Q3 2023 Cherry Hill Mortgage Investment Corp Earnings Call
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Good day and thank you for standing by welcome to the Cherry Hill Mortgage investment Corporation third quarter 2023 earnings call. At this time all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session to ask a question during this session.
You will need to press star one one on your telephone you will then hear an automated message advice. Your hand is raised to withdraw your question. Please press star one again.
Please be advised that today's conference is being recorded.
I would now like to hand, the conference over to your Speaker today Garrett Edson with Investor Relations. Please go ahead.
We'd like to thank you for joining us today for Cherry Hill mortgage investment corporations third quarter 2023 conference call.
Fishing 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 Irey 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 <unk> future expected cash flows as well as prepayment and recapture rates like what six and non-GAAP financial measures.
Earnings available for distribution of our 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.
Carriage listeners to review the more detailed discussions related to these forward looking statements contained in the company's filings with the SEC and the definitions contained in the financial presentations available on the company's website. Today's conference calls 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 Jay.
Thanks.
Thanks, Garrett and welcome to our third quarter 2023 earnings call.
While the third quarter initially seemed as if we were headed to a soft landing.
And at the end of the rate hike cycle.
Hotter than expected inflation and an overheated economy led to a significant rise in the 10 year treasury to nearly 4.6%.
As it became clear that higher for longer was likely going to persist for some time.
Along with the rise in the tenure agency mortgage spreads widened considerably during the quarter.
While agency rates have been feeling the pain of the spread widening for the past few months given our capital structure, we proactively positioned our portfolio to mitigate the spread widening by hedging out a portion of our basis risk in our our MBS portfolio with Tpa.
We believe this positioning along with our portfolio of Msr's.
To our shareholders advantage in the quarter as we successfully preserve the vast majority of our shareholder equity.
Okay.
We have maintained this positioning through October given the elevated volatility as markets digested macroeconomic data globally and reacted to the events in the middle East.
The 10 year crossed the 5% threshold at one point in October and mortgage spreads have widened further as others have noted.
In these volatile and turbulent times, we believe that it remains prudent to minimize our exposure to mortgage basis risk and the potential for any additional widening such as what we have seen impacting much of the REIT space over the past few months.
As a result, we believe we remain positioned well to take advantage of select RMB S opportunities that offer attractive risk adjusted returns and that's the overall strategy of pairing MSR with agency MBS remains the proper strategy for the current environment.
For the third quarter, we generated a GAAP net gain applicable to common stockholders of 49 cents per diluted share.
And we generated earnings available for distribution or a D. A.
non-GAAP financial measure are $4 4 million or 16 cents per share.
Each exceeded our quarterly distribution.
As we've noted before.
Only one of several factors considered in setting our dividend policy.
Additionally, factors such as the existing market environment and portfolio return potential.
Our level of taxable income, including hedge gain impacts.
And the degree of certainty regarding forward investment return economics, all contribute to determining what we believe is the appropriate dividend level.
Book value per common share finished at $4.99 as of September 30th down three 9% from June 30.
On an NAV basis, which includes preferred stock and the calculation we were down one 9% relative to June 30th.
As we've previously noted our existing mix of common to preferred equity amplifies the impacts of changes in our total equity or common book value.
Creating a more stable equity profile, it's in our shareholders' best interest and remains a top priority for us.
During the third quarter, we remain firm on our MSR portfolio as we believe agency MBS continues to present, a better return profile in the current environment.
Prepayment speeds on our MSR portfolio remained low.
The pace of reinvestment required to maintain the allocation of capital to the asset class is low.
Recapture rates on MSR remained minimal given.
Given the higher interest rate levels.
Our portfolio of Msr's weighted average note rate of approximately three 5% provides us with plenty of room to weather potential rate cuts down the road before impacting our prepay speeds in a meaningful manner.
At the end of the quarter financial leverage again stayed consistent at four four times as we opportunistically deployed additional capital during the quarter, while remaining prudently lever is a volatile market dynamics persist.
