Cherry Hill Mortgage Investment Corporation (NYSE:CHMI) Q2 2023 Earnings Call Transcript
Cherry Hill Mortgage Investment Corporation (NYSE:CHMI) Q2 2023 Earnings Call Transcript August 3, 2023 Operator: Ladies and gentlemen, thank you for standing by. Welcome to the Cherry Hill Mortgage Investment Corporation Second Quarter 2023 Earnings Call. [Operator Instructions] 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. Please go ahead. Garrett Edson: We would like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation’s second quarter 2023 conference call. In addition to this call, we have filed a press release that was distributed earlier this afternoon posted to the Investor Relations section of our website at www.chmireit.com. 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, IRRs, future expected cash flows as well as prepayment and recapture rates, delinquencies and non-GAAP financial measures such as earnings available for distribution, or EAD and comprehensive income.
robert cicchetti / Shutterstock.com Forward-looking statements represent management’s 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 company’s filings with the SEC and the definitions contained in the financial presentations available on the company’s website. Today’s conference call is hosted by Jay Lown, President and CEO; Julian Evans, Chief Investment Officer; and Michael Hutchby, the Chief Financial Officer. Now I will turn the call over to Jay. Jay Lown: Thanks, Garrett and welcome to our second quarter 2023 earnings call. Markets in the second quarter were again largely driven by the Fed and economic data as regional bank pressures eased and markets absorb the MBS asset sales from the FDIC. At a macro level, while rates ended the quarter higher at 3.84%, the U.S 10-year treasury fell as low as 3.3% early in the quarter and the banking crisis was still top of mind. Spreads tightened slightly toward the end of the quarter, creating some tailwinds for agency MBS investors and the worst case scenario of a significant recession seemed to wane. In light of the uncertainty around Fed policy and the direction of rates during the quarter, we continue to maintain the discipline neutral posture, avoiding significant rate bets in either direction, working to protect and enhance value. Inflation, while stabilized has remained elevated above the Fed’s 2% target, giving the Fed enough justification to raise rates 25 basis points in May and again last week. We believe we are near the end of the tightening cycle. And as others have noted, this should be a positive catalyst for agency MBS securities and potentially drive more attractive returns. Assuming that remains the case in quarters ahead, we are positioned well to deploy capital into new RMBS opportunities as we move through the back half of the year. For the second quarter, we generated a GAAP net loss applicable to common share of stockholders of $0.03 per diluted share and we generated earnings available for distribution or EAD, a non-GAAP financial measure of $4.2 million or $0.16 per share. As we have noted before, EAD is 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 foreign investment return economics all contribute to determining what we believe is the appropriate dividend level. Book value per common share finished at $5.19 as of June 30, down 6% from March 31. On an NAV basis, which includes preferred stock and the calculation before taking into account any issuances of equity through our common stock ATM program, we were down 3% relative to March 31. As noted in our prior quarter, 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 is in our shareholders’ best interest and remains a top priority for us. During the second quarter, we continue to stand firm on our MSR portfolio. As we believe agency RMBS presented a better return profile in the current environment. Prepayment speeds on our MSR portfolio remain low and thus the pace of reinvestment required to maintain the allocation of capital to the asset class is low. Recapture rates on MSRs remain minimal given the higher interest rate levels. Our portfolio of MSRs has a weighted average note rate slightly less than3.5%, providing us with plenty of room to weather potential rate cuts down the road before impacting our prepay speeds in a meaningful manner. We continue to believe our strategy of pairing MSRs with agency MBS, along with proactive portfolio management and hedging is the right long-term strategy to steer through the current challenging environment. At the end of the quarter, financial leverage stayed consistent at 4.4x as we opportunistically deployed additional capital through the quarter. We remain prudently levered and assuming the economy slowly continues its march towards stabilization, we expect to remain opportunistic in the deployment of capital. We ended the quarter with $53 million of unrestricted cash on the balance sheet maintaining a solid liquidity profile. Looking ahead, we are maintaining our conservative yet proactive approach to portfolio management for the near-term. If the volatility around the Fed further diminishes and we begin to return to an environment where mortgages typically perform better, we believe there is an opportunity to deploy capital into additional agency MBS, which currently presents a strong risk adjusted return profile. Our priority