Cherry Hill Mortgage Investment Corp (CHMI) 2014 Q4 法說會逐字稿

Greetings, and welcome to the Cherry Hill Mortgage fourth quarter 2014 earnings conference call.

(Operator Instructions)

I'd now like to turn the conference over to you host, Mr. Michael Hutchby. Please go ahead sir.

Good afternoon.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's fourth quarter 2014 conference call. In addition to this call, we have filed a press release that was distributed today and posted 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, IRR's, 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 forward-looking statements in the future.

We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the companies 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 Chief Investment Officer. Also present on the call today are Marty Levine, the Chief Financial Officer, and Julian Evans, our Senior Portfolio Manager. And now I'll turn the call over to Jay.

Thanks Mike, and thank you everyone for joining us today on our fourth-quarter 2014 earnings conference call. As part of today's call, we posted on our website a presentation that we'll touch upon throughout the call, and will reference specific slides where appropriate. After our prepared remarks we will open up the call for questions.

Cherry Hill achieved solid results in the fourth quarter of 2014 despite an economic environment marked by ongoing declining interest rates and lower mortgage rates. The results are a testament to the hard work of both our entire team and our strategic partner, Freedom Mortgage.

Our performance is even more remarkable when you consider that on December 31, the US 10 year Treasury closed 86 basis points lower than at the prior year end. The 10 year Treasury fell 32 basis points in the fourth quarter alone compared to September 30, and until recently, it had continued its decline during the first quarter of 2015. Over the course of 2014, Cherry Hill's book value decreased by only $0.17, or 0.8%, which given the absolute drop in interest rates, speaks to the quality and positioning of our portfolio.

As we look at the current interest-rate environment, coupled with the global geopolitical events, we remain biased toward a higher interest rate environment. Consistent positive domestic economic data during the quarter has continued into 2015, and our portfolio composition in the aggregate reflects this thesis.

Notable market takeaways for the quarter were a downward trend in interest rates, elevated market volatility, and higher gross prepayment fees in agency mortgage loans. As we show on Slide 5, MBS prepayment speeds have consistently increased quarter over quarter throughout the year, as interest rates have fallen. Accordingly, a primary focus for our team has been and continues to be minimizing the runoff of our portfolio with Excess MSRs and we spend a significant amount of our time working closely with Freedom to protect and defend our investment.

We strongly believe that the result of this partnership set us apart from other investors of mortgage servicing assets. And our prepay speeds net of recapture throughout the year demonstrates this.

Our investment strategy remains focused on the MSR asset class. We believe that at appropriate entry points, this asset class offers attractive returns over the long-term, especially in a rising interest-rate environment. As we have stated on numerous occasions, having the ability to purchase full MSRs should broaden our investment options.

Turning to our quarterly results, as shown on Slide 6, our fourth-quarter results were substantially in line with our third-quarter performance, and in spite of the decline in interest rates, we generated dividend eligible earnings of $0.52 per share. We declared and subsequently distributed a $0.51 dividend to our shareholders.

Net interest spread for the RMBS portfolio for the quarter was 1.67%, an increase from 1.55% in the previous quarter, with prepay speeds for the RMBS portfolio averaging approximately 6.8 CPR, in line with our expectations. Throughout the year, our RMBS portfolio has exhibited favorable prepayment characteristics versus generic and TBA cohorts. Julian will discuss the performance of the RMBS portfolio in more detail shortly.

Book value per share as of December 31, 2014 rose slightly from the prior quarter to $21.28. Primarily as result of an increase in the value of the RMBS portfolio and modestly offset by a $536,000 reduction in the value of our investment in Excess MSRs.

Our aggregate leverage ratio at quarter end was approximately 2.26 times, up from approximately 2.06 times at the end of the third quarter. This increase is a function of our reinvestment in principal and agency RMBS.

Beyond our fourth-quarter performance, we have noted on various occasions that we were actively searching for acquisition targets to aid us in pursuing our MSR and whole loan strategies in addition to our ongoing organic efforts. To that end, last month we announced an agreement to acquire Aurora Financial Group for $4 million, plus the assumption of $3 million of liability.

The acquisition will strengthen Cherry Hill in two ways. First, Aurora has an MSR portfolio with a UPB of approximately $700 million as of December 31, which will be additive to our asset base. Second, upon the announcement of the acquisition, we immediately began seeking approval for the change in control from the agencies, which we would expect to significantly accelerate the agency approval process.

Once the acquisition is completed, which we expect to occur sometime in a second quarter, we will have approvals in place to service loans for the agencies. Some additional state licenses will be required for Aurora to undertake nationwide servicing, at which point we can then begin purchasing full MSRs and gain the ability to create our own excess MSRs.

Furthermore, we expect to retain our close relationship with Freedom to provide us with a significant access to loan. Thus, we will have expanded our market opportunity while diversifying our business model for the long-term, consistent with the strategy we put forth on previous calls. We will also focus on secure additional opportunities that will provide attractive risk-adjusted returns for shareholders.

