Cherry Hill Mortgage Investment Corp (CHMI) 2013 Q4 法說會逐字稿

Greetings and welcome to the Cherry Hill Mortgage fourth-quarter 2013 earnings conference call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions)

I would now like to turn the conference over to your host, Michael Hutchby. Thank you. You may now begin.

Good afternoon. We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's fiscal 2013 and fourth-quarter conference call. In addition to this call we have filed a press release that was distributed today 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; delinquency; prepayment and recapture rates; as well as non-GAAP financial measures, such as comprehensive income.

Forward-looking statements represent management's current estimates, and Cherry Hill seems 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 releases available on the Company's website.

Today's conference call is hosted by Jay Lown, Cherry Hill's President and Chief Investment Officer; Marty Levine, our Chief Financial Officer; and Julian Evans, our Senior Portfolio Manager. And now I will turn the call over to Jay.

Thanks, Mike. And thank you, everyone, for joining us today on our first earnings call as a publicly-traded company. As part of our call, we have posted on our website a presentation that we will touch upon throughout the call, and we will reference specific slides where appropriate. After our prepared remarks, we will open up the call to your questions.

Let me begin with an overview of the Company and our strategy. 2013 was an exciting year for our Company, as we successfully completed the formation of a well-balanced investment vehicle to acquire residential mortgage assets that we think generate compelling returns for shareholders. The idea for Cherry Hill was born out of the experiences and observations of the Cherry Hill management team and our Chairman, Stan Middleman.

A few years ago we recognized an opportunity to acquire, invest in, and manage certain assets in the residential mortgage marketplace that traditionally have been unavailable to many investors. The culmination of that work resulted in our IPO last October.

Cherry Hill Mortgage is strategically positioned to capitalize on opportunities in the residential mortgage investment market. Our primary objective is straightforward: to generate attractive yields and risk-adjusted returns, primarily through dividend distributions and capital appreciation.

We are currently focused on three main asset classes to execute our investment strategy: excess mortgage servicing rights, or Excess MSRs; agency residential mortgage-backed securities, or Agency RMBS; and, when appropriate, prime jumbo mortgage loans.

We believe there are good market opportunities to acquire attractive investments in these assets, both today and over the next several years. Currently we see the greatest opportunity in the MSR market.

We believe Excess MSRs represent an attractive investment opportunity across multiple interest rate cycles. Given the current regulatory and interest rate environment, we expect to source significant opportunities to purchase Excess MSRs as banks look to shed assets and mortgage originators struggle to maintain profits.

Looking closer at the current state of the residential mortgage origination market, we believe that our business is poised for continued growth. As can be seen on slide 8, the US mortgage finance system has historically been dominated by large banks. The industry landscape is now undergoing substantial change. Increased government regulation and public policy are creating unique opportunities for investors to step in and provide non-bank capital in the servicing space that can become a significant part of the market over the next several years.

In fact, the top five banks' total share of originations has dropped from 61% in 2010 to around 41% at the end of the third quarter of 2013, highlighting the increasing role that non-bank capital plays today. To that end we are strategically aligned with Freedom Mortgage, a leading independent mortgage company that originates and services mortgage loans nationwide.

Freedom lends to primarily prime borrowers and originates conforming, FHA BO, and jumbo and Non-Agency mortgage loans. As banks continue to pull back from the mortgage finance business, non-bank originators such as Freedom are capturing market share.

Within the context of this industry shift, we recognized the need for a dedicated investment vehicle to take advantage of the large opportunities in mortgage servicing rights and other related assets being generated by Freedom and others. We believe our strategic relationship provides a meaningful and consistent platform for us to scale our operations over time.

We also believe over time both bank and non-bank originators will continue to look to monetize MSRs. Cherry Hill is well positioned to provide liquidity to these institutions looking to monetize their MSR assets. We expect to establish relationships with other originators and servicers to expand our portfolio of Excess MSRs and other assets that meet our return thresholds.

We believe having the flexibility to purchase the whole MSR may give us a wider potential market from which to acquire Excess MSRs. To this end, we are planning to pursue the appropriate licenses and approvals within our taxable REIT sub to be able to own MSRs.

