Cherry Hill Mortgage Investment Corp (CHMI) 2015 Q1 法說會逐字稿

Greetings and welcome to the Cherry Hill Mortgage First-Quarter 2015 Earnings conference call.

(Operator Instructions)

I would now like to turn the conference over to your host, Michael Hutchby, Controller for Cherry Hill Mortgage.

Please go ahead, sir.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's first quarter 2015 conference call. In addition to this call, we have filed a press release that was distributed today, and posted to the Investor Relation 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 core 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 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 will turn the call over to Jay.

Thanks, Mike.

And thank you, everyone, for joining us today on our earnings conference call for the first quarter of 2015. As part of today's call, we've posted on our website a presentation that we'll touch upon throughout the call. And we'll reference specific slides where appropriate. After our prepared remarks, we will open up the call for questions.

The first quarter of 2015 was characterized by one of the more extreme interest rate environments we have experienced in a while. The downward trend in interest rates prevail, as the US 10 Year Treasury hit an inter-quarter low of 1.64%. Debt closed the quarter at 1.92%, down 25 basis points from Q4 2014. Adding to the quarterly volatility, mortgages struggled to keep pace with treasuries throughout the quarter.

As shown on slide 5, RMBS prepayment speeds increased quarter over quarter with the persistent decline in interest rates. Accordingly, as we noted on the last call, a primary focus for our team has been, and continues to be, minimizing the runoff of our portfolio of Excess MSRs. And, our prepayment speeds, net of recapture, demonstrate this effort.

We remain focused on mortgage servicing rights as our primary investment strategy, as we believe this asset class offers attractive returns over the long term, especially in a rising interest rate environment. We look forward to gaining the ability to purchase full MSRs in the coming months, which should broaden our investment options.

Turning to our quarterly results. As shown on slide 6, our first-quarter 2015 results were in large part in line with fourth quarter 2014 performance. A noteworthy addition to the performance data we report is the calculation of core earnings. We generated core earnings of $0.50 per share, and 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 1.70%, a slight increase from 1.67% in the previous quarter. Prepay speeds for the RMBS portfolio averaged approximately 5.4% for the quarter. Our RMBS portfolio once again exhibited favorable prepayment characteristics versus generic and TBA cohorts, which Julian will discuss in more detail shortly.

Book value per share, as of March 31, 2015, was $20.78. The change from the prior quarter was primarily a result of a reduction in the value of our investment in Excess MSRs. Our aggregate leverage ratio at quarter end was approximately 2.4 times, up from approximately 2.3 times at the end of the fourth quarter, driven primarily by our reinvestment of principal in agency RMBS.

In terms of our overall long-term strategy, in April, we were pleased to enter into a loan agreement with NexBank. Whereby, Cherry Hill may borrow up to $25 million for general corporate purposes, including purchasing Excess MSRs and whole MSRs. To our knowledge, very few, if any, facilities exist for financing Excess MSRs. We remain on track to close, on our previously-announced acquisition of Aurora Financial Group by the end of the second quarter, which will enable us to embark on a strategy of purchasing whole MSRs.

Turning to our investment portfolio, slide 7 highlights our aggregate portfolio composition. At quarter end, our Excess MSR investment represented approximately 56% of our equity capital and approximately 16% of our investable assets excluding cash. Our RMBS portfolio comprised approximately 38% of our equity, and approximately 84% of our investable assets.

At the aggregate portfolio level, given the sustained low interest rate environment, our duration gap remained negative during the quarter. And at quarter end, our duration gap was approximately negative 1.5 years. Our recapture efforts continue to significantly reduce the volatility in this asset. And our net prepay speeds for the quarter reflect this as well.

As shown on slides 8 and 9, the Excess MSR portfolio performed well during the quarter, given the ongoing downward trend in interest rates. The current carrying value of the Excess MSR portfolio stood at approximately $85 million at quarter end. Our recapture agreement resulted in approximately $1.1 billion of loans being recaptured during the quarter. And we continue to set new highs for our recapture rates, with Pool 2 posting a 77% recapture rate. Pool 1 also posted a new high with a 45% recapture rate.

The FHA mortgage insurance premium reduction implemented in January had a pronounced impact on projected prepayment speeds for Pool 1. Overall, we believe we've done an excellent job protecting our book value in this volatile environment. And we are looking forward to expanding our opportunities in the residential and mortgage market in the coming months.

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

Thank you, Jay.

As of March 31, the RMBS portfolio stood at approximately $430 million, as shown on slide 10, up from approximately $416 million at the end of the fourth quarter. At quarter end, our RMBS portfolio's leverage stood at 6.22 times, with 55% of the portfolio's composition represented by 30-year fixed-rate whole pools, and 45% of the portfolios comprised of 20-year and 15-year fixed-rate whole pools, as well as shorter duration assets.

