Cherry Hill Mortgage Investment Corp (CHMI) 2015 Q2 法說會逐字稿

Greetings, and welcome to the Cherry Hill Mortgage second-quarter 2015 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Michael Hutchby, Controller of Cherry Hill Mortgage. Thank you, sir. You may begin.

We would like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's second-quarter 2015 conference call. In addition to this call, we have filed a press release that was distributed yesterday 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 and core earnings. 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 on the call today are 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 thanks, everyone, for joining us today on our second-quarter 2015 earnings conference call. As part of today's call, we have 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 second quarter was a noteworthy one for Cherry Hill on several fronts. First, I want to highlight the outstanding quality of the underlying assets we own. In a quarter where much of the industry saw their book value per share shrink, our book value per share increased quarter over quarter, by 0.9%, after giving effect to the payment of our dividend. The increase was almost entirely organic. Even without the assets we purchased in our acquisition of Aurora, we would've generated book-value growth of 0.7%. This was the seventh consecutive quarter of stabilizing and preserving our book value, and is a testament to the quality of the overall portfolio we've assembled since going public in late 2013.

During the quarter, we took significant strides toward being able to execute on our long-term MSR strategy. In April, we obtained a $25-million loan facility that is secured by the pledge of our existing portfolio of excess MSRs. We drew down $7.5 million in May, and we used the majority of the proceeds to help finance the acquisition of Aurora. The Aurora acquisition positions us to start purchasing full MSRs, and we are now actively evaluating and bidding on portfolios that meet our investment criteria.

Also noteworthy, at the end of the quarter, our wholly owned captive subsidiary, CHMI Insurance Company, was admitted as a member of the Federal Home Loan Bank of Indianapolis. As a member of the Federal Home Loan Bank of Indy, we have access to a variety of additional financing options and services that will allow us to fund the acquisition of prime home loans in RMBS. We have been clear, since we first became a public company, that we saw an attractive investment opportunity in MSRs, especially in a rising interest rate environment. As we've said consistently, our approach is based on a long-term investment strategy.

We've also demonstrated that we are focused on investing in a prudent manner that emphasizes preservation of capital and quality of investments. We continue to hold fast to this approach, and we believe we have the foundation in place to pursue additional opportunities to generate sustainable, attractive, risk-adjusted returns.

Moving on, the second quarter was characterized by improved domestic economic data, ongoing uncertainty about the timing of a fed rate hike, and concerns about global growth and inflation. The US 10-year Treasury closed the quarter at 2.35%, up 43 basis points from the end of Q1 2015. Despite healthy upward-moving rates in the second quarter, the interest rate rally in the first quarter resulted in elevated prepayment speeds. They carried into Q2, as loans worked their way through origination pipelines. In addition, the absolute level of the interest rate sell-off in the second quarter was not enough to shut down the origination refinance engine.

Turning to our quarterly results, as shown on slide 5, our second-quarter earnings were down slightly from the first-quarter 2015 earnings. While it was a difficult decision, we reduced our quarterly dividend in June by $0.02. Our goal was to set a dividend that we believe will be sustainable in light of the composition of our current portfolio and previously discussed strategic plans. For the quarter, we generated core earnings of $0.48 a share, and dividend-eligible earnings of $0.49 per share. We declared and subsequently distributed a $0.49 per share dividend to our shareholders.

Net interest spread for the RMBS portfolio for the quarter was 1.46% and prepay speeds averaged approximately 8.2% CPR. Book value per share, as of June 30, 2015, was $20.90. Again, a 0.9% increase from the prior quarter. Our aggregate leverage ratio at quarter end was approximately 2.5 times.

Slide 6 highlights our aggregate investment portfolio composition. At quarter end, our servicing-related investments, which include MSRs and excess MSRs, represented approximately 55% of our equity capital and approximately 18% of our investable assets, excluding cash. Our RMBS portfolio comprised approximately 39% of equity and approximately 82% of our investable assets.