Putting all this together, we have created a strategy to invest prudently in real estate related assets that meet our investment criteria and have constructed what we believe to be a strong portfolio of high quality residential mortgage assets to generate attractive current yields and risk-adjusted total returns for our shareholders. This portfolio lays the foundation for us to execute our strategy in a variety of market conditions and economic cycles.

I'd now like to discuss some details around fourth-quarter results. As depicted on slide 11, noteworthy highlights for the quarter include declaring and subsequently paying a $0.45 dividend and our book value increasing to $21.44 per share.

Our aggregate debt-to-equity ratio at quarter end was 1.62, which is due in large part to the Excess MSR asset being unlevered. Net interest spread for the Agency RMBS portfolio for the quarter came in at 1.43%, and prepayment speeds for the Agency portfolio averaged just over 3%.

Slide 12 outlines our aggregate portfolio composition, both in terms of the percentage of equity capital as well as the percentage of total assets. At year end, our Excess MSR investment represented approximately 70% of our equity capital and approximately 28% of our assets, excluding cash. Our Agency RMBS portfolio comprised of approximately 26% of equity and approximately 72% of assets, again, excluding cash.

Let's spend a few minutes on our Excess MSR portfolio. Turning to slide 13, we have made meaningful progress into since our IPO last year. Concurrent with the offering, we acquired our first investment of Excess MSRs and began executing on our plan of investing in assets that we believe will provide consistent returns to shareholders over time. The portfolio generated significant returns during the quarter and increased in value by over $15 million, approximately 60% over adjusted cost basis.

The current carrying value of the Excess MSR portfolio at year end rose to $110 million. The increase in value is spread pretty evenly between Pool 1 and Pool 2.

Worth mentioning are some benefits of our recapture agreement with Freedom on this investment. During the quarter Freedom recaptured over $77 million in 3/1 hybrid VA ARM loans from Pool 2, which were replaced with new 30-year fixed-rate loans. This, along with the continued success of Freedom's recapture effort in the first quarter of the current year, underscores the significance of our partnership with a strong originator like Freedom.

Pool 1 experienced little recapture activity during the quarter. However, the net CPR remained in line with expectations at approximately 6%. We believe this investment will continue to experience low prepayment speeds, given the low gross net rate of the underlying mortgages.

Slides 14 and 15 highlight some statistics around the performance of these investments, including delinquency rates, prepay speeds, recapture rates, cash flow projections, and IRRs. We are very pleased with the overall performance of these investments to date.

I would like to point out that subsequent to the fourth quarter, we entered into a flow agreement with Freedom for a portion of their first-quarter 2014 production, as well as a bulk agreement with Freedom for a portfolio purchased during the first quarter. It should also be noted that we have been prudent and deliberate in our deployment of additional capital as we continue to evaluate Excess MSR transactions that meet our criteria.

Let's turn to our Agency RMBS portfolio. Julian Evans, our Manager of Senior PM, will provide some detailed information on its performance over the quarter. Julian?

Thank you, Jay. Following the IPO, we deployed approximately $38 million of proceeds along with leverage to fund the purchase of approximately $297 million of Agency RMBS assets. As shown on slide 16, the portfolio stood at approximately $293 million, including TBAs, at year end.

Our main focus with the Agency RMBS portfolio is to concentrate on a couple of factors: one, to preserve capital; and two, to minimize mortgage extension risk. It has been our goal to maintain a portfolio comprised of shorter-duration assets, and to this end 51% of our Agency RMBS portfolio was comprised of 15-year and 20-year fixed-rate whole pools, and the remainder in 30-year fixed rate whole pools, including our net TBA position at quarter end.

As we embarked on our deployment of capital, premiums paid for collateral stories were minimal, especially loan balance pools. During the fourth quarter the portfolio also experienced favorable prepayment speeds, with the portfolio averaging just over 3% CPR.

Turning back to the portfolio in aggregate, given our view on interest rates and increased volatility during the fourth quarter, we chose to maintain a conservative duration gap for our aggregate portfolio, which includes the Agency RMBS portfolio as well as the Excess MSR portfolio. As can be seen on slide 18, we ended the quarter with a duration gap of negative 0.15 years.

