Q2 2019 Earnings Call
Greetings welcome to the Cherry Hill mortgage investment Corporation's second quarter 2019 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.
Please note this conference is being recorded.
I will now turn the conference over to your host Rory Rumore, Vice President I see our Chris' remarks, you may begin we'd like to thank you for joining us today for Cherry Hill mortgage investment Corporation's second quarter 2019 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. I read dotcom.
On 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.
They are.
Future expected cash flows as well as prepayment and recapture rates delinquencies and non-GAAP financial measures such as corn 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 the more detailed discussions related to these forward looking statements contained in the Companys filings with the FCC and the definitions contained in the financial presentation is available on the company's website.
Today's conference call is hosted by Jay Lown, President and CEO , Julian Evans, our Chief investment Officer.
And Michael Hutchby, our Chief Financial Officer, now I will turn the call over to Jay.
Thanks, Rory and welcome to todays call.
As we've noted in past calls geopolitical and macroeconomic concerns are largely in control of the market.
Great volatility in 2019, it's starting to look a lot like 2016.
The sharp rise in yields following the surprise Trump election in late 2016 as reverse his tenure yield now revisit the fourth quarter 2016, those proceeding the Trump election.
The 2018 fiscal boost to the economy from a tax cuts seems to have run its course.
And the markets are now driven by anticipated actions of the world Central bankers.
This theme also applies to our two asset classes.
Prepayment rates on our MBS portfolio.
Have increased quarter over quarter going from 5.5% in Q1.
To 8.9% in Q2.
Well prepayment speeds on our MSR have increased from 6.4% for Q1 to 12.5% for Q2.
We're certainly not alone in experiencing the impact from prepayments.
It Unfortunately has been widely felt within the sector.
Furthermore, given the size of our MSR portfolio prepayments naturally had a greater bearing on our results.
Prepayments of the underlying loans permanently terminate the related servicing fee income, thereby reducing the earning capacity going forward.
The sequential reduction of core earnings per share to 52 cents is indicative of the initial facts faster prepayment speeds.
We expect that the challenging conditions of Q2 are likely to persist until at least sometime in the fourth quarter.
When seasonal factors should have a stabilizing effect on prepayment speeds.
However should interest rates continued to decline.
The seasonal benefit may not have the same impact as is customary in a more stable market environment.
In light of current market conditions, we continue to hedge the MSR portfolio in order to maintain our duration gap as close to neutral as our model allows.
Those changes helped moderate the impact in book value from 17 54.
Just 16 80.
Or a 4.2% decline net of the dividend from the end of Q1.
That strategy remains intact in the third quarter as well.
We have also seen the pace of prepayment speeds carry through into July and now into the first weeks of August .
We slowed the growth of our MSR portfolio in the second quarter, given the ongoing push to lower rates.
As a result at the end of the second quarter. The MSR portfolio remained at approximately 39% of our equity capital.
Additionally, we continue to be selective in adding to our non agency MBS investments comprised predominantly of CRT and non agency jumbo securities that meet our risk return hurdles.
Given our expectation that market conditions will further deteriorate in Q3 and should persist for the remainder of 2019, we expected it at its meeting in September our board will set a common dividend policy for the third quarter that is 15% to 20% lower than the second quarter dividend of 49 cents per share.
Subject to any changes in our outlook.
Well, we expect our funding costs to improve somewhat as lower interest rates work through the expense side of the equation.
We believe that a reduced dividend would better reflect our anticipated earnings capacity given current market conditions.
We will remain disciplined in our portfolio construction.
Our management team will continue to utilize our collective investment experience to proactively manage our portfolio with the goal of preserving our book value and continuing to generate attractive returns for shareholders.
This is a proven in cycle tested team and we believe that longer term, we are positioned to create additional shareholder value overtime.
With that I will turn the call over to Julian who will cover more detailed highlights of our investment portfolio and its performance over the quarter.
Thank you Jay.
During the second quarter global interest rates rallied and global manufacturing weakness geopolitical concerns and continued rising U.S., China trade tensions.
These concerns increased volatility and lower global interest rates despite increased volatility.
The majority of credit sector spreads move tighter and equity indices moved higher because the expectations of greater global Central Bank intervention Benson group.
Not only was the fed expected to intervene, but a majority of global central banks are expected to implement some form of policy easing as well as asset purchase programs in the future.
Despite global Central banks policy being supportive for spread sector assets and equity indices. The mortgage sector, specifically RMBS struggled to keep pace given the increased volatility.