We ended the quarter with $45 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile.
Looking ahead, we maintain a concerted focus on risk management to reduce our exposure to mortgage spreads in the near term, which we believe is the prudent approach in the current environment.
We will continue to selectively deploy capital into eight additional agency MBS, which currently presents a strong risk adjusted return profile.
While awaiting signs of market stabilization and lessening volatility.
Our priority remains to protect book value and we remain mindful of our liquidity and leverage profile.
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.
Third quarter commenced with expectations that the fed rate hiking cycle was nearing completion.
However, persistent inflation, however, U S economy than expected and hawkish fed commentary led not only to an expected 25 basis point rate hike increase in September but also the renewed sentiment that higher for longer would be for much longer than investors initially expected.
Those factors coupled with continued increased treasury issuance.
Because of the rising budget deficit put additional pressure on interest rates.
These themes led to the 10 year spiking during the quarter and also led to significant mortgage spread widening.
The poor sentiment has extended into October.
Along with major geopolitical turmoil injecting additional volatility into the market.
During the quarter, we positioned our portfolio to minimize current spread widening and the potential for additional spread widening by hedging our MBS purple with.
TBD.
In the near term.
<unk> has paid off for our portfolio.
In October we believe our investment strategy of hedging our risk and reducing our exposure to mortgages remains in our best interest until there is a clear picture of stabilization.
At quarter end, our MSR portfolio at a UTV of $20 3 billion and a market value of approximately $266 million.
MSR related net assets represented approximately 45% of our equity capital and approximately 31% of our investable assets, excluding cash at quarter end.
Meanwhile, our MBS portfolio accounted for approximately 41% of our equity capital as a percentage of investable assets.
Our MBS portfolio represented approximately 69% excluding cash at quarter end.
During the quarter prepayment speeds were RMB S and MSR portfolios did not shift a great deal from the prior quarter given the continued elevated rate environment.
Our MSR portfolios net CPR averaged approximately five 6% for the third quarter modestly down from six 2% CPR in the previous quarter.
The portfolios recapture rate remained consistent but low at approximately 1% as the incentive to refinance continues to be minimal.
Moving forward, we continue to expect low recapture rates and a stable net CPR for the foreseeable future given the current levels of interest and mortgage rates.
The <unk> portfolio as prepayment speeds remained low as expected driven by the 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 of interest rates remain at these levels or move higher.
For the quarter, the our MBS portfolios weighted average three month CPR moved slightly higher to approximately four 4% compared to approximately four 2% in the second quarter.
As of September 30 year, MBS portfolio inclusive of TBA stood at approximately $583 million compared to $682 million at the previous quarter.
They're over quarter, we shifted the composition of our portfolio as we moved up in coupon taking advantage of higher yielding assets.
As we position the portfolio and higher coupon mortgages. We also continued to maintain TBA hedges in the portfolio, especially in lower coupon mortgages.
For the third quarter, our MBS net interest spread was three 6% the.
The decrease from the prior quarter was driven by higher repo and larger net interest expense, which were partially offset by higher asset yields, resulting from new purchases as well as a change in the portfolio coupon composition.
At quarter end the portfolio financial leverage remained at approximately four four times and the 30 year securities position continue to represent a 100% of the <unk> portfolio.
Looking forward, we remain mindful of the ongoing challenging environment and continue to expect to minimize our exposure to mortgage spreads in the near term.
So there are clear signs of stabilization.
I will now turn the call over to Mike for a third quarter financial discussion.
Thank you Julien.
Our GAAP net income applicable to common stockholders for the third quarter was $13 1 million or <unk> 49 per weighted average diluted share outstanding during the quarter while.
Comprehensive loss attributable to common stockholders, which includes the mark to market of our available for sale arm, Yes was $1 1 million or <unk> <unk> per weighted average diluted share.
Our earnings available for distribution attributable to common stockholders was $4 4 million or <unk> 16 per share.
