Cherry Hill Mortgage Investment Corporation (NYSE:CHMI) Q3 2023 Earnings Call Transcript

Cherry Hill Mortgage Investment Corporation (NYSE:CHMI) Q3 2023 Earnings Call Transcript November 2, 2023

Operator: 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 speakers’ presentation, there will be a question-and-answer session. [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, with Investor Relations. Please go ahead.

Garrett Edson: We’d like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation’s third quarter 2023 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.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.

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, the 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 third quarter 2023 earnings call. While the third quarter initially seemed as if we were headed to a soft landing and an end of the rate height 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 10-year, agency mortgage spreads widened considerably during the quarter. While agency REITs 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 RMBS portfolio with TBAs. We believe this positioning, along with our portfolio of MSRs, worked to our shareholders’ advantage in the quarter as we successfully preserved the vast majority of our shareholder equity.

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 1 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 RMBS opportunities that offer attractive risk-adjusted returns, and that the overall strategy of pairing MSRs with agency RMBS remains the proper strategy for the current environment.

For the third quarter, we generated a GAAP net gain applicable to common stockholders of $0.49 per diluted share, and we generated earnings available for distribution, or EAD, a non-GAAP financial measure of $4.4 million or $0.16 per share, which exceeded our quarterly distribution. As we’ve 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 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 30, down 3.9% from June 30.

On an NAV basis, which includes preferred stock in the calculation, we were down 1.9% relative to June 30. As we 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 is in our shareholders’ best interest and remains a top priority for us. During the third quarter, we remained firm on our MSR portfolio as we believe agency RMBS continues to present 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 MSR remain minimal, given the higher interest rate levels.

Our portfolio of MSR’s weighted average note rate of approximately 3.5% 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 4.4x as we opportunistically deployed additional capital during the quarter while remaining prudently levered as the 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 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.

A high angle view of a real estate professional taking pictures of a property.

Julian Evans: Thank you, Jay. The third quarter commenced with expectations that the Fed rate hiking cycle was nearing completion. However, persistent inflation, a hotter 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 a 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 RMBS portfolio with TBAs. In the near-term, that decision 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 had a UPB of $20.3 billion and a market value of approximately $266 million. The MSR and related net assets represented approximately 45% of our equity capital and approximately 31% of our investable assets, excluding cash at quarter-end. Meanwhile, RMBS portfolio accounted for approximately 41% 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 RMBS 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 5.6% for the third quarter, modestly down from 6.2% net CPR in the previous quarter. The portfolio’s recapture rate remain consistent, but low at approximately 1%, as the incentive to refinance continues to be minimal. Moving forward, we continue to expect lower recapture rates and a stable net CPR for the foreseeable future given the current levels of interest in mortgage rates. The RMBS portfolio’s prepayment speeds remain 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 the 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 if interest rates remain at these levels or move higher. For the quarter, the RMBS portfolio’s weighted average three-month CPR moved slightly higher to approximately 4.4% compared to approximately 4.2% in the second quarter. As of September 30, the RMBS portfolio inclusive of TBAs stood at approximately $583 million compared to $602 million at the previous quarter-end. Quarter-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 in higher coupon mortgages, we also continue to maintain TBA hedges in the portfolio, especially in lower coupon mortgages.

For the third quarter, our RMBS net interest spread was 3.6%. 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’s coupon composition. At quarter-end, the portfolio’s financial leverage remained at approximately 4.4x, and the 30-year securities position continued to represent 100% of the RMBS 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 until there are clear signs of stabilization. I will now turn the call over to Mike for a third quarter financial discussion.

Michael Hutchby: Thank you, Julian. Our GAAP net income applicable to common stockholders for the third quarter was $13.1 million or $0.49 per weighted average diluted share outstanding during the quarter. A comprehensive loss attributable to common stockholders, which includes the mark-to -market of our available for sale RMBS, was $1.1 million or $0.04 per weighted average diluted share. Our earnings available for distribution attributable to common stockholders were $4.4 million or $0.16 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, TBAs, 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 in 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 14, our Board of Directors declared a dividend of $0.15 per common share for the third quarter of 2023, which was paid in cash on October 31, 2023. We also declared a dividend of $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 October 16, 2023.

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

Operator: [Operator Instructions] Our first question comes from Mikhail Goberman with JMP Securities. Your line is open.

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