Q3 2021 Cherry Hill Mortgage Investment Corp Earnings Call

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Issues 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, Chief Investment Officer, and Mike All participants are now muted press star two.

Your line, Thanks, Garrett and welcome to today's call.

The third quarter of 2021, so a rebounding economy.

Concerns remain about inflation and significant supply chain issues.

We continue to actively position our portfolio toward a rising rate environment, while maintaining a strong balance sheet.

However, while rate ended the quarter slightly higher than they were on June 30, we saw significant volatility intra quarter.

The 10 year dropped to a low of one 7% in August and remained low until the tail end of the quarter.

Given the absolute movement in rates intra quarter origination volumes remained high and prepayment speeds, while slightly lower quarter over quarter remained elevated in both portfolios.

In light of the positive economic and employment data year to date.

We believe rates have now stabilized at higher levels.

Persistent inflationary pressures as well as pending fiscal aid.

Also should support this thesis over the near term.

We expect this will be positive for our portfolio as we have positioned it for a steeper higher rate environment.

Beginning with this quarter, we re titled core earnings as earnings available for distribution or.

We believe this title is more indicative of how investors use this metric.

In the third quarter, we generated <unk> of 25.

After giving effect to a onetime regulatory settlement payment by Aurora, our MSR holder.

Equivalent to approximately <unk> <unk> per share.

Over the past 18 months or so states have become more aggressive in attempting to license MSR holders.

Although Aurora holds msr's it does not directly service the underlying loans or have any contact with the borrowers.

All of these activities are your line is muted license or exempt from licensing and the applicable states.

Notwithstanding the lack of any direct servicing activity by Aurora or impact on borrowers dates.

States are aggressively asserting the need for licenses and assessing penalties.

This onetime outsized payment firmly settled the issue with one of the more aggressive states.

Excluding the effects of this onetime payment.

We would have exceeded the quarterly dividend.

As we've noted before.

As just one of several factors, we consider in setting our dividend policy.

Continue to closely watch the interest rate environment, along with the impact of inflation and supply chain issues are having on a macro level.

But we remain confident in the near term sustainability of our dividend.

During the quarter, we continued purchasing MSR is through our flow program.

Pricing has been robust as new entrants deploy fresh capital and others aggressively compete for a finite supply of product.

We have been prudent in our approach to investing in this asset class in light of those factors.

We expect the market for MSR is to remain competitive for the foreseeable future.

And we will maintain our discipline.

With respect to deploying capital there.

We continue to believe our ability to manage this asset cloud effectively exceeds those who speculatively enter and leave this space, whether large or small.

Leverage was approximately half a turn lower to three two times from three six times at the end of the prior quarter.

This was primarily driven by us not tapping our Fannie Mae MSR facility pending replacement of that facility in October.

We expect our leverage to graduate we returned to levels. We saw earlier this year.

Book value for common share finished at $9 seven as of September 30.

The change in book value on a quarter over quarter basis was driven by a couple of factors.

Most notably the removal of the adverse market fee and corresponding behavioral model impact.

Low coupon RMB S underperformance.

And our hedge strategy, not providing adequate protection at an aggregate portfolio level.

Julian will provide more details on this shortly.

Part of the change in book value is a function of preferred stock, making up a significant portion of our overall equity profile.

On a net asset value basis, which doesn't account for the difference in common or preferred equity our performance has been notably more effective.

That said, we remain committed to drive improvement in our NAV and book value.

We realize it is taking time, but we would expect book value to begin to recover as we look to next year and beyond.

Okay.

Our recapture efforts remained strong with.

With a 22% recapture rate on our msr's in the quarter.

We firmly believe retaining borrowers is instrumental to our successful investment strategy and servicing.

Managing this effort will continue to be a focus of the company over time as the portfolio grows.

During the third quarter, we acquired approximately 720 million PBT of Fannie and Freddie Msr's utilizing our flow purchases program.

We believe this approach provides benefits as it mitigates the impact of spread widening on our portfolio.

