Cherry Hill Mortgage Investment Corp (CHMI) 2014 Q1 法說會逐字稿

Greetings, and welcome to the Cherry Hill Mortgage First Quarter 2014 Earnings Conference Call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Michael Hutchby, Controller for Cherry Hill Mortgage. Thank you, Mr. Hutchby. You may begin.

Good afternoon. We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's first quarter 2014 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, as well as prepayment and recapture rates, delinquencies, and non-GAAP financial measures such as 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, our President and Chief Investment Officer. Also present are Stan Middleman, Cherry Hill's Chairman, Marty Levine, our Chief Financial Officer, and Julian Evans, our Senior Portfolio Manager. Now, I will turn the call over to Jay.

Thanks, Mike, and thank you, everyone, for joining us today on our first quarter 2014 earnings conference call. We posted on our website a presentation that will touch upon, and we'll reference specific slides when appropriate. After our prepared remarks, we'll open up the call to your questions.

Not much time has passed since our last call. However, we have a good deal to update everyone on, as we report our results for the first quarter of 2014. Cherry Hill delivered another solid quarter of performance, and remains focused on generating attractive returns to shareholders over time.

As can be seen on slide 7, the interest rate environment today is quite different than what we saw in the fourth quarter of last year. At the end of last year, the 10-year treasury bond closed at just over 3%, and there was an expectation that rates would continue to rise throughout 2014. Clearly, that has not materialized year-to-date.

Instead, we saw a healthy rally in interest rates during the month of January, reversing the entire fourth quarter's market move. Since February, however, we have been range bound, and the 10 year bond has remained in the mid to high 2% area.

As the markets continue to digest mixed economic data and geopolitical news, it is evident that a higher interest rate environment in the immediate term is not likely. The drop in interest rates, however, has not resulted in higher origination volumes thus far in 2014.

With the fed continuing its exit from QE3, we expect the non-bank mortgage origination committee will continue to compete for a smaller pool of assets, resulting in continued compressed margins, and forcing many to continue monetizing their MSR asset. While we expect there to be an abundance of MSR assets available for purchase going forward, there continues to be strong demand for these assets, as investors look for ways to capitalize on continued record low mortgage interest rates.

We remained focused on the excess MSR asset class to execute our investment strategy. We continue to believe it represents our most attractive investment opportunity over the long term, given our view of interest rates rising, as the economic recovery gains steam.

As we stated on our last call, having the flexibility to purchase the whole MSR should give us a wider potential market from which to acquire excess MSRs. We believe owning the full MSR may allow us to obtain leverage on the asset, thereby, increasing returns on the investment. As such, we are in the process of pursuing the appropriate licenses and approvals within our taxable REIT subsidiary to be able to own MSRs.

In addition to agency MBS and excess MSRs, we continued to explore the non-agency mortgage space. We're positioning ourselves to be ready to invest in these assets at the appropriate time, and believe that the new issue market will gain traction as the economy continues to improve and house prices rise.

Let's move on to our first quarter results. Turning to slide 8, the first quarter, once again, resulted in dividends consistent with the previous quarter, and a slight increased book value. Our book value per common share rose to $21.47 and we declared and subsequently distributed a $0.50 dividend to our shareholders.

With our excess MSRs unlevered, our aggregate debt to equity ratio at quarter end was 1.67 times, which is essentially unchanged from the fourth quarter. Net interest spread for the agency RMBS portfolio for the quarter was 1.59%, and prepayment speeds averaged just under 2%, well below management expectations.

Slide 10 outlines our aggregate portfolio composition, both in terms of the percentage of equity capital, as well as the percentage of total assets. At quarter end, our excess MSR investment represented approximately 68% of our equity capital, and approximately 26% of our assets, excluding cash.

Our agency RMBS portfolio comprised approximately 26% of equity, and approximately 73% of assets, again, excluding cash. The portfolio is concentrated in lower duration assets, given our view on interest rates. In addition, we continued to run a fairly neutral duration gap over the quarter at 0.19 years, and Julian will discuss the performance of the RMBS portfolio in more detail shortly.

I'd like to now discuss our excess MSR portfolio. Referencing slides 11 through 13, we continued to experience favorable performance on our initial investments in excess MSRs. The portfolio continued to generate significant returns during the quarter.