As shown on slide 11, the RMBS portfolio's collateral composition was primarily comprised of loan balance collateral at quarter end. As Jay noted, during the first quarter, the portfolio continued to exhibit favorable prepayment speeds despite lower interest rates and mortgage rates. The portfolios posted a weighted average three-month CPR of approximately 5.4%, and a weighted average six-month CPR of approximately 6.1%.

Over the past year, our portfolios prepayment speeds have outperformed Fannie's aggregate prepayment speeds. In the future, we may see prepayment speeds rise, given the portfolio's collateral composition and originator timing lines. Throughout the quarter, the Treasury curve continued to rally, as weakening global growth and the prospect of deflation increased investor concerns.

To minimize the effects of the continuous fall in rates, we adjusted the portfolio's assets as well as liabilities. Despite the RMBS portfolio's changes, the aggregate portfolio continues to be managed conservatively. During the quarter, the aggregate portfolio operated with a modest leverage of 2.39 times and a negative duration gap.

As shown on slide 12, we ended the quarter with an aggregate portfolio duration gap of minus 1.48 years. Following a 200-basis-point instantaneous move, according to our model, our aggregate duration gap would move from a minus 1.48 years, to a positive 0.25 year. The portfolio's gap is driven by the composition of the RMBS portfolio, associated hedges, and the fact that 56% of the portfolio's equity was composed of Excess MSRs during the first quarter of 2015.

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

Marty?

Thank you, Julian.

Net interest income was approximately $5.2 million for the first quarter of 2015. However, our Excess MSRs, RMBS, and derivatives produced a combined net decrease in asset value of approximately $3.7 million for the quarter.

Our GAAP net loss for the first quarter was $2.4 million or $0.32 per share. Our core earnings, as detailed on slide 23, was $3.8 million, or $0.50 per share, while our dividend-eligible income was $0.52 per share. For the first quarter, our comprehensive income, which includes the mark-to-market of our held-for-sale RMBS, was approximately $50,000.

As detailed in slide 26, we used 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 first quarter, we held interest rates swaps and swaptions with a combined notional amount of $342 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 a component of the net gain or loss on interest rate derivatives.

Operating expenses were approximately $1.4 million for the quarter. Of which, approximately $90,000 was related to our licensing efforts and our other infrastructure costs relating to CHMI Solutions, our taxable REIT subsidiary. For the quarter, our total operating expense ratio as a percentage of variance in equity was $3.5 million. On March 5, 2015, we declared a dividend of $0.51 per share for the first quarter, which was paid on April 28. 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'd 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. While the interest rate environment has been difficult for the past few months, we believe we've done a good job protecting our book value. And are well-positioned, with the impending Aurora acquisition and the NexBank loan, to grow and diversify our business over multiple economic and interest rate environments.

We will now open the call up for questions.

Operator?

(Operator Instructions)

Our first question comes from Jeremy Campbell from Barclays.

Thanks, guys. Can you just talk a little bit about book value, quarter to date? Have you guys retraced the decline, given the rate selloff, so far, in the quarter?

Jeremy, I'm not sure I can answer that question. But, we are clearly in a slightly different interest rate environment. I think that what we could tell you is, the changes within the MSR marks were related more to a one-time regulatory event, that happened in January, around evening the MIP premiums associated with FHA loans. And, we think we have that nailed down.

But, I think we were pretty clear in the presentation that, while the interest rate environment was definitely on a downward trend, much of the change in the book value, that you saw, was as a result of an expected increase in some prepay activity around the FHA loans, which comprised about 40% of Pool 1, and 25% of the aggregate. If you would recall, Pool 2 is exclusively VA.

We see it more as kind of a one-off. If you remember, over the last 15 months, as the 10 year's retraced downward over 100 basis points, we've virtually had tail effect on the book value, given a lot of the recapture efforts that you see. So, this is somewhat of a regulatory event that we're trying to capture. We think we have it factored in.

Got it. We've heard some other mortgage REITs out there that were granted FHLBA membership this past quarter. Can you guys count, at all, where you may be in that process, or in the queue?

Sure. We feel good about that process. It is a process. It's been less than 90 days, officially, with them. We are in constant dialogue with them on our application. And, we have no reason to believe that there's anything that would prohibit us. But, we are in that queue, and we feel as though that is moving along, as planned.

And then, assuming your service elections come through, late in the quarter, can you remind us -- are you looking to source full MSRs outside the Freedom complex? Or, just still work, nearly exclusively, with them?

One of the great things about having the licenses is, the ability to take advantage of buying MSRs, within the total market. And so, while we would love to have a relationship with Freedom, on that front, we think that the overall market, around that asset class, was the most compelling thing. And, we're looking forward to being able to transact with multiple counter parties, not just Freedom.