remains to protect book value and we remain mindful of our liquidity and leverage profile. With that, I will turn the call over to Julian who will cover more details regarding our investment portfolio and its performance over the second quarter. Julian Evans: Thank you, Jay. The second quarter of 2023 began with the overhang of the banking crisis as the market seemed to believe that the Fed would need to stop raising rates. As concerns related to the banking crisis end and began to fade during the quarter, rates began to rebound higher as the Fed used the resilient economy as a backdrop to continuous war in inflation rising rates 25 basis points in May and once again last week. Notably, with the headline CPI posting 3% in June, it seems that the Fed is getting close to a terminal rate for Fed Funds, with the possibility of one or two more rate hikes left, if the Fed attempts to get inflation back to the target rate of 2%. Optimistically, this appears to be giving the market signs of stabilization amid a growing belief that the Fed maybe able to achieve a soft landing, while holding rates higher for longer. We continue to employ thoughtful hedging strategy in the second quarter, remaining long duration, which impacted our book value. However, we believe we are properly positioned from a hedging perspective given the current macro environment and managing through the environment as best as possible. Our investment strategies carried over thus far into the third quarter. At quarter end, our MSR portfolio had a UPB of $20.8 billion and a market value of approximately $265 million. At quarter end, the MSR and net related assets represented approximately 43% of our equity capital and approximately 31% of our investable assets, excluding cash. Meanwhile, our RMBS portfolio accounted for approximately 40% of our equity capital. As a percentage of investable assets, the RMBS portfolio represented approximately 69%, excluding cash at quarter end. During the quarter, prepayment speeds for our MSR and RMBS portfolios rose modestly as rates fluctuated for much of the quarter. Our MSR portfolios net CPR averaged approximately 6.2% for the second quarter, up from 4.7% net CPR in the previous quarter. The rise was mainly driven by seasonality. The portfolio’s recapture rate remain consistent was low at approximately 1% as the incentives 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 in mortgage rates. The RMBS portfolio prepayment speeds remain low driven by the combination of new asset purchases as well as the fact that the current higher mortgage rate environment is compressing CPRs 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 RMBS portfolio’s weighted average 3-month CPR moved a bit higher to approximately 4.2% compared to approximately 3% in the first quarter. As of June 30, the RMBS portfolio inclusive of TBA stood at approximately $602 million compared to $709 million at the previous quarter end. Quarter-over-quarter, the spec pool portion of the portfolio remained constant, but the composition of the portfolio changed during the quarter as we opportunistically moved into higher coupon mortgages and put new cash to work. At the same time, we materially increased our TBA hedges as an offset. For the second quarter, our RMBS net interest spread with 3.84%. The increase was driven by higher asset yields resulting from new purchases as well as a change in the portfolio’s composition, both of which helped to offset higher repo costs. At quarter end, the portfolio’s financial leverage remained at approximately 4.4x and the 30-year securities position represented 100% of our RMBS portfolio. Looking forward, we remain mindful of the ongoing challenging environment, but are optimistic that we maybe getting close to a terminal rate given encouraging inflation data. I will now turn the call over to Mike for a second quarter financial discussion. Michael Hutchby: Thank you, Julian. Our GAAP net loss applicable to common stockholders for the second quarter was $0.9 million or $0.03 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 RMBS, was $3.9 million or $0.15 per weighted average diluted share. Our earnings available for distribution attributable to common stockholders, was $4.2 million or $0.16 per share. Our book value per common share as of June 30 was $5.19 compared to a book value of $5.52 as of March 31, 2023. 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, TBAs and treasury futures, all of which had a combined notional amount of approximately $700 million. You can see more details with respect to our hedging strategy in our 10-Q as well as in our second 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. Our operating expenses were $3.7 million for the quarter. On June 15, 2023, our Board of Directors declared a dividend of $0.15 per common share for the second quarter of 2023, which was paid in cash on July 31, 2023. We also declared a dividend of $0.5125 per share on our 8.2% Series A cumulative redeemable preferred stock and a dividend of $0.515625 on our 8.25% Series B fixed to floating rate cumulative redeemable preferred stock. Both of which were paid on July 17, 2023. At this time, we will open up the call for questions. Operator? See also 15 Best Countries for International Students to Study and Work and 15 Countries with the Most IKEA Stores Worldwide in 2023.