We ended the quarter with $63 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile.

As we move forward with respect to our portfolio and the overall environment. We believe rates have stabilized and are poised to head higher potentially aided by fed policy tailwind or.

Our team will continue to proactively manage our portfolio to ensure that we're positioned appropriately and able to take advantage of attractive investment opportunities.

We remain constructive on the U S economy, and expect to invest further in msr's in anticipation of a bounce in interest rates that we believe should generate value for the company and our shareholders.

With that I'll turn the call over to Julian who will cover more details regarding our investment portfolio and its performance over the third quarter.

Thank you Jay and the third quarter. The U S economy continued to rebound nicely, thanks to sizable consumer demand with lowest pandemic protocols relax.

At the same time inflation was clearly beginning to weigh on many Americans with inflation metrics that havent been seen in decades.

First interest rates did not rise in concert with completion and in fact materially decline into early August however by the end of the quarter. We started to see inflation have an impact as the U S. 10 year ended the quarter slightly higher than where it stood on June 30.

Although interest rates have stabilized at these higher interest rate levels for now the portfolio was still impacted by the lower interest rates, we saw for the vast majority of the quarter.

As prepayment speeds remained elevated.

Looking forward, we continue to believe interest rates will progress higher over time, and we will remain opportunistic as we continue to pursue investments while closely monitoring inflation and supply chain issues that are impacting the global economy.

At quarter end MSR had a <unk> of approximately.

<unk> 21 billion and a market value of approximately $211 million.

During the quarter, we purchased $720 million UTV of newly Miss owners, who are flow programs at.

At the end of the third quarter. The MSR portfolio represented approximately 43% of our equity capital and approximately 13% of our investable assets excluding cash.

Meanwhile, our R&D portfolio accounted for approximately 39% of our equity.

As a percentage of investable asset RMB ads represented approximately 87% excluding cash at quarter end.

Our MSR portfolio average of approximately 22% net CPR for the third quarter down from approximately 27% net CPR in the previous quarter, driven by gradually slower prepayment speeds as well as the steady recapture rate.

We saw mortgage speeds declined further as <unk>.

Rates began to decline towards the end of the quarter and into October.

Meanwhile, the RMB portfolios weighted average three month CPR also improved slightly in the third quarter to approximately 17%.

Compared to approximately 18% in the second quarter.

During the quarter, we increased our exposure to 30 year Securities as of September 30, the <unk> portfolio inclusive of TBA stood at approximately $1 4 billion.

Which is comparable to the previous quarter.

The repositioning of the <unk> portfolio helps liquidity improves the overall RMB as prepayment speeds increase as carry as well as allows for further investments in <unk>.

Quarter over quarter, we increased our 30 year securities position from 83% the previous quarter, 87% of the portfolio this quarter.

15 year Securities and other collateral positions were reduced to 13% of the portfolio to finance the increase in 30 year Securities.

For the third quarter, we posted a 226 RMB as net interest spread versus a 232 net interest spread reported for the second quarter.

Higher interest expense was mostly offset by lower mortgage amortization, which benefited from the better prepayment speeds.

As interest rates have started to rise mortgage volumes should begin to taper off from previous highs and we should expect the trend to continue into 2022 should rates continue their current <unk>.

Trajectory.

Which would allow for improved prepayments speeds in the future in the near term. We continue to expect repo cost to remain low as the fed allow growth and inflation to run hotter than the historical norms to compensate for periods when inflation is run too little previously.

Quarter end portfolio leverage stood at approximately three two times at the aggregate level.

I'll now turn the call over to Mike for our third quarter financial discussion.

Thank you Julian.

Our GAAP net loss applicable to common stockholders for the third quarter was $6 2 million or.

<unk> 36 per weighted average share outstanding outstanding during the quarter, while comprehensive loss attributable to common stockholders, which includes the mark to market of our held for sale RMB FFS was $4 $6 million or <unk> 27 per share.

