Q4 2021 Cherry Hill Mortgage Investment Corp Earnings Call

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Greetings welcome to the Cherry Hill mortgage investment Corporation fourth quarter 2021 earnings call.

At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation.

If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.

And please note that this conference is being recorded.

Now I'll turn the conference over to Garrett Edson Investor Relations. Thank you you may begin.

We'd like to thank you for joining us today for Cherry Hill mortgage investment corporations fourth quarter 2021 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 Dot C. H M Dot 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 Irr's future expected cash flows as well as prepayment and recapture rates delinquencies and non-GAAP financial measures such as <unk>.

Earnings available for distribution or AAD and comprehensive income.

Statements represent managements 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 the company's filings with the SEC and the definitions contained in the financial presentations available on the Companys website. Today's conference call is hosted by Jay Lown President.

Julian Evans, the Chief investment Officer, and Michael <unk>, The Chief Financial Officer, now I will turn the call over to Jay.

Thanks, Garrett and welcome to today's call.

The fourth quarter of 2021 appeared as if it was going to be a breakout quarter for rates as we made progress through mid November until Covid concerns returned in late November and remained a major factor through the end of the year.

The fed also signaled its timeframe for exiting its bond purchase program, which impacted mortgage spreads going into the end of the quarter.

To top it off the fed backed off it's transitory stance around inflation as it was clear that inflation was going to be persistent.

Ultimately a key rate for our sector. The U S 10 year Treasury.

Finished the quarter essentially flat to the previous two quarters.

Interestingly, though.

Shorter dated rates did sell off through the quarter and the yield curve flattened with a two year 10 year spread tightening by over 40 basis points.

Economic conditions domestically remains strong throughout the quarter and data broadly speaking did not disappoint.

Volatility persisted through the quarter as well.

This theme has continued into the first quarter of 2022 and rates have lifted off meaningfully in anticipation of a rate hike. This week.

Unfortunately, the events in Ukraine over the past couple of weeks have become a significant concern globally and are making for a volatile near term economic environment.

While we still believe rates will rise in longer term as the fed has signaled a clear need to fight inflation we.

We are keeping a watchful eye on our portfolio and maintaining our strong liquidity.

For the quarter, improving prepayment speeds continue to aid our earnings available for distribution or <unk>.

In the fourth quarter, we generated GAAP net income applicable to common shareholders of $4 1 million or <unk> 23 per share and.

And <unk> of 32.

Exceeding our quarterly common dividend level.

As a reminder.

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

Book value per common share finished at $8 56 as of December 31.

As other agency rates have stated mortgage spreads widened quarter over quarter, particularly in the higher coupons and were responsible for a significant portion of the decline.

The interaction between the hedges and the composition of the portfolio accounted for a portion of that client as well.

Julian will provide more details on the portfolio's performance shortly.

As we noted on our prior call. Our current book value performance as 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 or.

Our performance in the quarter was more effective with AB down three 3% quarter over quarter before taking into account any stock issuances.

That said, we remain committed to beginning to drive improvement in our NAV and book value in 2022.

We remain constructive on the MSR segment of our business given our view on interest rates over the near term.

We have been disciplined in our approach to investing in msr's, given sizable competition and robust pricing, which we expect to continue well into 2022.

As prepayment speeds further decline at a higher rate world and behavioral modeling risk increases.

We continue to believe the best approach remains being selective in adding or replenishing MSR assets.

During the fourth quarter, we acquired approximately $1 2 billion and Fannie and Freddie Msr's.

We continue to believe the strategy of marrying Msr's with agency RBS.

Rides for attractive risk adjusted returns and AIDS in protecting the portfolio from the full extent of current coupon spread widening.

On our last call. We noted that we expected our leverage to gradually rise again and at the end of the quarter leverage was a modest have turned higher at three six times from three two times at the end of the prior quarter.

The leverage increase was mainly driven by our utilization of the new Fannie Mae facility for MSR advances as well as converting some TBA securities into specified pools during the quarter.

Our recapture efforts remained strong with a 23, 1% recapture rate on our MSR in the quarter.

We expect that recapture rates will decline as mortgage rates rise prepayment speeds net of recapture should continue to improve.

We ended the year with $64 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile.

As we move forward in 2022, our expectation is for continued volatility as the fed begins to tighten monetary policy.

While higher rates should improve asset yields on reinvested capital the pace of the tightening may result in a further flattening of the yield curve impacting borrower cost, resulting in NIM compression for the aggregate portfolio.

We believe the composition of our hedges and higher hedge ratio AIDS in mitigating some impacts from such fed tightening.