Our book value per common share as of September 30 was $4 99.
Compared to a book value of $5 19 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 TBA <unk> and Treasury futures all of which had a combined notional of approximately $791 million 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've not elected to apply hedge accounting for our interest rate derivatives and as a result, we record the change in estimated fair value as a component of the net gain or loss on interest rate derivatives.
Our operating expenses were $3 4 million for the quarter.
On September 14th our board of directors declared a dividend of <unk> 15 per common share for the third quarter of 2023, which was paid in cash on October 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> 51 565.
At this time, we will open up the call for questions operator.
As a reminder to ask a question. Please press star one one on your telephone and wait for your name to be announced.
To withdraw your question. Please press star one again please.
Please standby will be compile the Q&A roster.
Our first question comes from Mikael Guberman with JMP Securities. Your line is open.
Hey, good evening gentlemen, congrats on a very very strong quarter book value preservation and the stability in the D.
I guess the question I have right off the top of my head is perhaps if you guys could flesh out the tradeoffs between MSR and agency MBS going forward, if we were to get a.
A pretty strong bond rally assuming.
Good bond rally for the next couple of months into the end of the year.
How do you guys see that trade offs in terms of capital allocation. Thanks.
Hi, Julien.
Currently we signed.
Our MBS to be more attractive than MSR.
We have been adding additional dollars into RMB as we've just chosen to hedge those additional dollars with buying a spec pools and hedging it with TVA on the site.
So kind of just taking out some of the duration curve.
As for the extended bond rally I think it all depends on why we are rally.
Because we obviously know that the mortgage basis spread is on the wider side, but if were rallying in these markets because.
Spread gains that you might be seeing in RMB.
We're rallying because theres stabilization by the fed which we've seen over the last couple of days and volatility has come down which is typical after a fed meeting.
We would expect the basis to outperform I don't think that our gains would be as much as our competitors because of the way. We're currently hedging the portfolio, but we also have the opportunity to remove some of those hedges and thus would increase our overall leverage in the portfolio and have some additional gains via that.
So.
I'll add one thing and a lot of a lot of what I'm going to say is revolving around.
And costs.
So on top of the yields the financing cost for each asset class matters as well. So we think about the Levered return.
On each of the assets as it relates to the risk return profile. So.
One of the things that is obviously creeped up as the cost of financing the MSR and so when we think about the MSR.
One of the things that factors into it is the cost to lever it can sell.
Yes, Julien pointed out at least sitting here today.
Our MBS has over the last few months or six months or so have been better.
Sure.
Potentially get an update on book value one month into the quarter.
Sure we see R. R.
December 31 book value per share down approximately 5% at quarter end and that is prior to any fourth quarter common dividend accrual or has not yet been approved by the board.
Great. Thank you for that and good luck going forward guys.
Yes.
Thanks, Thank you.
One moment for our next question.
Our next question comes from palette with B Riley Your line is open.
Oh, Hey, guys. Thanks for taking my question, a remarkable quarter really as a hedging really paid off and it shows.
My question is are you.
Covering you covered the dividend.
You've got the.
Hedges in place seems like the prudent thing to do.
Is your earnings available for distribution is that going to be a function primarily of Cerro where you want to take leverage how much risk you want to.
If you want to call. It takes some hedges off like you said I mean, what what's going to drive that AAD or the core income kind of going forward from here. It seems like you've got the <unk> de.
Derisked as possible with the portfolio.
Yes.
Hi, Matt its Julien.
So in terms of.
Let's say you want to increase some additionally.
We've obviously said that we can take off some hedges and obviously increase our leverage I think we've also tried to shift the portfolio around in terms of moving to higher yielding cash.
Assets into the portfolio.
We did have a.
Each quarter I would say as rates have risen here you almost had been playing a little bit of catch up with the repo cost.
Moving higher and your assets kind of on the lower end. It was constantly trying to make some adjustments to that in the portfolio. So I think those are kind of some of the primary drivers that we have are changing around the composition of the portfolio as we assess.