Under various interest rate scenarios, aggregate portfolios duration gap changes little, according to our prepayment model. In fact, with an instantaneous 200 basis point parallel interest rate shift, our duration gap extends 0.3 of a year, or a third of a year.

This is mainly driven by the vast majority of our equity being deployed in Excess MSR assets, and secondly from the composition of our Agency RMBS portfolio as well as associated hedges. At year end we believe we were well positioned for a rising interest rate environment over the near-term and medium-term.

I would now like to turn the call over to our CFO, Marty Levine, who will review our fourth-quarter financial results in more detail. Marty?

Thank you, Julian. Let me begin by reminding everyone on the call that our IPO was completed on October 9, 2013, and as a newly formed company, we have no comparable yearly or quarterly data. We purchased our Excess MSR portfolio and invested in our Agency RMBS portfolio in the fourth quarter of 2013. As such, all my remarks will focus solely on the performance of the portfolio from our IPO to year-end December 31.

In October we acquired from Freedom interest in two pools of FHA and VA loans which produce Excess MSR income. Pool 1 had an aggregate outstanding UPB of approximately $10.1 billion. We purchased an 85% interest in the 20 bp Excess servicing fee for approximately $60.6 million. This pool is substantially all fixed-rate mortgages. As of December 31 the weighted average coupon was 3.5%, and the remaining term was 335 months.

Pool 2 had an aggregate outstanding UPB of approximately $10.7 billion. We purchased a 50% interest in the Excess servicing fee of 34 bp for approximately $38.4 million. This pool originally consisted of 100% VA adjustable-rate mortgages. The origination vintage of this pool is subsequent to January 1, 2011; and as of December 31, 2013, the weighted average coupon was 2.6%, and the remaining term was 341 months.

$77 million of this pool has been refinanced and recaptured into new 30-year fixed-rate loans. These pools are unlevered. In October, as Julian mentioned, we used $38 million of our IPO proceeds along with additional leverage to fund the purchase of our diversified portfolio of Agency RMBS assets. As of December 31 our RMBS assets had an estimated fair market value of $287 million, consisting primarily of Agency RMBS collateralized by fixed-rate loans.

We financed and levered the RMBS portfolio with $261 million of repurchase agreements. The effective borrowing interest rate on the repos was 39 bp at the end of the fourth quarter.

Moving on to our financial results for the fourth quarter, GAAP income was $21.2 million. And our comprehensive income, which includes the mark-to-market of our held-for-sale RMBS, was $16.2 million.

GAAP earnings per share for the quarter was $3.14. It should be noted that the earnings per share calculation is based on the weighted average shares outstanding for the full quarter. This difference has resulted in an earnings per share number that is based on a weighted average of 6,750,000 shares, and not the 7,500,000 shares outstanding as of December 31, 2013. If we were to use the 7.5 million shares outstanding and apply it across the entire quarter, earnings per share would have been $2.84.

Our earnings were driven by two items: the first was approximately $4.6 million in net interest income related to our Excess MSR and Agency RMBS portfolio; and the second and larger driver was related to the $15.6 million change in fair value of investments in Excess MSRs. That increase in value is partly due to the difference between the negotiated purchase price and the actual purchase date.

We had negotiated the contract in the mid-third quarter of 2013, and the purchase of these assets closed in October 2013, so there was an embedded discount in the acquired assets. We do not expect similar movement in the mark-to-market of these assets going forward.

As detailed in slide 28, we also use interest rate swaps and interest rate swaptions 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 had swaps with a notional value of $172 million.

Swaptions provide us as the purchaser with the right but not the obligation to enter into a swap at a future date. At the end of the fourth quarter, we held 6 swaptions which allow us to enter into swaps with $125 million notional value at expiration of the option period, which occurs in the fourth quarter of 2014.

For GAAP purposes, we have now 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 rates and derivatives.

On December 17 we declared a dividend of $0.45 per share for the fourth quarter of 2013. This prorated dividend reflects the 81 days during the quarter after which the Company's initial public offering was completed. It is our goal to distribute regulate regular quarterly dividends of all or substantially all of our taxable income to holders of our common stock and to the extent authorized by our Board of Directors.