As shown on slides 7 through 9, our servicing-related investments performed well during the second quarter, given the rise in interest rates. The current carrying value of our portfolio stood at approximately $93 million at quarter end. Our recapture agreement resulted in approximately $900 million of loans being recaptured during the quarter, with Pool 1 posting a 44% recapture rate and Pool 2 posting a 57% recapture rate. As we mentioned last quarter, the FHA mortgage insurance premium reduction implemented in January had a pronounced impact on projected prepayment speeds for Pool 1. And we did see an increase in the actual prepay speeds in that portfolio during the second quarter.

The Aurora acquisition represents our initial foray into the conventional servicing space. And this portfolio performed well in its first month, posting a June CPR of 7%. This represents what we believe will be the beginning of a shift to a more operationally centric business.

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

Thank you, Jay. As of June 30, the RMBS portfolio stood at approximately $433 million, excluding net TBAs, as shown on slide 10, up modestly from $430 million at the end of the first quarter. At quarter end, the RMBS portfolio's leverage stood at 6.28 times, with the portfolio evenly split between 30-year fixed rate whole pools and a position comprised of 20-year and 15-year fixed-rate whole pools, as well as shorter-duration assets. During the quarter, we utilized the proceeds from 30-year position sales and principal runoff to increase our 20-year and 15-year position, as well as other assets.

As shown on slide 11, the RMBS portfolio's collateral composition remain primarily composed of loan balance collateral at quarter end. The portfolio posted a weighted average three-month CPR of approximately 8.2%, as Jay previously mentioned, and a weighted average six-month CPR of approximately 6.8%. Our portfolio's prepayment speeds continue to outperform Fannie aggregate prepayment speeds. However, we experienced a 285-basis-point increase from the previous quarter, as originators made increased efforts to finance as many homeowners as possible as interest rate rose during the quarter.

At quarter end, the aggregate portfolio continues to be managed conservatively. During the quarter, the aggregate portfolio operated with modest leverage of 2.5 times and a negative duration gap. As shown on slide 12, we ended the quarter with an aggregate [to a] portfolio duration gap of minus 1.18 years. Following a 200-basis-point instantaneous move according to our model, our aggregate duration gap would move from a minus 1.18 years to a positive 0.15 years. The portfolio's gap is driven by the composition of the RMBS portfolio, associated hedges, and the fact that 55% of the portfolio's equity was comprised of servicing-related assets, including excess MSR and full MSRs, during the second quarter of 2015.

I will now turn the call over to Marty Levine. He will review our second-quarter financial highlights in more detail. Marty?

Thank you, Julian. Net interest income for the quarter was $4.9 million. In combination, our excess MSRs, whole MSRs, RMBS, and derivatives produced a net increase in asset value of approximately $1.5 million for this quarter, after paying our quarterly dividend. Our GAAP net income, applicable to common shareholders, for the second quarter was $11.2 million, or $1.49 per share. Our core earnings, as detailed on slide 24, was $3.6 million, or $0.48 per share, while our dividend-eligible income was $0.49 per share. For the second quarter, our comprehensive income, which includes the mark-to-market of our held-for-sale RMBS, was $5.1 million, or $0.68 per share.

As detailed in slide 27, 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 second quarter, we held interest rate swaps, swaptions, and TBAs, with a combined notional value of $367 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 $1.3 million for the quarter, of which approximately $60,000 was related to our licensing efforts and other infrastructure costs relating to CHMI Solutions, our taxable REIT subsidiary. For the quarter, our total operating expense ratio as a percentage of average equity was 3.4%. On June 18, 2015, we declared a dividend of $0.49 per share for the second quarter, which was paid on July 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 over to Jay for closing remarks

Thanks, Marty. We are pleased with where we are with respect to our long-term strategy. We now have access to additional sources of financing, and we're actively attempting to acquire full MSRs. We believe we are well positioned to grow and diversify our business over multiple economic and interest rate environments, and deliver consistent attractive returns for shareholders.

We will now open the call for questions. Operator?

(Operator Instructions)

Our first question comes from the line of Steve DeLaney, JMP Securities.

Jay, where I would like to start, is just digging a little bit into the sequential declining core. This quarter has been about higher speeds, for everybody other than yourself pretty much, lower book values. Digging into your statement of cash flows, it looks like that [premium] amortization on RMBS went up about $160,000-some. It looks like $0.02 a share to me, and probably one of the main culprits in your core dropping from $0.50 to $0.48 temporarily. Just curious if you guys attribute the bulk of the sequential decline to premium amortization as these numbers would indicate.