Our earnings available for distribution attributable to common stockholders were $4 2 million or 25 per share after giving effect to the one time payment equating to approximately <unk> <unk> per share that Jay referenced earlier.

Our book value per common share as of September 30.

It was $9 seven <unk>.

Compared to a book value per common share of $9 63.

As of June 30.

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 interest rate swaps swaption TBA short.

Additional treasury futures and options on Treasury futures, all of which had a combined notional amount of $2 billion.

You can see more details with respect to our hedging strategy and our 10-Q as well as in our third quarter presentation.

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 $3 7 million for the quarter.

On September 17th our board of directors declared a dividend at <unk> 27 per common share for the third quarter of 2021.

This was paid in cash on October 26.

We also declared a dividend of <unk> 51, <unk> <unk> per share on our eight 2% series, a cumulative redeemable preferred stock and a dividend of <unk> 50 156 to five.

On our 825% series B fixed to floating rate cumulative redeemable preferred stock both of which were paid on October 15.

At this time, we will open up the call for questions operator.

Yeah.

If you would like to ask a question. Please press star one on your telephone telephone keypad now and you will be placed in the queue in the order received.

These people.

All participants are now needed press star two and mute your line.

Okay.

Okay.

Hello.

Hi, Henry.

How are you.

Oh, okay.

Is this Q&A session, Yeah, Yeah, Hey, Henry.

Yes.

Alrighty.

So the new metric.

Is.

Really just operating earnings minus the fair value adjustments and that's your that's what you're thinking as the basis for paying the dividend.

Okay.

D is really just a name change from core earnings previously it would see the same formula as we've had for our core earnings up to this point.

And then of course on this this regulatory charge does that mean that I.

I don't want to get into specific states because you know we're always listening.

But there's usually a list of like state and number one in this state number two is most aggressive on this stuff do they do they all queue up and see a moneymaking opportunity or not.

Is this.

Hey.

The problem with.

Ltd.

Scope.

Yeah No sure. That's a good question. So there are a handful of states that we.

We had conversations with.

That were much much much more reasonable.

With respect to kind of how to be productive about.

The situation and each day with different relative to you know.

Whether it was being clearer unclear and we just had one state.

Out of that group that.

Really decided to do and that was the last date that we dealt with which we settled in October currently we.

Don't have any others can I tell you that.

Any others will never come up no, but we are spending an enormous amount of time trying to make sure that we're ahead of the curve now relative to.

You know what states are thinking.

And with this as a money conversation.

I want to emphasize that we don't service the loans directly and don't have any contact with borrowers. So this is.

You know about them getting fees for us being.

Licensed and paying them annually.

Yeah, I figured that part on.

In terms of the impact of the removal of the 50 basis points, we did see a couple of other people.

Right down MSR is based on that.

Okay.

The perpetual adjustments negatively on the fair value side.

How close when do we get to a point where.

No you're very right in your MSR is down to the point where it is.

Unless they're going to go away in a year it doesn't matter that the fair value process has kind of run itself out.

And what does that look like under the current interest rate situation.

So I definitely can't speak for what.

FHFA or any other regulatory bodies will do relative to changing.

Goalposts relative to how they think about the asset but.

Broadly speaking.

Outside of anything that's outside of our control we feel as though you know the asset has been and continues to be.

Marked appropriately and at fair value and broadly speaking.

The asset on a fair value basis.

Not necessarily quote unquote mark down.

Quarter over quarter, but.

<unk>.

The impact.

Of that had that definitely had.

A negative.

I guess impact to the final valuation relative to how the models treat the asset with respect to our lifetime speeds et cetera.

Chart that you showed in your deck.

Yes that forbearance is just an evaporating problem for you all.

Brian My Associates done some work and you know the one thing that sticks out is that.

Delinquencies are high and foreclosures are low.

If those two correct.

That can have an effect on your portfolio performance.

Sometime next year or are foreclosures going to dish.

Kind of roll through in a very smooth and orderly fashion and not have an impact. Your line is muted deliberate takeover in it for a second but all participants are now on muted.