In February 2015, we completed the licensing of our wholly owned captive insurance subsidiary, CHMI Insurance Company. A process that had been previously suspended in response to the actions of the FHFA. We remain hopeful we will have an opportunity to obtain membership in a Federal Home Loan Bank, and we therefore took the appropriate steps to be ready for that opportunity should it become available to us. We would use the financing from the FHLBs primarily to fund the acquisition of investments and real estate mortgage loans as well as RMBS.

Turning to our investment portfolio. Slide 7 highlights our aggregate portfolio composition. At quarter end, our excess MSR investment represented approximately 59% of our equity capital, and approximately 18% of our investable assets, excluding cash. Our RMBS portfolio comprised approximately 36% of equity, and approximately 82% of investable assets.

At the aggregate portfolio level, given the lower interest rate environment, our duration cap became negative during the quarter, and at quarter end our duration gap stood at negative 0.91 years. This was primarily driven by the sensitivity of the excess MSRs to the absolute level of rate. Our recapture efforts significantly reduced the volatility in this asset, and our net prepay speeds for the quarter reflect this as well.

The Excess MSR portfolio as referenced on slides 8 and 9 performed well, generating solid returns during the quarter. The current carrying value of the excess MSR portfolio stood at approximately $91 million at quarter end. Our recapture agreement resulted in approximately $870 million in loans being recaptured during the quarter.

The vast majority from pool two, which posted a 67% recapture rate, the highest recapture rate since our acquisition of the portfolio. Pool one also experienced its highest recapture rate of 23%, as lower mortgage rates had a more pronounced effect on the loans in this investment.

Life to date, our recapture agreement with Freedom has resulted in over $2.6 billion in loans refinanced by Freedom, and retained for our portfolio. We are excited to grow our business in 2015, and we strongly believe that initiatives we are working on will afford us an opportunity to expand our investment opportunity in the residential mortgage market.

I will now turn the presentation over to Julian, who will provide some detailed information on the agency RMBS portfolio, and its performance over the quarter.

Thank you, Jay.

As of December 31, the RMBS portfolio stood at $416 million, as shown on Slide 10, up from $376 million in at the end of the third quarter. At quarter end, our RMBS portfolio's leverage stood at 6.19 times, and the portfolio was evenly split between 20 year and 15 year fixed rate whole pools and 30 year fixed rate whole pools.

During the quarter, additional RMBS purchases were made in 30 year and 20 year collateral, at the expense of 15 year collateral. Our allocation to 30 year collateral increased because the fundamental valuations of 15 year collateral had become lofty.

In addition, the Treasury curve continued to rally, as weakening global growth and deflation increased investor concern. To minimize the effects of the continuous fall in rates, we adjusted the portfolio's asset and liability.

As shown on Slide 11, loan balance stories remained a majority of the collateral composition for the RMBS portfolio at quarter end. Due to its composition, the portfolio continues to exhibit favorable prepayment speed, posting a weighted average 6.8% CPR for the quarter, and approximately 6% CPR for the last six months.

Going forward, we would expect prepayment speeds to increase, given the portfolio's composition and the persistent drop in mortgage rates that occurred during the fourth quarter and the beginning of the first quarter 2015. Despite the RMBS portfolio changes, the aggregate portfolio continues to be managed conservatively. During the quarter, the aggregate portfolio operated with a moderate leverage of 2.26 times and a negative duration gap.

As shown on Slide 12, we ended the quarter with an aggregate portfolio duration gap of a minus 0.91 years. Following a 200 basis point instantaneous move according to our model, our duration gap would move from a minus 0.91 years to a positive 0.52 years. The portfolio's gap is driven by the composition of the RMBS portfolio, associated hedges, and the fact that 59% of the portfolio's equity was comprised of excess MSRs during the fourth quarter.

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

Thank you, Julian.

As Jay stated in his opening remarks we had another strong quarter, and continue to execute on our strategy of effectively investing in and managing residential mortgages. Net interest income was approximately $5.4 million for the fourth quarter, and $20.7 million for 2014. Our excess MSRs, RMBS, and derivatives produced a combined net increase in asset value of approximately $0.4 million for the fourth quarter, and a net decrease of $1.2 million for the year.

Our GAAP net loss for the fourth quarter was $0.5 million, or $0.07 per share. Our dividend eligible income was $3.9 million, or $0.52 per share.

For the full-year 2014, our GAAP net income was $2.4 million or $0.31 per share, while our dividend eligible income was $2.05 per share. For the fourth quarter, our comprehensive income, which includes the mark-to-market of our [held to sale] RMBS, was $4.2 million or $0.56 per share, and for the full-year 2014, it was $14.0 million or $1.87 per share. As detailed in Slide 25, we used 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 held interest rate swap, swaptions and Treasury futures with a combined notional amount of approximately $337 million. 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 the component of the net gain or loss on interest rate derivative.