The rally in interest rates the pronounced in version of the funding curve versus long term interest rates and the expected increase in prepayment speeds.
As a result, RMBS failed to keep pace with treasuries and swaps during the quarter.
The mortgage basis widened being limited the performance of our book value as investment assets could not keep pace with the treasury and swap hedges.
Over the quarter swap hedges outperformed agency MBS as well as non agency MBS.
Mortgage securities on a positive note the price premiums of our spec portfolio increased as rates rally.
But it too struggled against the decline in interest rates.
The rally in interest rates also had a negative impact on the market value of our servicing assets.
As shown on slide five servicing related investments comprised of full MSR is represented approximately 39% of our equity capital and approximately 10% of our investable assets, excluding cash at quarter end.
Servicing assets were flat as a percentage of equity from the previous quarter as the MSR valuations decline alongside interest rates.
Meanwhile, our RMBS portfolio accounted for approximately 57% 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 90% excluding cash at quarter end.
As of June Thirtyth, we held M.S. ours with the U.P.B. of approximately 28 billion and a market value of approximately 274 million.
Given the falling interest rate environment, we made the decision to slow the rate of additional MSR purchases during the quarter.
As we had expected prepayments speeds accelerated considerably during the quarter and have remained high in July in early August driven by seasonality and lower mortgage rates.
Our conventional MSR and government MSR averaged approximately 12% CPR and 14% CPR, respectively for the second quarter.
Conventional MSR speeds were up from 6% CPR in the prior quarter, while the government MSR speeds rose from 9.1 CPR posted during the same timeframe.
As of June Thirtyth, the RMBS portfolio stood at approximately 2.3 billion approximately 9% 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 grew to 80% up from 78% as of March 31st and the remaining assets represented 20%.
In the second quarter, the collateral composition of the RMBS portfolio posted a weighted average three month CPR of approximately 8.9% an increase from the previous quarter as prepayment speeds rose.
Persistent lower interest in mortgage rate environment.
For the second quarter, we posted a 0.84 RMBS NIM versus a 1.25 NIM for the first quarter.
The Nims decline was driven by faster prepayment speeds and elevated financing costs versus lower asset yields near term, we expect the NIM to fluctuate based upon lower mortgage rates the seasonality of the housing market.
Some of which will be offset by lower financing costs and by the receipt portion of our swap portfolio.
To improve the NIM, we continue to purchase collateral stories for the RMBS portfolio as well as resetting some of our payer swaps to lower rates.
At quarter end, the aggregate portfolio operated with leverage of approximately 5.2 times.
And a positive duration gap, we ended the quarter with an aggregate portfolio duration gap of a positive 0.49 years, we maintain a positive duration gap given continued global trade tensions weaker global growth as well as limited clarity from the fed.
The continuous rally in interest and mortgage rates has shortened mortgage durations and thus made the RMBS portfolio only a partial hedge for the MSR portfolio.
As we move forward, we will continue to evaluate known to the portfolio as necessary.
I will now turn the call over to Mike for our second quarter financial discussion.
Thank you Julien.
Our GAAP net loss applicable to common stockholders for the second quarter was $29.3 million or $1.75 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 RMBS was $4.2 million or 25 cents per share.
Our core earnings were $8.7 million or 52 cents per share.
As Jay mentioned, our book value as of June Thirtyth 2019 was $16.80. A decrease of 74 cents per share from March 30, Onest 2019, or 4.2% net of the second 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 second quarter, we held interest rate swaps Swaptions Tvs and Treasury futures all of which had a combined notional amount of $2.2 billion.
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 $3.1 million for the quarter of which approximately $561000 was related to our taxable REIT subsidiary.
On June 13th we declared a dividend of 49 cents per common share for the second quarter of 2019, which was paid on July Thirtyth 2019.
We also 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 July 15th.
Now I'd like to turn the call back over to Jay.
Thanks, Mike.
At this time, we will open up the call for questions.
Operator.
At this time, we'll be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad.
And Tony will indicate 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 keys.
One moment, please while we poll for questions.
Our first question comes the line of Tim Hayes from B. Riley FBR.
Please proceed with your question.
Hey, Good evening guys. My first question around the dividend guide just wondering what exactly this new dividend level reflects core earnings has been the proxy for the dividend and is it your expectation that core earnings will also declined by 15% to 20% as as soon as the three Q or are resetting the dividend at a level that reflects a longer term view I know this is a board decision but.
I was just wondering if theres any insight there and then maybe what payout ratio you'd be targeting.
