Q4 2022 Cherry Hill Mortgage Investment Corp Earnings Call

March 7, 2023

The conference will begin shortly.

Raising Malawi Johan during Q&A, you can dial star one one.

[music].

Yeah.

Thank you for standing by and welcome to the conference call. The Cherry Hill mortgage investment corporations fourth quarter 'twenty two earnings call. At this time all participants are in a listen only mode. After the speaker's presentation there'll be a question and answer session.

I ask the question at that time, Please press star one on your telephone.

Today's call is being recorded I would now.

Now I'll turn the conference host Mr. Garrett Edson of ICR. Please go ahead.

We'd like to thank you for joining us today for Cherry Hill mortgage investment corporations fourth quarter 2022 Conference call. In addition to this call. We have filed the press release that was distributed earlier this afternoon and posted to the Investor Relations section of our website at Www Dot <unk> Dot com.

On today's call management's prepared remarks and answers to your questions may contain forward looking statements 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 earnings available for distribution or EAP and comprehensive income forward looking 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 more detailed discussions related to these forward looking statements contained in the Companys filings with the SEC and the definitions contained in the financial presentations available on the company's website today's conference call hosted by Jay Lown, President and CEO Julian Evans, the Chief investment Officer, and Michael <unk>, The Chief Financial Officer, now I will turn the call over to <unk>.

Jay.

Thanks, Karen.

Welcome to our fourth quarter 2022 earnings call.

Our efforts were effective in the fourth quarter to protect book value.

As investment markets remained in a challenging economic environment.

High inflation and a well supported U S employment market led the fed to hike rates 125 basis points during the fourth quarter and it appeared that the fed was making headway with its efforts to lower inflation back to its target level.

Volatility subsided during the quarter and spread sector assets recovered some of the losses experienced in the third quarter.

As many of our peers have noted the mortgage basis improved throughout the quarter as well.

The U S treasury yield curve however.

Main inverted and has shown no signs of Steepening, thus far this year.

Which has significantly impacted the earnings power of many companies in our sector.

Given the most recent economic data markets are bracing for a higher for longer scenario.

And the potential for a recession later this year.

The combination of our efforts to refine our investment and hedging strategies has enabled us to be successful at stabilizing in protecting book value in recent quarters.

Given the expectation of continued interest rate hikes, and the evolving macro environment.

We remain positioned for additional rate hikes.

To that point, we continue to utilize TBA is to partially offset spread widening risk as we await the fed to convey when it expects to end its tightening cycle at which point, we could look to increase our risk profile.

For the fourth quarter, while we generated a GAAP net loss applicable to common stockholders of $1 59.

Per diluted share, we generated earnings available for distribution or AAD, and non-GAAP financial measure of $5 3 million or 20% per share.

It bears repeating that AAD is only one of several factors considered in setting our dividend policy.

Thus, while not a line this quarter our board continues to monitor our earnings capabilities to ensure our dividend is at an appropriate level.

Value per common share finished at $6.06 as of December 31 up a penny from the prior quarter.

We believe creating a more stable book value profile is in our shareholders' best interest and remains a top priority for us.

When you consider that our preferred stock makes up a significant portion of our overall equity profile. We were pleased that on an NAV basis and before taking into account any issuances of equity through our common stock ATM program.

We posted a stable NAV relative to the third quarter.

As such during the second half of 2022.

He was off approximately five 1%, which we believe compares favorably to the performance of many others in our industry and.

And speaks well to our ability to navigate a very challenging macro environment and the unprecedented speed of fed rate hikes.

During the fourth quarter, we acquired approximately $780 million in new PB, Fannie and Freddie Msr's via flow and bulk purchases.

Prepayment speeds on our MSR portfolio remained low.

And thus the pace of reinvestment to maintain the allocation of capital to the asset class has decelerated.

Recapture rates on MSR has also slowed to the low single digits as expected given our higher interest rate levels.

Our strategy of pairing MSR with agency MBS.

Along with proactive portfolio management and hedging has continued to benefit shareholders.

At the end of the year financial leverage improved modestly to three eight times as we took a more targeted and disciplined approach in the fourth quarter with respect to deploying capital.

Given the ongoing market volatility, we believe we remain prudently levered and expect to be opportunistic in deploying capital and increasing our leverage in 2023.

We ended the year with $57 million in unrestricted cash on the balance sheet, maintaining a solid liquidity profile.

As we look forward in 2023, we expect to maintain our conservative and proactive approach to portfolio management.