We believe there will be opportunities in agency MBS as spreads normalize and rates begin to peak.

As such we are keeping a firm hand on our balance sheet and when we see attractive investment opportunities, we will look to invest prudently.

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

Thank you Jay.

During the quarter there were two diverging main themes that impacted the credit spread and interest rate markets.

One was the fed's announcement of pending policy changes based on elevated levels of inflation and the other was the Expediate did rise of the latest Covid variant.

Those themes increased market volatility and change the shape of the U S yield curve, which impacted mortgage performance during the quarter.

The fed announcement was an admission that inflation was not transitory and an indicator to the market that policy was changing.

Not only with the fed about to raise interest rates, but it also indicated that a reduction to their balance sheet was possible it might occur sooner than previously thought.

At the same time markets were reacting to another widespread COVID-19 , Barry the threat and global growth.

On paper it might seem as though interest rate markets. We're com during the fourth quarter. The 10 year Treasury has remained relatively steady however.

However, there was plenty of volatility that drove the U S 10 year as high as 170 and as low as 135 only to settle three basis points higher at $1 51.

Despite the movement in the tenure too.

Two year treasuries rose 46 basis points flattening the spread between the two year and the 10 year curve based on the Fed's announcement.

The yield curve changed rise in volatility and previously mentioned themes weighed on the mortgage sector and our portfolio.

The middle of the coupon stack as well as higher coupons underperformed during the quarter.

At quarter end MSR has had a <unk> of approximately 21 billion.

And a market value of approximately $219 million.

During the quarter, we purchased $1 2 billion of new MSR.

Hello programs as Jay mentioned.

At the end of the fourth quarter. The MSR portfolio represented approximately 42% of our equity capital and approximately 14% of our investable assets excluding cash.

Meanwhile, our RMB BFS portfolio accounted for approximately 39% of our equity capital.

As a percentage of investable assets, our MBS represented approximately 86% excluding cash at quarter end.

During the quarter, we experienced ctr improvements in both the MSR and <unk> portfolios.

Our MSR portfolio net CPR averaged approximately 19% for the fourth quarter down from approximately 22% net CPR in the previous quarter.

The decline was driven by slower prepayment speeds in the quarter as well as steady recapture rate.

Similarly, the RMB is portfolio as prepayments slowed.

The portfolio's weighted average three month CPR reduced to approximately 12% for the fourth quarter compared to approximately 17% in the third quarter.

The fourth quarter CPR improvements were mainly driven by the fall seasonal and those CPR improvements have rolled into the first quarter.

However, the drivers of the slower CPR.

First quarter improvements had been mainly impacted by the steady and quick rise of interest rates and mortgage rates as well as some seasonal.

As mortgage rates have moved higher mortgage securities have become less refinance accordingly.

According to Citigroup approximately 12% of the mortgage universe is currently re financeable.

As of 12 31.

Our MBS portfolio inclusive of TBA stood at approximately $1 4 billion comparable to the previous quarter.

Quarter over quarter, there were a marginal improvement as the 30 year securities position increased slightly to 89% up from 87% at the expense of shorter duration securities.

15 year Securities and other collateral positions represented 11% of the portfolio at quarter end.

During the quarter, we reduced our TBA holdings and initiated the move into specified pools as the RMB as well as special needs to begin to diminish.

For the fourth quarter, we posted a 246 RMB.

Net interest spread versus the $2 two six net interest spread reported for the third quarter.

Improved asset yields were aided by better prepayment speeds, which more than offset slightly higher interest expense.

As we move forward in fiscal year 2020 to expect improvements in amortization to remain at current interest and mortgage rates are higher than they have been for the past two years.

As a result, the mortgage market with less refinance will than it has been.

In addition rates should remain higher given the fact that the fed and other global central banks are embarking on raising rate programs as well as stopping their asset purchase programs to combat improved economy and locked the inflation levels.

Intending higher repo costs are expected to be the negative.

Which should be minimized as interest rates hedges reset at three month, LIBOR and sofa increases.

At quarter end the portfolio leverage stood at approximately three six times at the aggregate level.

I will now turn the call over to Mike for a fourth quarter financial discussion.

Thank you Julian.

Our GAAP net income applicable to common stockholders for the fourth quarter was $4 1 million or 23 per weighted average share outstanding during the quarter.

While comprehensive loss attributable to common stockholders, which includes the mark to market of our held for sale, our MBS was $4 million or 22 per share.

Our earnings available for distribution attributable to common stockholders was $5 8 million or <unk> 32 per share.

As a note for the fourth quarter of 2021, we enhanced the calculation of unrealized gain or loss on investments in MSR is used to calculate.