Hey, Tim how are you so.
I think it reflects.
Well, we think we can sustainably on going forward.
And I think as we noted in the second half of the second quarter, we saw prepay speeds elevate meaningfully.
And what we're trying to do is not get behind.
That event and I think here, what we believe is that faster speeds are here for the foreseeable future relative to where rates are.
And it's our expectation that.
With the board decides relative to.
Devin dividend level.
As a reflection of what we think.
We can earn on a go forward basis in the near term.
Okay.
Understood and you noted that prepayment speeds remain elevated but are they it's through.
July and the first week of August are they in line with your expectation is heading into the quarter, where theyve been have they been even faster just wondering kind of what is.
Factored into the current MSR, Mark and if you expect it to be written down given even more in the third quarter, given what you've seen and I guess this would be a good time asked for a quarter to date book value update if possible.
No I think that relative to what we.
Modeled for speeds for the third quarter at least where we see it today.
Speeds are in line to slightly higher than where we model.
I think if you pay attention to things like the JP Morgan prepayment report you'll see.
Thats beazer are picking up pretty quickly.
If you.
If you take a look at what we bought in the MSR portfolio a lot of the growth in the MSR portfolio was 2018 vintage relative to originations.
And Mike and our view is that that.
Population has.
This susceptible to being refinanced.
Does that answer that part of the question.
Yes, that's a dead.
The second part of your question is.
As of July and remember the tenure is clearly slightly different place than it is now probably closer to 2%.
Weve, we saw book value.
Up in the 1% to 2% range.
Okay.
Thank god it thanks for that update appreciate that.
And then your view for lower earnings is that more a reflection of lower asset yields given the pickup in prepays or how much of that is maybe reinvestment yields.
Given how you're trying to position the portfolio.
I think it's a combination of the two but with with respect to MSR us.
As you can imagine.
We can hedge.
We can do a good job hedging the value.
I think Austin anybody else invested in the sector I would say that it's much harder to hedge the cash flows and with the pickup in speeds as quickly as we've seen quarter over quarter, our expectation is that.
Thank them as it relates to the degradation.
Around that asset class is has let us to.
Rethink the dividend policy.
Mhm.
Okay.
Makes sense.
And then I'll ask.
More of a high level question.
Excuse me and then hop back in the queue, but a lot of things are going on that could enhance the role of private capital in the mortgage market.
See reform QM patch expiration amongst others.
What type of opportunity does that potentially present for you guys given your strategy.
So if you're if you're referring to.
Okay are we looking to make an investment in an originator or something like that.
Good day.
That has not.
That's not something I can tell you that we're far along on I think it's a tough discussion clearly somebody like.
Pennymac has an advantage having an established program but.
You need to have a fairly robust origination platform to offset some of the.
Prepayments that we think will come down the Pike and.
For some of our peers, who have originators I don't think they're counting on that part of their operations.
To protect them.
More than they are their sub servicing partners.
Okay I appreciate the comments there Jay I'll hop back in the queue and.
Potentially follow up with some more.
Sure no problem.
Our next question comes from the line of Steve Delaney from JMP Securities. Please proceed with your question.
Thanks, Good evening everyone.
Hi, Jay no it's been tough quarter for everybody we've seen.
All the big guys cut their dividend, 15% to 20%.
I think we'll see more of those so keeps going up it's a it's a tough business.
Just a couple of couple of one question and then maybe just a couple of comments that kind of reflect on where you are today.
One.
When Julian gave the NIM compression in your opening comments about that.
At the CPR increases obviously.
But I wanted to know to get down to 84 from 125 Bips.
Wasn't the relationship of three month LIBOR to repo sort of also a factor.
We tend to believe that went annaly in AG and see pre announced second quarter dividends that it was not a belt speed, but it was about the relate that relationship in there.
The cost of funds, which.
And they modeled that so much maybe more but it's hard to predict other than seasonal it was hard to predict this tenure level. So just just curious if that was in fact also a component of that decline.
I think it's a big component of it hi, Steve This is Julian.
Look I mean, if you just look at where funding was during the quarter versus where the 10 year.
Treasury or 10 year swaps declined anywhere between 50 to 45 basis points, we saw a decline in the 10 year and 10 year swaps.
Funding probably only dropped.
About 10 basis points over that time same timeframe. So you are definitely purchasing assets on what I would kind of call an inverted curve between your funding and where your asset levels.
You are putting money to work as a very difficult situation.
Yes, I mean, it was probably bought a negative 20, some 25 basis points, maybe at the worse and.