On March 18 we declared our first-quarter 2014 dividend of $0.50 per share. For the fourth quarter of 2013 we had REIT taxable income eligible for dividend purposes of approximately $3.6 million, which represents $0.48 per share for the quarter. As such, the $0.45 distribution for the quarter was treated as ordinary income. Please reference the Investor Relations section of our website for additional information regarding the dividend and tax treatment.

Now I'd like to turn it back to Jay for closing remarks.

Thanks, Marty. We are pleased with what we have accomplished at Cherry Hill since our inception. It has been and continues to be our goal to provide investors with a platform to participate in attractive investment opportunities in the mortgage marketplace that were previously available only to large institutional investors.

We view the market opportunity in the long run to be significant. We believe we are in the early stages of a major industry shift that will benefit companies like Cherry Hill.

Amid the current healthy market for MSRs, we view our investment strategy as a marathon, not a race. We are constantly evaluating investment opportunities in our target asset classes, and we are confident that our capital deployment strategy will over the long-term generate attractive yields and returns for our shareholders.

We will now open the call up for questions. Operator?

(Operator Instructions) Steve DeLaney, JMP Securities.

Thank you. Good afternoon, everyone, and congratulations on a great start at Cherry Hill. You guys went into a lot of detail on the Agency strategy and the MSRs -- and a very solid performance there, as you predicted at the time of the IPO.

Just looking ahead a little more strategically, Jay, I wondered if you could just comment on the third leg of the stool -- the prime jumbo market -- and how you see the opportunities there looking out? When might we see that as part of the story?

I guess we saw Redwood did a deal this week. It was much improved in terms of being backed from Agency. So any thoughts you can give us on the jumbo outlook as it relates to Cherry Hill would be welcome. Thanks.

Sure. We have spent a fair amount of time on it. But as everybody probably knows, the large banks have dominated this sector over the last six months.

It's welcome to see Redwood come out with a deal versus federal loans. I would say that we are working hard on this sector, and we are ready to be involved in a meaningful way when the time is right. But we are looking for a little bit more activity to be a little bit more committed to that space in the near term.

Yes. Understood. That seems to be the challenge there right now, is just the hit-or-miss kind of nature of whether the window is open or not.

And then, secondly, given Freedom's leading role in Ginnie Mae and expertise in the FHA market, we are seeing increasing flow of nonperforming loans coming out primarily from FHA. I was just curious -- given that those would help you with the 40 Act and would give you sort of an alternative to a whole-pool agency, are the FHA non-performing schools that are coming out -- is that an opportunity for you that would maybe be a fourth leg to the stool?

That's a good question, and we definitely see an increase in activity around that space. We have not necessarily put a lot of time and energy into the non-performing loan market.

With respect to things around Ginnie and Ginnie buyouts, it is something that we think about. And we do evaluate it on the merits you just mentioned. And we will continue to look at it. And should it be compelling for us, then we will certainly let you guys know.

Okay. Appreciate it. Marty, when should we expect to see the 10-K hit?

I'm expecting to file it tomorrow.

Great. Anything else I have I'm sure will be in there. Thanks, gentlemen, I appreciate it.

Jeremy Campbell, Barclays.

Good evening, everybody. So of that MSR value increase that you guys booked in the P&L, you mentioned a good portion of that was due to the disparity between the negotiated price and the fair value at closing date. Can you just give us a better sense of maybe what the numeric value to that would be? So what was the difference between the negotiated and the closing fair value, versus what actually you experienced as far as valuation increase during the quarter?

So we haven't publicized anything specific around what percentage of the market is due to each. But to Marty's comments in the prepared remarks, we are confident that the volatility in the change of the value was mostly reflected in the fourth quarter. So I can't give you a specific number, because we just haven't published or presented that to anybody. But a considerable amount of the write-up was due to the timing of the trade.

Got it. And then you also mentioned bulk and flow agreements. Can you give us any sense of any magnitude there -- how big they are going to be, or what percentage roughly of what Freedom is originating this quarter you guys might be interested in as far as the flow side?