Where there are risk adjusted opportunities to selectively deploy capital we will take advantage.

Additionally, we anticipate our hedge ratio will likely remain elevated.

Given our expectations of ongoing fed rate hikes to further combat stubborn inflation.

Our priority remains to protect book value and we will remain mindful of our liquidity and leverage profile given the environment.

With that I will 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.

Investment themes that were prominent in the third quarter rolled over into the fourth quarter heightened volatility thinly liquid investment market widening spread sectors and a weakening equity markets were all influenced by fed determined to reduce inflation.

All changed after the October and November CPI reports as the reported inflationary numbers suggested that inflation was moderating faster than expected.

Post the inflationary numbers spread sector in equity markets tightened and interest rate markets as.

As investor sentiment changed.

The sentiment change was driven by a perception that the fed might end up doing fewer fed fund rate increases than we initially expected.

With that said most inflationary measures have moderated but remained elevated above the fed's, 2% target for the first two months of 2023.

Stubbornly high inflation has led to renewed predictions that the fed having to increase the fed funds rate greater than what the market had initially perceived.

The market is currently expecting a terminal fed fund rate level between five and a quarter and $5 75 as.

As a result, we continue to employ a thoughtful hedging strategy in the fourth quarter to protect our book value and we believe those efforts have largely been working as intended.

This investment strategy has carried over into the first quarter of 2023.

At year end, our MSR portfolio had a <unk> of $21 7 billion and a market value of approximately $280 million.

During the quarter, we purchased approximately $780 million UTV of new msr's through our bulk and flow programs at.

At year end, the Msr's and related assets represented approximately 38% of our equity capital and approximately 30% of our investable assets excluding cash.

Meanwhile, our RMB <unk> portfolio accounted for approximately 45% of our equity capital as a percentage of investable assets. The rvs portfolio represented approximately 70% excluding cash at.

At year end.

During the quarter, we continued to experience CPR improvements in both our MSR and <unk> portfolios.

Our MSR portfolios net CPR averaged approximately 5% for the fourth quarter down from approximately 7% net CPR in the previous quarter.

The decline was mainly driven by seasonality and the change in mortgage production coupons, which drove slower prepayment speeds in the quarter.

The portfolios recapture rate was lower at approximately 2% versus approximately 7% in the third quarter.

As expected with mortgage rates rising as the incentive to refinance has lessened.

Moving forward, we continue to expect low recapture rates and stable net CPR for the foreseeable future given the current levels of interest and mortgage rates.

The RMB as prepayment speeds remained low lower CPR was driven by a combination of new asset purchases as well as the fact that the current higher mortgage rate environment is compressing CPR for the existing portfolio.

As of today, the majority of the mortgage universe remains out of the money in terms of refinancing we would expect prepayments to remain at low levels as long as interest rates stay at these levels or move higher for the quarter. The RMB is portfolio weighted average three month CPR reduced to approximately three 8%.

Compared to approximately four 7% in the third quarter.

As of December 31, the <unk> portfolio inclusive of TBA stood at approximately $646 million compared to $759 million at the previous quarter end.

Quarter over quarter, the spec pool portion of the portfolio continued to grow as we opportunistically took advantage of higher interest rate levels, and lower price premiums, but putting new cash to work as well as converting a few dollar rolls into pools as dollar rolls we can further.

The <unk> portfolio number is lower as we further utilize TBA securities to hedge a portion of the portfolio. We also continue to proactively change the portfolio's composition moving into higher coupons and reducing spread duration for the portfolio.

At the end of the fourth quarter. The 30 year securities position represented the entire rvs portfolio up from 96% at the end of the third quarter.

For the fourth quarter, we saw an increase in our MBS net interest spread to 377% as compared to 349% net interest spread reported for the third quarter. The improved NIM was driven by previously mentioned factors. One we took advantage of wider mortgage spreads and high.

Your yield levels by putting new money to work throughout the quarter, two we rotated our portfolio swapping out of low yielding assets and purchasing higher coupon mortgages with better yields.

Overall expenses were greater but were more than offset by increased income, which was driven by the previously mentioned reasons.

At year end the portfolio financial leverage stood at approximately three eight times at the aggregate portfolio and the portfolio was managed with a negative duration gap.

Looking forward, we remain mindful of the current environment as we expect the investment markets to remain choppy until there is a clear sense that the fed is reaching its terminal rate.

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

Thank you Julien.

Our GAAP net loss applicable to common stockholders for the fourth quarter was $34 5 million or $1 59 per weighted average diluted share outstanding during the quarter.