You know eight times leverage it adds up but but has not reversed almost completely.
Not to the point, where it's.
I think it reversed for maybe a day or two in the new quarter as the fed obviously.
Did its first ease yes.
Now while.
But then the recent tweets that have been coming out of obviously place tenure yield levels down again right. So we we have a very similar in version that we had.
Towards the end of the second quarter beginning here in the third quarter. So very similar situation, but overall I can tell you that the funding costs are coming down.
That is slowly coming down not to the same.
Level. They we had seen in the past so I would definitely say that three month LIBOR. For example, we were putting that on it probably to 60 in the second quarter, we have been able to execute around 230.
235 into the third quarter.
Okay. Thank you yeah, we were hearing.
Something to 30 handle so and then just switch to the new dividend I think it's important to kind of put it in perspective.
I can do that you guys can't necessarily be objective about it I'm I'm going to try to be so let's assume the new dividend rounds off to 40 cents just a nice round number $1.60 a year. Your current share price is 16 84.
That is a non in the half percent dividend yield.
There are not many.
Investment opportunities out there.
That off or anything like that especially where we are with with everything else in the market.
Down below two.
Below 2%.
My thought is and you guys are trying to compete and on it.
In terms of probably between the agency and hybrid guys. Its 22 companies, there's some big ones.
When everybody's taking leverage up and it seemed that everybody was trying to work towards an 11% or a week I don't I don't.
I'm not going to say people were forcing to a yield but if you want to be competitive.
Trade, well and have access to capital.
I do believe people have been operating with far too much leverage for this business model. Okay. I'm, just generally speaking and I think we're going to get a lot more vocal about it because if we look back over the last two years, even at the largest companies and with all the manpower.
They will pay you 10, or 11, but every year that losing 5% to 7% or six or more consistently and that's happened over the last two or three years.
So any event my hope, but the business is that people operate with seven to eight.
Times leverage normally and they were happy to pay 9% dividend yields with more stable book values and I think we'd have a much healthier mortgage riet industry now that's just a thought but the final thought I want to throw out to you.
Is a stabroek real quick just a quick start certainly you.
We used to get to 9.8 used our book value, but if you looked at our share price.
I believe the dividend yield today would be 10.8.
Okay apologies, yes, I did intentionally do it off book just to kind of reflect on you know the return, but because the stock price can move all around but but thanks. Thanks, So frankly that even makes sure but you are still over 10% right. I mean, 13% was is crazy.
In the <unk> in the first place, but I think it just gets to the question of these these.
Yields were being were driven up because of expectations for cuts I think they were cuts were being price stand when something's trading to 12 or 13. So the last thing is that it.
Right. So the last thing that I would just throw out and this has to do with we don't know.
You know, what we have going on right now and the fed into trade wars and everything else I was with the client in Boston yesterday. It was absolutely convinced that rates are going to zero and he will not touch credit now. So he is very interested and the most offensive investments you get that I thought it was a little extreme but he's smarter guy than I am and has it made a lot more money. So yes, I have to listen to him. So my question to you guys as you sit today.
Complexity is not necessarily.
A benefit to any bodies model and I don't think you really do I mean, how about how about complex model, but my I'm opposed the question is.
Are you an agency read or are you a hybrid mortgage riet and when you came public just because you had this odd thing called MSR as we necessarily to you in the hybrid.
Comp table because there you were not would not have been considered a pure plain vanilla agency rate, let me say out of the seven right now we have seven agency Reits in 15 hybrid Reits.
They are only one or two quote pure everyone is doing something different.
I would say that in the agency space five or seven have less than 500 market caps and the hybrid space only two with 15 of less than 100, I guess, what I'm, saying is I think you guys have strong management, you've operated very well since your IPO generally speaking and I'm just wondering if presenting your story.
Whether its agency MBS are agency MSR as you're in the agency security type of business and I Wonder if positioning yourself as such limiting the complexity.
You know of other possibly other strategies at this point in time, when we're going into a.
Hi volatility risk off mode, if that might serve you better.
So if you wish to comment on that fine if not how I'll, just hang up and and leave it on the table, but I just I had to share it with you because it's fresh after my meeting yesterday afternoon in Boston.
I think it's insightful relative to just how you think about our sector.
Clearly if you look at the.
The assets that were invested in there all agency ask aside from the us small parts in the portfolio that is.
Jumbo Jumbo way securities, but even the securities are sort of agency based I think we do think ourselves of ourselves as a hybrid relative to just agency MBS given that 40% of the equity is invested in something else.