And despite interest rates falling, the investments performed well, primarily driven by lower long term prepayment expectations. This was mostly evident in pool one, which is comprised of fixed rate 30-year FHA VA loans. The current carrying value of the MSR portfolio dropped by $4 million, and stood at approximately $108 million at quarter end, which was driven primarily by amortization.

Our recapture agreement resulted in over $470 million hybrid arm loans from pool two being refinanced and recaptured into fixed rate 30-year loans during the quarter. This translates into a recapture rate of over 58% for this pool. We continued to be very pleased with Freedom's efforts to retain dollars in this portfolio, and we look forward to continued success there as the portfolio continues to mature.

Recapture activity for pool one was minimal, as you would expect with weighted average CPRs under 6% for the quarter. Well within management expectations, given the collateral characteristics of the underlying loans.

As we have stated before, the MSR market continues to be well bid, and many buyers are discounting the recent rally on interest rates as a short term bump in the road. We evaluate excess MSR purchases with Freedom on a regular basis, and continued to be prudent and deliberate in our deployment of additional capital.

We evaluate transactions within the context of our investment criteria and return thresholds. During the quarter, we completed both a flow purchase and small bulk purchase of excess MSRs from Freedom. While these transactions were nominal in size, we expect that we'll continue to execute with Freedom over the upcoming months, as more assets that meet our investment criteria become available to purchase.

At this time, I'll turn the presentation over to Julian Evans, who will provide some detailed information on the agency RMBS portfolio, and its performance over the quarter. Julian.

Thank you, Jay.

At March 31, 2014, the agency RMBS portfolio, including TBA, stood at $309 million, up from $293 million at 2013 year-end as shown on slide 14. The portfolio continues to concentrate on shorter duration assets, and was run on modest leverage at 6.3 times. At quarter-end, approximately 54% of assets were comprised of 20-year and 15-year fixed rate loans.

Loan balance stories continued to comprise the majority of the overall collateral composition at the quarter-end as shown on slide 15. Due to the portfolio's collateral composition, the portfolio continued to exhibit favorable prepayment speeds, posting a weighted average 1.95% CPR for the quarter.

Because the prepayment speed for the first quarter was relatively low, we would expect that similar prepayment speeds will be hard to duplicate going forward. The slower speed was a combination of collateral composition and seasonals.

During the first quarter, we continued to manage the aggregate portfolio conservatively. As Jay mentioned earlier, given our interest rate views, the portfolio operated with modest leverage and a fairly neutral duration gap. As shown on slide 16, we ended the quarter with an aggregate portfolio duration gap of positive 0.19 years.

Under various interest rate scenarios, the portfolio's duration gap remained stable according to our prepayment model. In fact, with an instantaneous 200 basis point parallel interest rate shift or 2%, our duration gap moved from a positive 0.19 years to a negative 0.13 years. The portfolio's gap was driven by a composition of RMBS portfolio and associated hedges, as well as the fact that two-thirds of the portfolio's equity was comprised of excess MSR.

At the end of 2013, we noted that the portfolio was positioned for a rising interest rate environment, and our hedge strategy was designed to protect book value. As such, our profits were impacted as rates dropped during the quarter. Despite the market move to lower rates, we still believe higher interest rates will materialize, just at a slower pace.

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

Thank you, Julian.

As Jay stated in his opening remarks, we had another solid quarter. GAAP income was $0.7 million, and our comprehensive income, which includes the mark-to-market of our held for sale RMBS, was $4.1 million. GAAP earnings-per-share for the quarter was $0.10. Comprehensive income per share was $0.54.

Net interest income was approximately $5.1 million in the first quarter of 2014. Our holistic hedging strategy produced a combined net increase in access of excess MSRs, RMBS, swaps and swaptions of $0.2 million.

As detailed in slide 29, we 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 first quarter, we had swaps with a notional value of $175 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 first quarter, we held six swaptions, which allow us to enter into swaps with a $125 million notional value at expiration of the option period, which occurs November 30, 2014.

For GAAP purposes, we have now elected to have [fly] hedge accounting for our interest rate derivatives. And as a result, we record the change and estimated fair value as a component of the net gain or loss on interest rate derivatives.