While comprehensive income attributable to common stockholders, which includes the mark to market of our held for sale, our MBS with $6 2 million or 29 per weighted average diluted share.

Our earnings available for distribution attributable to common stockholders were $5 3 million or 24 per share.

Our book value per common share as of December 31, 2022 was $6 six.

Compared to a book value of $6 five.

As of September 30th 2022.

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 Tba's Treasury futures and options on Treasury futures all of which had a combined notional amount of $930 million 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 2 million for the quarter.

On December 15th 2022, the board of Directors Directors declared a dividend of <unk> 27 per common share for the fourth quarter of 2022, which was paid in cash on January 31 2023.

We also declared a dividend of <unk> $51 25 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 17 2023.

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

Thank you again, ladies and gentlemen, who'd like to ask a question. Please press star one on your telephone to ask a question. Please press star 111 moment. Please.

Thank you one moment.

Our first question comes from the line of Mcgill government of JMP Securities. Your line is open.

Hey, good afternoon, gentlemen, thanks for taking the question.

Could you, perhaps expand a little bit further on.

A comment about the.

The viability of the dividend versus.

What sort of a sustainable level of core earnings.

Might see going forward, given the especially given karl's comments today.

But where rates are headed.

And also I don't know if I heard you guys correctly, but did you say that book value was down 5%, thus far this quarter.

Hi, how are you sort of answering the second question is no. We didn't we didn't say that it all book value.

Through the end of February .

Prior to the dividend is flat.

Right. Okay. Thank you apologies for that.

<unk> with respect to the dividend.

Look I think you've heard from us before and Youll continue to hear that we consider AIG as a measure and I think we alluded to that in the script, but.

We look at total return, we obviously think about where rates might go and how sustainable that dividend is overtime and.

Broadly speaking as the board meets every quarter and we'll continue to evaluate.

The strength of the dividend relative to earnings.

Earnings power and the.

The requirements of the market relative to our space and.

We expect to provide more information on that later this week.

Alright, thank you.

Just going forward, how do you guys think about the tradeoffs between building the portfolio towards agency RMB.

MSR is.

Interest rates to keep sort of breaking through.

The five in the quarter to five and three quarter expected rate as we start going into a six handle.

Do you start thinking about your portfolio then thanks.

Alright.

Look I think the early read is that.

We have preferred our agency RMB asset these particular levels, which we would say is kind of in the mid mid teens that we kind of see the returns.

We have also aiding I think some of that some of the performance we have a large rather large swap portfolio, which has kind of moved again and kind of coincide with repo rates rising.

Almost on a one to one basis for us so that has offset some of the rising repo costs that we've seen so if the fed is moving higher that portfolio has kind of benefited us.

In terms of MSR in the kind of the returns that we're seeing right now in terms of the portfolio.

I would say kind of low to mid teens is kind of what we're seeing for those type of returns, but in general we are evaluating that constantly over time, but I would say just from a spread widening perspective.

Agency MBS looks rather attractive.

Alright. Thank you gentlemen, appreciate it good luck going forward.

Thanks Mikael.

Thank you one moment please.

Our next question comes from the line of Mr. Hallett.

B Riley your line is open and Matthew Hallett.

Hey, guys, Hey, Jade Thanks for taking my question.

Matt.

I would love to hear from the team how do you characterize the risk profile of the company today I mean, clearly the leverage is low from historical basis. It went down in the fourth quarter I look at your sensitivities.

Because of interest rates, it's nothing one way or the other the book doesn't change all that much youre out the overhead.

How do you characterize it.

Without asking the obvious question.

What's it going to take.

To begin.

Taking increasing leverage taking advantage of these.

These underpriced Mark.

Cheap MBS values and so forth I'd, just love to hear you put that into context in terms of where the company is versus historically, where it's operated.

It's Julian again.

Look I think we sit here and say look the market looks very attractive, but I think you need that better clarity from the fed.

Clearly Paul had statements to today and in the statements as kind of alluded to interest rates and the fed funds rate moving kind of a higher the market is kind of projecting it at this point in time to be five and a quarter somewhere between five and a quarter $5 75.

I would say.

Just take a month ago outside of the more improved data that we got from January the market was probably expecting the fed to stop somewhere between five and five and a quarter at that point in time, I think if we get greater clarity from the fed in terms of the directionality or how high they want to take rates I think that becomes your opportunity time.

That kind of take.

Probably increase leverage and take more advantage of the market.