And then, finally, what kind of returns are you guys seeing, both levered and unlevered, for the full MSR market opportunity these days?

In the conforming space -- I'll let Ray answer that. But, we will tell you on the conforming side and on the Ginnie side.

Sure, in the conforming space, we are really looking at mid to high single-digits, on an unlevered basis. Ginnie Mae would be a little bit higher, we're talking low double-digits, so call it 10 to 12. But, Ginnie had some additional concerns around there. We'll probably look to play, mostly, in the GSE space.

Got it. Thanks a lot, guys.

Our next question comes from Steve DeLaney from JMP Securities.

Hi, good evening, everyone. And, thanks very much for the new core EPS metric. It will simplify things dramatically, for all of us. I don't want to beat this to death on the Excess MSRs. But, Jay, taking your comments about the regulatory change, we noted that the fair value mark, overall, on all the Excess MSRs, was about $2.8 million. Would it be reasonable for us to assume, based on your comments, that the majority of that mark was associated with Pool 1?

Yes. Actually, in these Qs that will come out later, you'll see that Pool 1 actually was the majority of that. It was around 3 million. And then, there was a small of around of offsets, which got you to the 2.7. So, it was almost all in Pool 1, which has the FHA majority.

Okay, that's helpful. Thank you very much. And, talking about your new loan agreement by NexBank, we found that's a Dallas Texas bank, about $2 billion. Just curious, that's a fairly esoteric loan. Is there a relationship there, between Freedom and NexBank, that led to that?

It's a combination of that, as well as a former FBR banker that we've had a relationship with. We've been trying to think about a loan within the context of Excess MSRs for quite a long time. So, he left FBR and went to NexBank. And, given the relationship that Freedom had with NexBank, and their comfort with the servicing asset, it became a natural fit. And, it is something that we are really excited to take advantage of.

Congratulations. Sometimes, a small world and relationships make big things happen. You suggest -- I'm sorry? You suggest in the press release, Jay, that the $25 million line was backed by the Excess MSRs. I'm just curious, are the entire $87 million of EX MSRs pledged on the $25 million? Or is there --

It's in the general, but there is no pledges of specific Excess MSRs, at all, with this line.

Oh, they are not? Okay. Then, my follow-up would be, does $25 million, in your mind, represent the maximum leverage that you would seek to attain against the current Excess MSR book?

We only have some negative covenants around the Excess MSRs. So, theoretically, we could get more than the $25 million. If we could find somebody else that will do it also.

Interesting. Okay. Thanks for the comments, guys.

Our next question comes from Michael Kaye from Citigroup.

Hi. With stocks still trading at a well-below book value, could you just give some updated capital raising thoughts, here? Does this new loan agreement give you enough firepower for now?

Hi, Mike. How are you? I would tell you that the first quarter was a fairly interesting quarter, with respect to just managing the portfolio. And yes, the stock has not hit a level that we would like it to be at, today.

But, I think we've told you before, we have been less focused on the actual aspect of raising capital as we navigated the first quarter, and more about finishing some of the things that we've been talking to all you folks about over the last year.

Now that some of those things are in place, we're hopeful that we get an opportunity to execute on the strategy. And hopefully, the market thinks that's a positive event. And, we will be able to think about raising capital at some point in time.

Could you comment on your comfort on the sustainability of the $0.51 dividend? As, you got a pretty high Pool 2 IRR, to about 19% running off?

Pool 2 has been performing terrifically. If that is that 3/1 Hybrid ARM VA portfolio. And, Freedom's been extremely successful moving a lot of those loans into 30-year fixed-rate loans. And, that portfolio is really doing its job.

With respect to the dividend, it's hard for me to comment, going forward, with respect to the first quarter. We were confident that we were able to pay $0.51. Dividend eligible was actually slightly north of that. So, we feel pretty good about that. You obviously know where rates are today.

I think our average borrowing cost for the quarter was somewhere around 39 basis points, which was not very high. And so, we have not done anything substantially different, so far, this quarter. So, I would tell you that we feel good about the business today. But it's pretty hard to comment about, with respect to how sustainable that is, going forward.

Great, and the last question. Just comment on any thoughts about, potentially, moving to a monthly dividend.

We recognize some people have. We've had conversations about it internally. We know some investors are interested in it, some of which are on the phone.

We continue to give it some thought. We've actually socialized it with the Board. But, we have not made any decisions, yet, with respect to moving down that road. If we do, you will be one of the first people to know.

Great. Thank you.

(Operator Instructions)

We appear to have no further questions. I will turn the call back over to our speakers for closing comments.

Terrific. Thank you. Thank you for joining us on the first-quarter 2015 investor call. We look forward to having additional conversations, and have a great evening.

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