By backing out hedging income.

Ore expense financing interest expense and any administrative servicing costs.

We believe this change better presents AAD generated by investments in Msr's with AAD generated by investments in RBS.

Our book value per common share as of December 31.

Was $8 56 com.

Compared to a book value of $9 seven as of September 30th.

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 fourth quarter, we held interest rate swaps swaption, Tva's and 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-K as well as in our fourth 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 5 million for the quarter.

On December 9th our board of directors declared a dividend of <unk> 27 per common share for the fourth quarter of 2021, which was paid in cash on January 25 2022.

We also declared a dividend of <unk> 51 to <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 January 18th 2022.

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

Thank you at this time, we'll be conducting a question and answer session. If you'd like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate that your line is in the question queue. You May Press Star two if you would like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star.

Our keys.

One moment, please while we poll for questions.

Our first question comes from the line of Mikael Goldberg government with JMP Securities. You May proceed with your question.

Hello, everybody. Thanks for taking the call question.

I'm almost done amazingly with the first quarter here mid March I'm wondering if.

If you could provide a book book value update where we are right now.

Hey, Macau how are you.

How are you guys doing.

Great So yeah I.

Right. The fact that it's March 15th.

And for the first two months of the first quarter.

We show <unk> down.

Roughly six 5%.

Book value per common share down, 12% and that's before accounting for the common dividend.

And I'd highlight that.

NAV.

I'd highlight the NAV because as you know comprises both common and preferred.

And we believe that's the driver for the earnings power of the company and thus the dividend.

And.

Despite the inherent leverage and I would say is embedded in the composition of our capital structure.

Doing a good job weathering the storm around all the mortgage spread widening so far.

Got you good to hear and I saw you guys had your 10-K come out just now with respect to that DTA I seats at the end of the.

At the end of the year, we're still around $20 million, what can we expect a similar amount.

I guess the quarter closing and a couple of weeks.

I'll, let Mike take that.

Well the DTA fluctuate in large part by changes in the mark to market value of the MSR and <unk>.

To the extent that the mark to market of Msr's.

Got it.

Increases there would be a portion of a decrease in a DTA associated with that markup, but obviously at this point in the period, we don't have.

We don't have insight into those numbers, just yet but broadly speaking that's how it should work.

Okay.

And.

One more if I can just just to kind of Oh.

Hopper level view of how you guys are thinking about portfolio construction.

Thus far through the first quarter and of course going forward given what the fed is about to do all the uncertainty in the market. How are you guys thinking about the mix of.

Agency MBS versus MSR is and what kind of coupons well within the agency MBS. Thank you.

Sure so.

As we mentioned.

In the prepared remarks speeds have dropped and.

Need to replenish the portfolio to keep it at the current size, obviously drops as well and so.

What I tried to imply in the remarks is we don't need to go out and buy a ton and given that approximately 40% of the equities in the asset.

What we do in terms of thinking about adding to that is really more a function of value.

In addition to just the mix itself and I think.

Everybody on this call would tell you that.

They think that the asset classes.

Lease fairly valued and potentially for full valued so.

We're going to continue to stick to the flow program.

We spatter in some bulk sales, but I wouldn't expect any meaningful changes to the composition of the portfolio outside of potentially.

Potentially reducing some.

Exposure to the RBS sales through the App.

Asset class during the quarter as a result of trying to protect from further spread widening in terms of coupons.

I'll, let Julian talk about that yeah, I would say throughout the quarter I mean, we've slowly progressed to higher coupons, but I would say that if you look over the performance of the first the first quarter just the mortgage basis in general it has widened somewhere between 40 and 45 basis points, but I would say all coupons have underperformed.

During the quarter. It Hasnt just been one specific coupon you can say in January it was lower coupons and in February it has been in the middle of the coupon stacks. So I wouldn't necessarily say there has been anywhere two really high in terms of this quarter in terms of.

Mortgages, so, but I would say in general we have moved up in coupon and continued to progress in that manner.

Okay. Thanks, a lot guys best of luck going forward in a pretty difficult environment for for MBS.

Thanks.

Thank you as a reminder, if you would like to ask a question. Please press star one on your telephone keypad.

Confirmation tone will indicate that your line is in the queue. You May press star two if you would like to remove your question from the queue.

One moment, while we poll for more questions.

At this time there are no further questions and I'd like to pass it back over to management for any closing remarks.

Great. Thank you. Thank you all for joining us on our fourth quarter 2021 call and we look forward to updating you in may towards first quarter of 2020 to have a good evening.

This concludes today's conference you may disconnect. Your lines at this time. Thank you for your participation and have a great day.

Sure.

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