At year-end, 59% of our equity capital is deployed in excess MSRs. Our investment in excess MSRs are currently unlevered, and our implied leverage ratio on the RMBS portfolio was 6.19 times at year-end. Our overall leverage ratio was 2.26 times at year-end.

Operating expenses were $1.9 million for the quarter, of which approximately $260,000 was related to our licensing efforts and other infrastructure costs relating to CHMI Solutions, our taxable REIT subsidiary. And as such, our total operating expense ratio as a percentage of equity was 4.7% for the fourth quarter, and 3.5% for the full year.

On December 16, 2014, we declared our fourth-quarter dividend of $0.51 per share, which was paid on January 27 of this year. For the full-year 2014, we paid total dividends of $2.03 per share. Our goal remains 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.

Now I would like to turn the call back to Jay for closing remarks.

Thanks, Marty. Our primary goal at Cherry Hill has been, and continues to be, aimed at delivering consistent, attractive returns for shareholders. We believe that we delivered on that front in 2014. The initiatives underway today are designed to grow and diversify our business over multiple economic and interest rate environment.

We will now open the call for questions. Operator?

(Operator Instructions)

Steven DeLaney, JMP Securities.

Thank you. Good evening everyone, and Jay, congratulations on the acquisition. I guess I would like to start there.

You've disclosed you paid, I guess, $7 million including the cash and the liabilities for the $700 million in UPB. I'm just curious, where there any other material assets of Aurora financial that you will be acquiring?

Steve, this is Marty Levine. The only thing that we will acquire is some receivables for the escrows related to the servicing advances, but that's it.

Okay.

That's about $450,000.

Okay, and will any additional employees come over into your TRS? I'm just wondering whether we need to consider modeling any additional operating expenses?

The TRS will inherit the people that are currently servicing the portfolio, and eventually that will be transferred over to a sub servicer and those people will also be transferring over to whoever -- they've been offered employment by Freedom.

I was going to say --

(Multiple speakers)

I would be surprised if it was another subservicer other than Freedom. (laughter) That was my next question. Okay.

(Multiple speakers)

Understood.

(Multiple speakers)

One more thing, the only other thing that we missed is we will have a small servicing oversight group that we'll have in house.

Understood. Just for good corporate governance there. Yes.

My only other thing, Jay, was Marty mentioned the 59% of equity, $94 million in Excess MSRs that's currently unlevered, and I recall looking over the third quarter transcript, or the deck, you mentioned that you were exploring opportunities to leverage your excess MSRs and in the future full [SMRs]. Is there any update that you can give us on the possibility of that happening? Thank you.

Other than saying we are still in discussions around that front, there's nothing I can tell you today. But we continue to look for ways to leverage both of the assets you mentioned.

Can I ask you this, are you aware of other entities leveraging those assets?

We are aware of people that are able to leverage conforming mortgage servicing rates, correct, yes. As well as some potential opportunities around some Ginnie Mae mortgage servicing rates, but we believe that we would probably play in the conformance space first.

Appreciate the comments. Thank you.

(Operator Instructions)

Paul Miller, FBR.

Hey, guys, This is actually Jessica Ribner for Paul, how are you?

Hey Jessica, how are you?

Just two quick questions. What's the pricing differential that you see between purchasing an Excess MSR versus a whole MSR? Is that significant? Or is it just the ability to purchase the whole MSR gives you a little bit of a competitive edge in bidding?

Sure. There are two things to that. One, there's a broader market for the full MSR, and that allows us to grow and build the Company both with Freedom and outside of Freedom, and so we think that the opportunities to grow our better with respect to the full MSR versus just the excess, that was the primary driver.

And number two, we have a reason to believe that we'll be able to obtain leverage on the full MSR, and that would be able to enhance the retained -- returns, so we could meet the return hurdles.

What kind of leverage are you thinking? A turn and a half? Two turns?

It is clearly nothing that would be anything close to what you see in the agency RMBS space, but in terms of what we are currently seeing, it would be somewhere between one and two turns.

All right. Thanks, and then what's the capacity of Freedom's servicing platform?

Freedom's servicing platform today is in the [$50's] billions in terms of absolute size.

They continue to build that department out, and I believe Stan is interested in growing that and potentially doubling the size, so the initiatives here on the Freedom side are with the intention of ultimately turning that into something in the neighborhood of $100 billion, so that is what's happening on their end around building that department out.

Great. Thank you so much.

(Operator Instructions)

It appears we have no further questions. I will turn the call back over to Jay Lown for closing comments.

Great. Thank you. Thanks for joining us today on the call.

We look forward to updating you on our progress on the 2015 Q2 call. Have a great afternoon.

Thank you. This does conclude today's teleconference.

You may disconnect your lines at this time. Thank you for your participation.