completed into Q1 9, or Three Q1 9.
Right. So we aren't that is I believe we corrected that Oh I see yarn.
We're not we're not giving them round point acquisition by freedom or the proposed acquisition around point by Freedom. You know we made the decision to to kind of keep that as is a and today. They currently only service or subsurface our gennine portfolio.
But with the do it looks like it shows.
Well, what do you expect to close around point, you know and I have no idea where that when that's going to close you know obviously freedom will become a site you know a sub servicer of a decent part of our fanning portfolio. So.
Today.
I believe.
You know the official words that we said and.
More recently it was that it was reinstated virginie, a and want to documents off to get you to the actual okay. So the point is your you you are going to the the way things have worked out regardless of how we got there. It sounds like you were maintaining our relationship with freedom to service a portion of your part of your portfolio. That's correct. Okay that makes.
Okay, well. Thank you that's always be Thomas good job. Thanks.
Thank you. Our next question comes from line of Tim Hayes with B. Riley FBR. Please proceed with your question.
Hey, good evening guys. Thanks for taking my questions. My first one just you know your your weighted average interest interest expense went down this quarter and it sounds like you expect that to continue trending down.
In terms of your funding costs, there, but it doesn't seem like your materially impacted by the disruption in the repo market. This quarter I at least on price level, but you know if not on price for you impacted in terms of.
The availability of capital or haircuts or in any other way and have you seen that normalized more broadly.
Okay I'll take that Tim.
We have seen it normalize definitely as the fed is added an additional liquidity into these markets and we expect them to continue to add a as much liquidity as they've added currently or even a greater amount into the December timeframe as we kind of move over yearend.
I would say we were not as impacted as maybe some of our other counterparties because a lot of the repo that was impacted was overnight repo majority of the repo. We have it's been more term specifically, it's been kind of three month on average and so we were not as impacted as our counterparties.
Right that makes sense. Thanks for that clarification, there and then Julian what are Levered returns on M.S. ours, and your prepay protected RMBS right now are you able to deploy capital accretive Lee.
And then how attractive do you view buybacks as a source of capital deployment right now with your stock trading at about 11% yield.
So I'll take the first one just repeat the second one but I think given you know where we've been buying a MSR us.
High single digits Unlevered analyst call eight to 10.
And I think our average advance rate isn't a 60, 65% range. So you know where we're looking at a low to mid teens.
<unk>.
In terms of the agency RMBS I would say that that's a low double digits currently given the backup that we've seen in rates are the asset yields are a completely more attractive now than they were let's say a month ago.
Huh.
And so that the stock I think you know what we tried to convey on the call was saying that we expect to be active.
And repurchasing shares you know when it's appropriate I think that's a fluid discussion.
You know, but we are committed to executing.
On that program and you know what I don't have for you is you know a number what we'll do how we'll do it you know et cetera.
Huh.
Okay.
Still helpful. Appreciate the comments there and then.
You made a well your coverage or dividend this quarter with core earnings and you guys made some constructive comments around your NIM outlook and yeah, I know that there's a lot of uncertainty in but you know volatility potentially ahead.
But how do you think about dividend coverage can you just remind us if you of course <unk> is really the benchmark you guys used for setting a dividend or if you take economic return into account as well.
So I think you [laughter]. It's it's good question relative to some other costs out over the quarter, but I still think that you know what's our desire to have a dividend policy that is representative of the earnings power here.
And you know today I believe that still you know equates to core and so you know.
We set the dividend of 40 cents you know, we still think in the near term that Oh.
We have the ability to cover the dividend you know.
If we get a break in rates a you know continued horizon that you know the outlook looks better for spread sector assets, great. You know, but today, what I think we tried to do a set of dividend level that we could sustain for awhile.
If you recall I think our last dividend level was you know for.
16 consecutive quarters or something like that so.
Oh, we're looking to have a stable dividend you know if for some reason the market goes our way great.
Okay.
And I'll just sneak one more in here and.
If you would have just a book value update so far I intra quarter.
Yeah. So I think you know as the end of October at somewhere around town around 1%.
Okay.
Great well, thanks, again for taking my questions and congrats on a strong quarter.
Thanks.
Thank you. Our next question comes from line of Henry Coffey with Wedbush Securities. Please proceed with your question, Yes. Good evening and thank you for taking my questions that that 1% gain in book value was probably the hardest work you've ever done to get 1%, but I think it's a significant benchmark for all of us. So.
Congrats there.
You know, we had a lot of discussions sort of online and offline and I'm sure you for sort of thought a lot of about where you want to go.
You know as the mortgage market keep sort of shifting and evolving.
The the very tight focus on on essentially.
Agency assets is good.
Have you.
Sort of evolved in your thinking in terms of what you might want to do or is it let's be narrow and deep in one area and optimize value or where we can.
You know at the eight for the 80 20 rule I think the the strategy still applies [noise].
You know were consistent only looking for opportunities you know in west interest rate sensitive areas to diversify.
But today, we don't have anything you know it's to report around that but 80 20 rule would still be that you know we're very focused on the two strategies that we can complement each other well.
Is there a place in this equation for something like a credit risk transfer bonds or is that.
Taking you too far away from your basic box right now.
No we actually have owned a credit risk transfer bonds for a few years.
Okay, so that that that scenario, where you would be able and happy to invest should you know as opportunities present themselves any other sort of asset classes like that that aren't MSR is aren't RMBS.
Yeah today, we're currently invested in some jumbo prime deals as well as.
Got it was transferred Yeltsin book Jaycees.
Are they.
Had those quote other assets you know the 20 as opposed to the 80, how have they perform for you and and and you know how are the spreads operating and in those other assets for you.
Well I would say that the spreads have tightened in resi 2.0, other credit spreads and they've also tightened in the CRT.
I would probably argue that they are less attractive today than maybe they were call. It three months ago, because the credit spreads have kinda tightened in in order to meet some of the returns you do have to go down in credit or to make double digit type of returns kind of achievable.
They've done well in our portfolio I would say from a spread tightening standpoint.
I would say from an amortization standpoint, or the non agency resi 2.0 is probably not been as an attractive an asset I'm in the past because rates rally down 50 basis points and made a lot of that product, they're very refinance will.
I I noticed the treasuries changed to ever so slightly in the last three or four days does that also the way you're thinking about.
Managing in balancing the portfolio or or.
Is it just a snap and now we're back into the same environment.
So if you're talking about just enhanced volatility in general I think the last five months have been if you know challenging you know we manage the portfolio to a range and where we try to be very.
Thoughtful and programmatic about how we think about staying within that range and I think we telegraphed to the market consistently over the last two calls that we're trying to maintain a fairly neutral you know duration gap.
In part just given a lack of clarity around where rates might go Oh, and so I can tell you that heading into an election year nothing has changed there.
Great and lessen congrats on on all the work this quarter and and giving US a fairly stable profile to fall back on so thank you very much.
Thank you for the interest center.
Thank you ladies and this ladies and gentlemen, it. This time there no further questions I'd like to turn the floor back to Jay for closing comments.
Great. Thanks, operator, Hello, everyone. Thank you for joining us in today's call 'em, we look forward to updating you soon on the fourth quarter results have a good night.
Thank you ladies and gentlemen. This concludes today's teleconference. You may disconnect. Your lines at this time. Thank you for your participation.