The rate market volatility.
Volatility as well as the fed and in addition to that we do have the option of pulling off some of our leverage components at this time.
How much Julien how much are you willing to move up coupons.
What's the risk reward of you hear some guys don't want to do with the.
The belly of the curve, so I'm going to be higher and the curve.
What do you guys stand right.
Right now to where you want to be.
Yes, it's interesting.
That perspective look I think long term and let's say.
Define maybe a year from now six months to a year from now I think if the economy is slowing down and the fed is truly on hold and rates are moving lower I do think that you want to have lower coupons in your portfolio maybe.
Maybe it's a combination of 3000.
<unk> in the portfolio.
If we remain at some of these higher levels, obviously, the higher coupons yields you're a little bit more on the portfolio. But you are also in the back of your mind kind of concerned about prepayment speeds up until the last couple of.
Dave.
If you take the last 36 hours six enhance our trading at a discount.
Trading slightly above above par call it at par in 'twenty.
I think thats not a bad place to say that the high of the coupons that I'm willing to kind of take on Covid.
I do believe at some point in time this market will become re financeable for some of the higher coupons, let's say, 7% seven and a half I think there.
Servicers have teed up those.
Borrowers that at some point when rates move to an attractive level, even if it's 25 to 50 basis points advantage. They will be refinancing now we've tried to stay around in terms of them or adding additional securities in this portfolio.
<unk> discount call at $98 price 96 dollar priced up to par. So lately, we havent purchased anything thats been above par, but you feel like youre getting a pretty decent amount of coupon income from a long term perspective.
It makes total sense.
I think the same way you guys are taking I think the position portfolios, what very well positioned.
My last question I guess just on.
Yes.
So you're seeing more relative value in the Ibs side.
Is there a catalyst for the basis to tighten.
And what will drive it.
Care would you rather just have these widespread.
Listen we wanted to reinvest in this or do you want to take advantage of.
The materially higher book value you would experience the data base it does tighten on MBS.
You can.
A lot of ways to make a lot of money here. The next cycle I mean, how do you feel I mean is it going to be just the MBS basis tightening or is it going to be that.
Sensitive part of the curve starts to go down and you guys can take leverage up.
Just wondering how you see the next year.
Year playing out.
Sure Matt.
It's a topic of a regular debate here and.
To your point.
No.
Cycles matter.
And if you.
If you pay attention to only the periods, where the fed was a major participant in this space and kept spreads tighter than you might have a view.
That spreads are.
Serially wide relative to historical levels, but once you introduce.
History going back further than the financial crisis.
You see a slightly different picture, which suggests that maybe theres slightly wide relative to historic levels. So I think what we're trying to.
Do you hear us.
Over time get a better picture of what spreads normalized would look like in an environment, where the fed is not an active participant in this space.
And how tight those spreads.
Should get relative to.
Relative value in the space and because.
Quite honestly, we don't have.
No perfect answer to that we have chosen two one hedge.
Hedge fair amount of that out with TBA to protect ourselves from.
The volatility in the space today and to the cost of the hedge with TBA today.
<unk> is not prohibited so we've decided to take that approach as well.
Should any of those catalysts change, although we have a more definitive view.
The direction of rates and the level of volatility I would expect us to make changes to our hedge strategy does that help.
Look the quarter you put up here I mean, that's just terrific what youre able to deal with volatility and absolutely ups. It seems like you guys are very conservatively positioned.
Ill.
Look at the portfolio as you see opportunities.
Let's look forward to hopefully the next leg of the cycle.
You guys are having great returns for shareholders. So I really appreciate Jay at the team.
Alright.
And I'm showing no further questions at this time I would.
I'd like to turn the conference back to Jay for closing remarks.
Thank you everyone for joining us on our third quarter conference call. We look forward to updating you on our fourth quarter earnings call next year.
This concludes today's conference call. Thank you for participating you may now disconnect.
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