And then in terms of the fed with what they do with the balance sheet and how much.

Any sort of thoughts regarding their MBS holdings and what are your thoughts there.

I think the initial subsidy does that basically that the fed would not sell MBS they've had multiple opportunities to kind of sell MBS through throughout this time period that they've been actually raising the fed funds rate I think thats. The most effective tool at least on their perception is that they'd like to continue to raise the fed funds.

Right to levels, they perceive that will kind of slow down the economy and retain the balance sheet.

You can allude to that at some point, if continuing to raise the fed funds rate proves to be an effective that they might try to do something on the balance sheet, it's a possibility, but it wouldn't be.

In my mind, a high percentage of that is what they would like to do.

Yeah.

Got it it makes a lot of sense.

Moving to servicing them and it's been a great asset and a great strategy for you.

How do you I mean, when you look at it where MSR values are today I mean, obviously rates rates you have a low coupon and underlying coupons in the show we're seeing would you look.

If there's a scenario where yes.

Some are forecasting the fed to cut at some point maybe later next year. Later this year early next year, but would you look to reallocate more MBS at servicing sort of run its course or do you feel like.

That profile with you recaptured still there's still going to be a core asset.

Going forward or if the interest rate cycle does change I was just curious how you look at servicing.

This year.

Yes, sure Matt So the portfolio has a.

A note rate of.

Let's just call it three and a half.

Right.

And the current interest rate on mortgages is let's just round at six and a half so from the perspective of that portfolio the way.

We look at that portfolio is theres a lot of runway.

In terms of having pretty strong cash flows before.

That portfolio is in danger of refinancing outside of normal.

Life events, and so we really feel good about.

The strength of the cash flows in that portfolio. Despite the rates.

At this point, given the duration and the convexity of that portfolio.

Which is almost nonexistent at this point, we think there is a lot of room to run on that portfolio should should the fed cut rates at some point in time before we have to even start thinking about recapture.

And and things around the degradation of that portfolio. So we feel really good about the profile of that portfolio today, because the reality is.

Speeds are your enemy.

You can hedge a lot of things right wise, but speeds are your worst enemy and from our vantage point given the cloud are characteristics that are inherent in the portfolio today.

We think that asset is going to continue to perform pretty strong.

Yes look it at the speed that they bought.

Were they under five I've never seen them.

This lowered my in my lifetime in my career and I don't know if <unk> seen I don't know how much lower they can go buy that made the spin just.

Incredible to see the speeds fall, but they are on it and I ask that I know your people your prepayment protected on the on the MBS side I was just curious on the servicing it makes a lot of sense.

With the.

With the strong cash flow.

In that scenario are you seeing I mean would you be more active in the bulk market with some of these smaller originators that are selling or buying that business.

I mean, it seems like the values cheapened up a little bit earlier. This year would you look to grow that portfolio Jay given them.

But it looks like it would be a lot of sellers out there even some big sellers.

So we look at portfolios.

Every day and for the smaller originators, it's our expectation that there is a concession in price.

Which is favorable to us in terms of yield and so we absolutely book and see look at and see a lot of those portfolios on a regular basis.

Youre asking me if we're seeing a lot of small guys. So I wouldn't say, we're seeing again out of small guys were seeing.

Decent steady flow of volume away from what I would call it the wells dynamic going on today, but.

Yeah.

There is an opportunity to acquire the asset at <unk>.

The levels that I would say that are slightly lower than.

The craziness in the fourth quarter.

Yeah right right.

So that might be an opportunity for you guys well look I'll, just say that the performance has been terrific and with the yield curves inverted and you guys are generating.

Positive economic return that that looks just terrific.

Really congratulating all really some great results in a.

Hopefully a very strong 23, thanks a lot.

Thanks Pat.

Thank you.

I'm showing no questions at this time I'd like to turn the call back over to management for any closing remarks.

Thank you operator, thank you everybody for joining us on our fourth quarter 2022 earnings call, we look forward to.

Updating you on our first quarter results sometime in May have a good evening.

Thank you ladies and gentlemen, this does conclude today's conference. Thank you all for participating you may now disconnect have a great day.

The conference will begin shortly to raise and lower Johan during Q&A, you can dial star one one.

[music].

Okay.

Yes.

Yeah.

[music].

Okay.

[music].

Okay.

Yes.

[music].

Sure.

[music].

Yes.

[music].

Okay.

[music].

Yes.

[music].

Sure.

Yes.

Okay.

[music].

Okay.

Yes.

<unk>.

Yes.

Okay.