Q&A Session
Operator: Thank you. [Operator Instructions] Our first question comes from Mikhail Goberman with JMP Securities. Your line is open. Mikhail Goberman: Hey, good afternoon guys. Hope everybody is doing well. With the recent kind of bonds sell-off firmly in mind, just kind of thinking about how are you guys thinking about the mix of agency RMBS and MSRs should rates continue to sell-off and we get a continuation of the rising rate environment? Julian Evans: Hi, Mikhail. How are you? Mikhail Goberman: Good. Thank you. Julian Evans: This is Julian. Mikhail Goberman: Hi, Julian. Julian Evans: Look, it’s been a very interesting week, very volatile. I think we are constantly updating and changing the portfolio on a given day. From a longer term, or I should say, perspective, the combination of MSR, as well as agency mortgages, is a very sound strategy that we truly believe in. I think in the short-term, what we found is that RMBs at the current moment yields a little bit better than what the MSR is yielding from a valuation standpoint. And so we’d probably be holding more agency RMBS, as for rates continuing to go up, we continue to move around the portfolio, manage the asset side, as well as the liability side. And we’re trying to effectively minimize the risk in the portfolio. Jay Lown: And one other thing to note Mikhail, is that a decent portion of our RMBS portfolio is hedged with TBAs, which mitigates some of the spread widening that we’ve seen this week. So, in a widening environment we feel great about what we’re doing obviously, when a spread widening you have more protection and when spreads tightened, we definitely don’t get the same benefit that others do. But we definitely have some of the spread widening and risky, in an environment where we think the Fed may not be done and if we are in higher rates, there’s the potential for further widening. Mikhail Goberman: Got it. Thank you for that. Just kind of thinking about the mix of possibly issuing more stock through the ATM versus buybacks for the stock at about 90% of both? How are you guys thinking about the trade offs there going forward? Jay Lown: So we haven’t really, so we haven’t thought about the ATM in a little bit with respect to where we are relative to – I think what you’re referencing his tangible book. It’s definitely something that we think about respect to the Board, but the decision that we make with the Board currently, we are not tapping the ATM today, but we do have some parameters internally think about relative to how we think about raising capital through that program. And similarly, I think if the stock gets to a level that would support buybacks then we would definitely consider that as well, same thing with the preferred. Mikhail Goberman: Got it. So when you’re thinking about buybacks, do you look at the stock on a tangible basis or on a straight up book value basis? Jay Lown: To be perfectly candid, tangible. Mikhail Goberman: Okay. And with that in mind, any update – just one more, if I may, just any update on book value this quarter – thus far in third quarter? Thank you, guys. Jay Lown: Yes, sure. So we just don’t have that yet. Honestly, it’s been all hands-on deck to be able to report at this point and we’re 3 days into the month. And as you know what the MSR is and in that we just don’t have that for you. I wish I did, but we will race into get done to be able to do the call on time and I just don’t have it yet. Mikhail Goberman: No problem. Best of luck going forward. Thanks, guys. Jay Lown: Thanks. Operator: [Operator Instructions] Our next question comes from Matthew Howlett with B.Riley. Your line is open.
Matthew Howlett: Hello. Hi, good afternoon. Hi, Jay. Hi, everybody. Jay Lown: Hi, Matt. Matthew Howlett: Thanks for taking my question. Just on the comments on RMBS and value and spreads. And I think I heard you correctly where you said sort of – you don’t see a lot of catalysts for things to tighten here. And in the least in the short-term, I want to hear how you look at value. Do you look at like – how do you look at spreads to treasuries you look at other – how do you address value in the RMBS space? And what are the signs you need to see where sort of spread widening is done and it’s time to kind of go in is it just a Fed needs a signal, they’re going to cut rates or the Fed needs to stop running off their book. I just love the hearing because everything we read is at RMBS is just cheap the corporates and it’s this huge value, there is not a lot of supply, Fannie’s book came down and that’s why it’s going to tighten spreads here in the back half of the year. Julian Evans: Yes, so. Hi, Matt, this is Julian. Look, I think when we look at agency RMBS in the past, we’ve looked at them versus swaps. Now that the swap curve has kind of gone away the question is, do you want to look at them versus SOFR or treasuries. I’d say on a nominal basis, we’re looking at them versus treasuries, we still run OAS to kind of see where mortgages are. I think those two are effective tools in terms of trying to figure out the valuation. In terms of spreads. I think, look, I think, we’ve all looked at spreads from a historical standpoint on a nominal basis. And if you take a look at them over the 5-year timeframe, they are very attractive from a historical standpoint. I think if you look at the average over the 5-year timeframe, it’s like 283 