All participants are now you did cross star six two unused your line was and where it is and our degree of comfort relative to.

How it's impacting our portfolio we've seen your line is muted.

Relative to this whole issue.

And get increasingly more confident that this problem is very very much behind us in that and it's very manageable I also know broadly speaking that.

The new Fannie Mae MSR line that we have in place has.

Room for servicing advances, which increases our ability to kind of manage through anything related to forbearance and.

As it relates to that.

The part of the question about.

The pig through the Snake Ray do you want to just give your opinion on.

2022 and beyond.

Yeah, I mean, I think that.

For the most part most of these guys will work out through the normal means a deferral or modification.

There'll be some small portion that that does go through till liquidation, but keeping in mind that while they were on forbearance. They couldn't be dual tracked so the forbearance timelines would essentially start once they've gone through.

Workout and determined that they don't qualify under a different role or a modification or some other <unk>.

Plan that would put them back on current.

So I suspect that given the state foreclosure timelines.

The amount that do end up going that route.

Don't actually find resolution until either late 2022 or early 2023.

Yes.

Our next question comes from Macau Goldman. Please go ahead Michelle.

Hi, Good evening gentlemen, thanks for taking the question just a question on the book value.

Sequential book value drop could you give us perhaps a little more color.

On that and also as it relates to the.

The future of the DTA.

Sure, we'll start with the DTA.

Sure. So the DTA will continue to fluctuate over time as the MSR.

Msr's.

Our marked up or markdown. So as msr's are marked up that would create a D. T. L. D. T L in that current period, which would eat away at the current DTA.

And so over time, you would expect as MSR is a written up the DTA will continue to shrink.

And on the on the first question just help me out and restate that again please.

Sure and I just wanted to get some color on what exactly drove the sequential book value was at 5.55% roughly.

That's right.

When you say sequential.

Well the drop the drop in book value quarter to quarter.

Right. So as I mentioned in his speech. It was it was a combination of things over the quarter.

Shape of the yield curve.

Definitely.

<unk> had an impact.

As I mentioned in the speech.

We're set up more for a bear steepened.

Relative to the yield curve relative to how these two assets one interact together and how the hedges protect us.

We still believe that.

There is an impending.

Rising interest rates as a lot of other things that we've mentioned in the speech come to fruition.

And that May take a little longer relative to fiscal policy et cetera, but we.

Main positioned for for that environment.

And that definitely did have an impact relative to how the portfolio and interact with together I will say that the changes in the model on our analytics around Youll book definitely as we mentioned had an impact relative to.

The final <unk>.

Our value on the MSR portfolio relative to how.

How the model trade the asset over the prior quarter.

And what am I missing some of the longer.

Lower coupon TBA positions also heard the portfolio as rates rose during we hit a low obviously of 118.

On the 10 year and then rose subsequently after that and that had an impact on the portfolio as well.

Yeah, I would add that you know as I'm sure others mentioned, the MSR definitely does help against spread spread widening on the lower coupon TBA.

But it doesn't cover it completely.

Alright expected no matter what happens if you have spread widening on TBA is I would say that a REIT that has MSR is and it will definitely fair better than pure agency REIT, but it doesn't cover all of that.

Got it thank you for that and.

With that in mind can I ask one more could you perhaps provide some color on where book value is now.

We're almost halfway through the quarter.

Yeah. So we don't have the MSR evaluations and and everything around that asset back in yet so I can't give you a a partial read on that.

Can't give you a partial rate on that it takes us usually so about the 12th of the 15th to get everything back.

On the MSR portfolio.

So I'd like to refrain on that one.

Sure I understand thanks, Thanks, a lot guys.

No problem.

And at this time, we have no further questions I would like to turn the call back to Jay for closing remarks.

Thank you operator, thank you very much for joining us today for the third quarter 2021 earnings call and we look forward to updating you early next year for fourth quarter have a great evening.

This concludes today's conference call. Thank you for attending.

The host has ended this call goodbye.