[music].

Yes.

Okay.

Yes.

Yeah.

Okay.

Yes.

Okay.

[music].

Yes.

Okay.

Yes.

[music].

Thanks.

[music].

Okay.

[music].

Okay.

[music].

Sure.

Okay.

Thanks.

Sure.

Okay.

Yes.

Hum.

Okay.

Yes.

Thank you.

Sure.

Okay.

Yes.

Sure.

[music].

Yes.

[music].

Okay.

Yes.

[music].

Okay.

Yes.

Okay.

Yes.

Okay.

[music].

Yes.

Okay.

Yes.

[music].

Yes.

Sure.

Yes.

Okay.

Yes.

[music].

Okay.

[music].

Okay.

[music].

Sure.

Yes.

Okay.

Yes.

Okay.

Sure.

Yes.

Okay.

Yes.

[music].

Okay.

[music].

Okay.

Yes.

[music].

Okay.

Yes.

Okay.

Yes.

Okay.

Sure.

Yes.

[music].

Okay.

Yes.

Okay.

[music].

Okay.

Yes.

[music].

Okay.

[music].

Okay.

Yes.

[music].

Okay.

Thanks.

Okay.

Yes.

Thank you.

Yes.

Okay.

Yes.

Okay.

Yes.

Thank you.

Okay.

Yes.

Thank you.

Thanks.

Okay.

Yes.

[music].

Okay.

Yes.

Okay.

Yes.

Thank you.

Yes.

Ask a question at that time, Please press star one on your telephone.

Today's call is being recorded I would now like to turn the conference host Mr. Garrett Edson of ICR. Please go ahead.

We'd like to thank you for joining us today for Cherry Hill mortgage investment corporations fourth quarter 2022 Conference call. In addition to this call and we have filed the press release that was distributed earlier this afternoon and posted to the Investor Relations section of our website at Www Dot <unk> 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 earnings available for distribution or AAD 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.

Encourage listeners to review the more detailed discussions related to these forward looking statements contained in the Companys filings with the SEC and the definitions contained in the financial presentations available on the company's website today's conference call hosted by Jay Lown, President and CEO Julian Evans, the Chief investment Officer, and Michael <unk>, The Chief Financial Officer, now I will turn the call over to <unk>.

Hey.

Thanks Garrett.

Welcome to our fourth quarter 2022 earnings call.

Our efforts were effective in the fourth quarter to protect book value.

<unk> investment markets remained in a challenging economic environment.

Volatility subsided during the quarter and spread sector assets recovered some of the losses experienced in the third quarter.

As many of our peers have noted the mortgage basis improved throughout the quarter as well.

The U S treasury yield curve, however remained inverted and has shown no signs of steepening, thus far this year.

Which has significantly impacted the earnings power of many companies in our sector.

Given the most recent economic data markets are bracing for a higher for longer scenario.

And the potential for a recession later this year.

The combination of our efforts to refine our investment and hedging strategies has enabled us to be successful at stabilizing in protecting book value in recent quarters.

Given the expectation of continued interest rate hikes, and the evolving macro environment we remain.

Positioned for additional rate hikes.

To that point, we continue to utilize <unk> to partially offset spread widening risk as we await the fed to convey when it expects to end its tightening cycle at which point, we could look to increase our risk profile.

For the fourth quarter, while we generated a GAAP net loss applicable to common stockholders of $1 59 per diluted share.

We generated earnings available for distribution or AAD, and non-GAAP financial measure of $5 3 million or <unk> <unk> per share.

It bears repeating that AAD is only one of several factors considered in setting our dividend policy.

While not a line this quarter our board continues to monitor our earnings capabilities to ensure our dividend is at an appropriate level.

Book value per common share finished at $6.06 as of December 31.

Up a penny from the prior quarter.

We believe creating a more stable book value profile is in our shareholders' best interest and remains a top priority for us.

Posted a stable NAV relative to the third quarter.

As such during the second half of 2022 NAV was off approximately five 1%, which we believe compares favorably to the performance of many others in our industry and.

And speaks well to our ability to navigate a very challenging macro environment and the unprecedented speed of fed rate hikes.

During the fourth quarter, we acquired approximately $780 million and UTV, Fannie and Freddie Msr's buyer flow and bulk purchases.

Prepayment speeds on our MSR portfolio remained low.

And thus the pace of reinvestment to maintain the allocation of capital to the asset class has decelerated.

Recapture rates on MSR has also slowed to the low single digits as expected given the higher interest rate levels.