Sure. And the 10-K will give a little bit more information about this later this week. It wasn't a significant set of trades in terms of size, but we were very adamant about making sure that we got a few things done with Freedom, both to present some kind of actual performance around what we said we would do, and to make sure that the process worked, and so that we can continue to look to transact with them on a go-forward basis.

As you know, the market is hot. It is very well bid. And to our remarks, also, we are being diligent about how we deploy the capital and to make sure that what we do represents a good return profile for the shareholders.

Got it. And then just one final question here, too, is: I believe when you guys were doing the roadshow, you mentioned targeting another offering, probably at the end of 2014. How much capacity do you have as far as UPB in the current bid environment before you have to go ahead and raise more capital?

So this leads me to the second part of your question. You know, at the IPO we were pretty fully deployed in the MSR strategy. And so today, at 70% of the strategy, I think that's pretty much in line with what we said around the IPO around the asset class.

To make sure that we are not out of compliance with certain REIT tests, we probably have a little bit more to go. But it's not anything significant. So, again, to that extent we've been pretty diligent about how we deploy that capital.

We do see a lot of activity in the space and continue to look at opportunities with Freedom on the bulk side. And the first quarter, for obvious reasons around the mortgage companies struggling to maintain profitability, we have seen a good amount of bulk bidding activity. And we expect to continue to work with Freedom to try to close on some transactions over the course of the year.

Thanks a lot, guys. That's all have.

(Operator Instructions) Henry Coffey, Sterne, Agee.

Good afternoon, everyone. If I've got this figured right, and maybe you can give us some guidance here, in terms of separating out your sort of core earnings from -- I mean, trying to get from GAAP to core, how would you do that? And what basic number did you come up with?

Henry, this is Marty. The net interest income was $4.6 million between the ARMs and the Excess MSR. That's for 81 days, not the 90.

Right.

If you extrapolate that out, you are at approximately $5 million for the quarter. Our total expenses are probably going to be running on average around $1.250 million a quarter.

Yes. Which is where they are -- well, they almost are.

That's going forward. So you can extrapolate from that what the quarter brings.

So in terms of just trying to create a template we can all work with. Basically, you are taking all the realized gains, losses, marks on derivatives, and MSR changes; and the $22 million -- we sort of look through that, and then just focus on the net interest income and total expenses, right?

Correct.

And then looking at the interest income, what was the breakdown during the quarter between the Agency portfolio and what it generated on a gross basis and the MSR?

The MSR -- are we allowed to say that? Are we allowed to give that, if it's not in the presentation?

Well, it's certainly irrelevant. (laughter)

How about we follow up with you, Henry?

Yes, that'd be -- yes, we can talk about that, or wait for the K.

Sorry, Henry.

I think some of Steve's thinking on this issue was good. Probably at this early stage of the game, we all need to wait on the K, anyways.

In terms of reinvestment opportunities, if you were to put new capital to work, what would your required hurdle rates be? And how challenging is it going to be to make those required returns?

Sure. So we haven't actually probably said what return hurdles are that we are looking for, but our goal is to be able to deliver dividends in line with what we have delivered so far. And so to that extent, yes, the market is hot today.

And to that extent, we have looked at putting the licenses in the TRS, and getting it to be a licensed servicer, to be able to acquire full MSR. And to that extent we could apply leverage in the instances where returns may not meet our hurdles.

But we have closed on a bulk transaction with Freedom that did essentially meet our return hurdles. We did that bulk from them, and we have seen a little bit more normalcy in the market since the beginning of the year.

So we do see good opportunities in the space. The mortgage origination community continues to figure out how they are going to survive, and we've seen some consolidation in that space. So we expect a fair amount of activity throughout the rest of the year.

Now, can I give you specific numbers? I would prefer not to do that on the call, but --.

Sure. Thank you. I'm just looking at the core number. It looks pretty strong, but we'll talk about that more.

Thank you. I will now turn to call back over to Jay Lown for our closing comments.

Thanks, everybody. Thank you for joining us on the call today. We look forward to updating you on our progress on subsequent calls. Have a great day.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.