spread. And right now, we’re probably about 175 given the widening that we’ve had continuing over the last couple of days, it’s been as high as 200. In our mind, I think that chops around I think it’s going to chop around a little bit, given that volatility has comes and goes all the time, it seems as of late, and it can come from anywhere in terms of statements either by our own Fed or from other central banks globally at this point in time. And I think what you’re asking for is, when will you finally see some type of tightening that’s more continuous then what we have experienced so far. I think you need stability in rates. I think you need volatility to kind of stabilize, if not truly be able to maintain the lower levels and continue forward. I do think that you need the banks to feel comfortable coming back into the market to buy mortgages. I think a lot of people have bought mortgages, that the wider levels 175 to 200 in that particular range, I think you’ll find a lot of the indexers or investors we’ve had been on the sidelines, are kind of neutral to kind of overweight at this point in terms of mortgages. There is no doubt that they are attractive from a long-term, but over their short-term timeframe, if volatility continues to move the way it is, I think it’s going to be hard for them to tighten and stay there continuously. And I think it’s the reason why we continue to hold TBA shorts in the portfolio. Matthew Howlett: Makes a lot of sense. And as spreads – did you say spreads did widen here this past week with a soften… Julian Evans: Yes, looks they have wide. Matthew Howlett: Okay, good. Well, look, it makes sense, what you’re saying and keeping the short TBA position. My next question is this. I mean, we all try to kind of figure out where how much excess capital each REITs has, and where they could take leverage up to and it’s hard to do it, no holistically across the space. So I want to ask you when you look at your leverage just over 4 turns in your asset mix with 40% RMBS and 43% servicing, I mean, what – when you talk about full deployment of where you could take the portfolio to or where you could take leverage to, I mean how should we think – I mean, how should we think about some REITs say 9, 10 times, but I know you have some MSRs, I mean, how do we look at your balance sheet and how much excess capital there could be when you finally decide to say let’s add some RMBS? Jay Lown: No, it’s a great question. I think that we have been holding more cash than I think I would like to in a normal stable environment. But I think this week is a perfect example as to why we do that still just given the margin calls around the spread widening is weakening in that side of the house. I do think that as you get closer to the end of the year and you get closer to the end of the Fed cycle that there is enough is going – there is going to be an opportunity to take up leverage whether that’s 1, 2 turns or whatever, we don’t have that dialed in yet, but I think that as Julian pointed out, as other REITs have as well, when the spreads start to widen at specific points in time, we do try to nibble in when we think there is value.
And I think you will see slowly us take up leverage of it as we feel again to Julian’s point, ball is coming down, things are starting to stabilize and market reactions to economic data, geopolitical news etcetera, it doesn’t create the volatility in the markets that it still currently does today. So, our intention, I can tell you is over time, we would like to take up the leverage somewhat. I can’t tell you exactly how, but I think that’s really – the federal says data dependent. It’s really dependent upon the ability to the market to get to a point where it’s able to absorb economic data and information and news and stabilize. And so I think that’s in the next 6 to 12 months? Absolutely. Matthew Howlett: Yes. Look, it’s clear, I mean, the earnings power is significant. I mean, if you take up just a turn and I think that’s – I think something we have all been waiting for, I know, clearly it’s been incredibly volatile and you are doing a great job managing through it. But I think to hear you say you have a lot of dry powder and that you are just – that you have the ability to – gives me comfort that obviously there is significant earnings power in the company when the time was right? Jay Lown: Yes, remember, that’s all going to come in on the RMBS too. We are pretty comfortable with where we are levered on, on the MSR front. Broadly speaking, we run about a 60% LTV. When we think about leverage on the MSRs and given some of the things that have happened over time etcetera, etcetera, we are comfortable with that level for the MSRs. So if you think about where this additional level could come from most likely, it would come from the RMBS side of us. Matthew Howlett: Got it. Well, great quarter and we look forward to the next story of growth with the company that Thanks, Jay. Thanks, everybody. Jay Lown: Sure. Take care, Matt. Operator: Showing no further questions at this time, I would now like to turn the conference back to Jay for closing remarks. Jay Lown: Thank you, operator. Thank you, everybody, for joining us on our second quarter 2023 earnings call. We look forward to updating you soon on our third quarter’s performance. Have a good evening. Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.