The majority, or 68% of our capital, is now deployed in excess MSRs. Our investment in excess MSRs are currently unlevered, and our applied debt-to-equity ratio on the RMBS portfolio, which includes our TBA position, was levered 6.3 times at quarter-end. Our other operating expense ratio as a percentage of our average equity is 2.8%.

On March 18th, we declared a first quarter 2014 dividend of $0.50 per share, which was paid on April 29th. It is our goal to distribute 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. For the first quarter of 2014, we had REIT taxable income eligible for dividend purposes of approximately $4 million, which represents $0.53 per share for the quarter.

Now, I'd like to turn the call back to Jay for closing remarks.

Thanks, Marty.

Cherry Hill is now seven months old. During this time, we have worked diligently to deliver consistent results for our shareholders. We are now focused on growing our business.

As we said on our last call, we view our investment strategy as a marathon and not a race. We are constantly evaluating investment opportunities in our target asset classes, and we are confident that our prudent and diligent capital deployment strategy will over the long term generate attractive yields and returns for our shareholders.

We will now open up the call to take your questions. Operator?

Thank you.

(Operator Instructions)

Our first question comes from the line of Henry Coffey from Sterne, Agee. Please proceed with your question.

Yes. Good afternoon, everyone, and congratulations on a good quarter. Just a small housekeeping item, the difference between comprehensive income at $0.54 and your core number at $0.53 was?

There's some options and LTIP costs that would not be tax deductible.

Okay. And then in terms of looking forward to the bigger picture, what's the likely timeline on you getting of a full servicer license?

Hey, Henry, it's Jay. Thanks for calling. So we continue to pursue that, obviously, as you would expect, to apply for those licenses takes a number of months. So we have begun that process, and it's our expectation to be able to do that as quickly as possible.

So I bet your desk gets loaded with a bunch of MSR opportunities every week, at least. Obviously, we don't see that flow. You probably see a lot of stuff you don't want, a lot of credit impaired stuff, a lot of really good stuff.

Just stepping back from CHMI for a bit, can you give us a sense of what you see in terms of possible service or sales and transfers beyond just the limited target that you've set for Cherry Hill?

Well, sure. As a general statement, whatever Freedom looks at, we look at as well. So I would say that we see a handful of transactions a week collectively. But as a general statement, I would tell you that the size of those transactions range from $200 million to $2 billion.

So we're not seeing the transformational type bids that you might expect that you would normally see around the non-conforming space or the legacy space. But we definitely continue to see this market as being very healthy, and extremely well bid.

Great. Well, thank you. Thanks for taking my questions.

Sure. Thanks, Henry.

Our next question comes from the line of Jeremy Campbell from Barclays. Please proceed with your question.

Hey, good evening, guys. So just -- but there's something back here -- your acquisition for the quarter, looked like the bigger piece is obviously that bulk bid with Freedom. Can you just touch on again how you prioritize acquiring MSRs going forward, whether it's in a bulk deal with Freedom or flow from their own production?

So it's not a matter of prioritizing. I think we make an attempt, one, to make sure that we talk to Freedom on a regular basis about flow, which is independent of the bulk activity. And so, it is our goal to try to transact with Freedom on a regular basis around their own production.

The portfolio that we bid on bulk was actually a portfolio that they purchased prior to the reclosing. So they weren't obligated to actually do anything for that portfolio, and we were able to work out a deal on that portfolio. So we'd consider that a very strong indication of our ability to actually transact with Freedom going forward.

Freedom does continue to bid on these MSR packages on a regular basis, and as you can imagine, number one, it takes a while to settle these things, a number of months. And two, they aren't really publicized in terms of who the bidders are, and what's happening until things are closed. So there's not a whole lot we can say about anything that we're doing with Freedom until something is actually closed, but we do continue to look at packages with Freedom on the bulk basis on a regular basis.

And then as far as Freedom production goes, what did they produce 1Q, and how is April shaping up so far? Just trying to get a sense for what the opportunity set may be for you guys going forward.

We have Stan here, I'll let him tell you what he's done over the first quarter, and April in terms of volume. I think it's a pretty good story for Freedom, but go ahead.