And.
We have a lot of discussions here about.
What's the right investment mix relative to exactly what you're discussing relative to when is the next recession coming when do I have to worry about credit.
Right is ministration going to push us into a recession and so.
Personally I think we have some time so people who are invested in credit today are definitely benefiting from that relative to the.
Good question. Thank you made it to rates, but I do believe that.
Credit will become an issue at some point and they will have some stress.
In their business as well.
To date, we don't have.
Meaningful direction towards the credit space.
Understood.
It's a.
It's not something you do lightly without the infrastructure right and the personnel.
You're not really in a position to to underwrite that additional venture at the current time.
I think it is more about infrastructure there is an enormous amount of non agency.
And credit experience here and.
At the at the right time, right, Tom I think we could.
But to your point can we get ramped up and will it be enough time to.
For those returns to be.
Interesting and compelling and enough time to get out when credit becomes a problem and those are things that we think.
Well I appreciate your comments and.
Wish you all the best.
Have the.
Good rest of the summer then Dan hanging in there.
Thanks, Rob well make it there thanks.
Hi.
Our next question comes line of Henry Coffey from Wedbush.
And with.
Oh beauty and the Beast.
It's always fun to listen to my my colleague.
Because I think he understands the space as well or better than anyone else.
Thank you and your team for lower leverage.
No I think you are building a better business I I don't think.
You know that that you're building a good business. Your your focus keenly on two asset classes and if I can join the editorial thinking.
Taking the.
Dividend down.
But still offering an acceptable return to investors should not be an issue.
And I will go on for a couple of hours on this subject if youd like because but we'll leave it at that.
It does make for a better business by lowering the dividend.
And lowering leverage and then the question is.
As the business evolves.
Do you want to dive deeper into where you are.
Or you know.
Wendy.
At what point of the equation do we wake up and buying that there is a.
Something else going on because your team knows the broader equation fairly well.
And to to join some of the other.
Questioners.
You know there is there is one dario foot, it's a very bizarre ones.
The Republicans get keep the White House and then when they go into mortgage.
Reforming the mortgage market.
They put more capital requirements out there.
And again Thats something that the reach can do very well.
Yeah, I think one thing I think we've been very on as volatility is here to stay for the foreseeable future and Oh I'm I'm. If you keep politics side of it you don't have any explanation for us for a while but yes. There are some political issues that are certainly scrambling that.
So that keeps it interesting.
But.
I'm trying to be correct there but.
We agree you know at some point.
Continuing to diversify makes sense.
And to Steve's earlier 0.1 thing you don't want to do is get.
Into something where you might be at the end of a very long cycle. So we.
We try to be thoughtful about how we think about.
Growing or diversifying what we do.
Meanwhile, making sure that we're paying close attention to the assets that we own.
I mean would you start nibbling at alternative asset classes I mean, if you take on a very small position.
Yes, it's the best education.
Yeah, that's very possible.
Likely I don't know, but possible we look at.
Diverse diversifying.
Every week, when we meet as a group and.
The returns have to be compelling you have to have the expertise in house to do it.
The financing at attractive levels.
So on a risk adjusted return basis, which is how I look at life.
It has to make sense.
The you did to your credit you did talk about this in the last couple of calls about expectations that the seasonality of CPR as we.
Well go the wrong way you just forgot to mention that we'd be in a 1.7% tenure.
Yeah. Good luck.
We've been outperforming given our size and given everybody knows our expense ratios et cetera, we've clearly been outperforming relative to our peers on a consistent basis that you can't do that forever.
And.
Yeah, we were pretty clear that we expected speeds to normalize in the portfolio.
And and if you build around that and you take your dividend I mean, I'd I'd encourage you to take it down even a little further just because you know that there's no point in paying people.
Somewhat ridiculous yield win.
The we were in a sub 2% 10 year kind of involved were counting on getting the word out to investors Henry.
Well, they don't listen to me as much as it was.
So.
Haven't talked to Steve.
Oh, Okay, we'll get Steve to do it.
I like it Steve if you go out and put out those tough message.
Well no I think it was a great move so that's all I have to say.
Well I appreciate the confidence Henry Thank you.
We have reached the end of the question and answer session and I will now turn the call back over to management for closing remarks.
Great. Thank you. Thank you for joining us on today's call everyone. We look forward to updating you soon on our third quarter results have a great evening.
This concludes today's conference and you may disconnect. Your lines at this time. Thank you for your participation.