Yes. I think we probably did in excess of $4 billion in first quarter, and in April, I think that we produced pretty close to $1.8 billion new originations. And we expect to hit or exceed that again in May with Freedom. So that pretty much covers production.

Great. Thank you. And then just finally, I think you guys -- your ratio of MSRs to your equity is still hanging right at that 68%, 69% or so. Just what's your upper limit on that? I know there's a little bit of wiggle room there. I'm just trying to get a sense for how [many] more capacity you have to acquire MSRs without them doing a capital raise.

Sure, no problem. I think that we've been open in public about the fact that anything above the mid-70%s puts us at our full amount in terms of appetite, given all the tests we have to meet.

Got it. That's all I have. Thanks a lot, guys.

Sure. Thanks a lot, Jeremy.

Our next question comes from the line of Cheryl Pate from Morgan Stanley. Please proceed with your question.

Hello, good evening. Just a question on -- there's obviously been a bit of a change in the regulatory environment on the larger end this quarter. Can you maybe speak to the extent that that has flowed down or has that changed the competitive dynamics and maybe some of the IRRs in the face as you look at potential MSR investments?

Sure. It has had, in our opinion, no effect on the transactions that we look at on a regular basis. We know, and I think we alluded to that in our presentation, there's been a little bit more scrutiny over some of the transactions that people like [Aquin] and [Welter] and Nationstar have looked to purchase based on some of the legacy component. And maybe that has some implications around just them as companies, but we have seen no issues around the markets that we bid on. And, like I said to Henry, it remains very well bid and very active.

So to your question about IRRs, we have noticed that pricing has been more competitive of late. But I think as the longer we stay in this mid- to high 2% range, the component of some convexity embedded in those packages might help us, and I think we'll see slightly better -- slightly more favorable pricing as we continue to go through the year. That's what we're hoping.

Has the -- I'm sorry. Go ahead.

I'm sorry. I said at least that's what we're hoping for.

Okay. Just as a quick follow-up on the pricing competition. Has it been fairly broad-based across, Fannie, Freddie, Ginnie? Or are you seeing it a little bit more competitive in any one area?

No. I think it's well bid across the GSEs, as well as for Ginnie Mae. And that may just be a function of who is interested in what product, but we've seen a number of packages out for bid. And on a regular basis, those packages are well bid by a number of people, and we don't see any significant issues around the GSEs versus Ginnie Mae.

Okay. Thanks very much.

Our next question comes from the line of Paul Miller from FBR. Please proceed with your question.

Hello, guys. This is actually Jessica Rivner for Paul.

Just one last question on the MSR, or your planned MSR acquisitions. Are you still looking for the same type of Ginnie product? Are you open to anything like Fannie and Freddie, or even private label?

Sure. So we're not limited to Ginnie. As a general statement, I think that what we've purchased or acquired from Freedom has been more focused on Ginnie, due to the fact that Freedom's core competencies have been in the FHA VA space over the last couple years.

But Stan alluded to around Freedom, their volume is growing this year. And the percentage of conforming business is growing with them as well. So we would expect to be in a position to look at some portfolios around the GSEs, as well as just Ginnie Mae. We don't believe that we're going to evaluate some of the legacy non-conforming or non-agency MSRs any time soon.

And I guess there's not enough new product to really take that into consideration.

No. I just don't think it's something we're very focused on around the non-conforming legacy MSR space.

Okay. Thank you very much. Oh, sorry.

I think we've been pretty clear about the fact we're looking forward, and not really that focused on looking backward.

Thank you.

Sure.

Our next question comes from the line of Michael Kaye from Citi. Please proceed with your question.

Hello. Could you comment how you're thinking about your future capital needs at this point? And since you're trading below book value, what kind of alternatives would you consider to raise additional capital? Then finally, what's your philosophy about where you're seeing equity below book value? Thank you.

Sure. So that's a couple questions. One, yes, we are trading slightly below book, and we recognize that, being six months old. We continue to do what we think we're supposed to be doing to make sure that we're generating returns that are consistent with what we set out to do.

With respect to the capital needs around us, at the end of the day, I think, as I said at the end of our prepared remarks, that we are interested in growing the business. And so we look to do that in a fashion and in a way that's prudent. We recognize that raising capital below book is dilutive, and we expect to work with both our current shareholders and our bankers to make a decision that's in the best interest of everybody over the next six months or so.

Thank you.

Our next question comes from the line of Steve DeLaney from JMP Securities. Please proceed with your question.

Thanks. Good evening, everyone. Jay, we were pleasantly surprised to see the book value actually tick up a couple pennies. We've seen some other companies that own MSRs, given the drop in rate, 30 basis points or so that we had in the first quarter actually take negative marks.

So just wondering if you could comment, everything I guess is a bit idiosyncratic in terms of pools and the makeup of the collateral. But how were you able to see a positive fair value mark in the face of that drop in rates? And any color you could give there would be helpful.

Yes, sure. I think that you'll be able to see some of that in the Q. That's predominantly around the discount rate in the fair value of the assets. And I think that from where we've purchased the assets and in the Fall of the last year versus today, that discount rate has continued to tighten.

Got it.

And as such, based on our evaluations that we receive externally and discussions with our third-party valuation agents as well as internally, those positions were not impacted by the drop in rates. And so we were happy about that. We think that they're marked fairly, and we expect many of those positions to continue to perform to our original modeling expectations.

Okay. And I guess to some degree, Jay, the discount rate is derived from the price someone is willing to pay, right, of applying their required returns. So as things are well bid, that I assume necessarily puts pressure on the discount rate to move lower.

Am I thinking correctly about that? In other words, is it a market observed discount rate or just something that's arbitrarily tied to the tenure?

No. Actually, I think another thing I mentioned on the call is the MSR buyers over the first quarter and even the fourth quarter have somewhat discounted the rally in interest rates, because they viewed the purchase of this asset tied to a much longer view on rates in general. So we have continued to see MSR assets remain very well bid, and that discount rate dropped at -- we're talking about it is essentially reflected in the analysis within the Q.

Got it.

Also, one thing that's important to note is that despite the drop in rates and the fact the MBS is directly correlated to that, if you take a look at the refinancing index. As I alluded to, also in our comments, origination volumes have not spiked. And that would also support some of the thesis around this being somewhat of a short term blip, given the heavy rebuy volume over the last two years.

Okay. That's helpful.

And then, Marty, just one thing for you. We noticed a large drop in non-interest G&A expenses, beyond the management fee, it was down about 25% to $457,000. I don't know whether that was in the fourth quarter expense as a [609], was there something kind of large one time maybe related to the IPO, and should we look at this $450,000 to say $500,000 level, is that a more normal level for G&A?

This quarter was more normal. The quarter last year, the LTIPs that were given at the onset, about $200,000 of additional expense in that quarter.

I got it.

That wasn't comparable to this.

Okay, thank you. And Julian, obviously this, you made a comment this CPR benefited from seasonal. But beyond just the first quarter seasonal, do you have any sense for thinking about the seasoning of your portfolio? It seems like a pretty fresh portfolio in terms of loan age.

Should we necessarily, say over the next four to six quarters as these things season a bit, expect even if rates don't move, expect that CPR to move up to more like a mid single-digit or high single-digit level? What kind of guidance -- guidance is a bad word, what kind of trend do you expect to see in the CPR, absent any kind of material move in rate?

Yes. I would definitely think if we continue to stay here or move even a little bit higher, mid single-digits is probably the best way to think about it. I think that we do hold a fair composition of loan balance collateral, but that has definitely helped us in terms of the rally here. We've definitely seen benefit in terms of the premium. So that collateral being increasing.

But I would say, in the CPRs have been somewhat well maintained. But as Jay has kind of alluded to, rates have gotten down here to about what, [2.61%] I think as we pulled the (technical difficulties). Any further, I would say that the mortgage universe becomes a little more cuspy at that point, so we would expect to pick up in speeds. But thus saying, if we moved back to [2.70%], we expect speeds to be on the lower end of that midrange that we've noted to you.

Okay, thanks. Well that's all I have, Jay, and I appreciate everyone's comments. Thank you.

There are no further questions in the queue. I'd like to hand the call back over to Jay Lown for closing comments.

Great, thanks very much. Thank you for joining us today on our call. I look forward to updating you on our progress on subsequent calls. Have a great evening.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.