Sure. Hey, Steve. Good morning. Thanks for taking the time to listen. I'm going to let Julian handle that one for me. Thank you.

Yes, Steve. There's no doubt that we did have an increase in prepayment speeds over the quarter. I would say it was basically throughout the portfolio, there wasn't anything that was significant that I could highlight and say that is what was targeted. We've seen the entire portfolio was targeted, almost as rates were rising. Services and originators trying to gobble up what they could, as the last effort for rising rates in the second quarter. That's definitely had an impact, in terms of our NIM in the second quarter.

Looking at the Fannie data, I've been trying to get a feel for what you would expect looking out to 3Q and 4Q in terms of the speeds here. I'm sure others will ask about speeds on the servicing related assets. I was just focusing currently on the agency. It looked like we got with looking at the Fannie Mae 30-year universe, it looked like we got a slight pickup in speeds, generally in July. I just looked at the August speeds and they crashed. It was almost a 12% drop in the Fannie 30-year cohort. Just curious. I know you have [spec] pools and a lot of prepaid protected stuff, so you won't see that kind of a delta. How do you feel about the probability of speeds, looking forward to the end of the year, are going to see something more in the 6%-7% CPR range that you've recently up until the second quarter?

Well I mean is clearly going to be interest rate dependent, right? If we are to rise in terms of rates, I would expect overall, not just our portfolio but everyone in the industry's prepayment speeds to kind of slowdown. And if we try to reverse course back down to 2%, it is going to make everyone's portfolio much more refinance able.

Right.

Given the volatility that we are having, not necessarily what is going on in the US, but globally here. The back end where rates are, could be anchored somewhat for little while, even though the Fed is trying to raise rates. In the first quarter of this year, we benefited a lot from what our speeds were. Actually as everybody's speeds were rising, ours actually declined in the first quarter. If I look over everyone in the sector. In the second quarter, we played a little bit of catch-up in the sector, obviously with rising rates. We weren't the only [read-to-head] had rising rates. I think the majority of them had it. We will probably would fluctuate somewhere between 7% and 8% CPR, and we will see where we will go from there. It will be rate-dependent.

Okay, great. That's helpful color. And we will have to obviously watch rates very closely here, meaning especially the 10-year. One final quick thing. Leverage on the agency book has stayed just slightly over six times. You now have the home loan back. While we think of the home loan bank as being primarily a great source of financing for whole loans, we have heard some commentary by other agency MBS PMs that, in terms of some term type funding, it is looking pretty attractive to them. I'm just curious if -- two-part question. Are you looking at the home loan bank to provide any incremental financing for the agency book? Given that the durability and stability of that relationship, would that entice you to take your leverage up to any degree on the agency portfolio? And I will leave it at that. Thanks.

Steve, it's Jay. Two per question.

Yes.

Having [their] home loan bank does not change our perspective on risk. From our perspective, it creates another counter-party that we think is accretive to the business. With respect to the FHLB, on its own merits, we are treading cautiously today. Obviously, everybody has shared their views with you guys. And we are one of the last to go, so I'm sure it will not be a surprise for you to hear that we remain cautiously optimistic about the regulations around the FHFA, and whether or not we got to stay in the system. We are making an effort to be prudent on how we utilize that financing. And we watch and monitor the situation every day. Both on our own, and with all of our peers through the MBA.

Okay Jay, thanks. I appreciate the time this morning and congratulations to you on the great book-value performance. Thanks.

Thanks, Steve.

Thank you.

Jeremy Campbell, Barclays.

How much dry powder do you think you guys have to go look for full MSRs on the marketplace right now?

Sure. If you take into account the fact that MSRs account for only about 55% of total equity today, plus, we currently have access to additional debt with Next Bank, that gives us approximately $15 million-ish with Next Bank, and probably another $15 million to $20 million in equity around taking positions out of the MBS and moving them to sourcing related.

Great. Can you remind us again about the -- your optimal leverage on the full MSRs? Before when we talked about this, it was going to look quite different then what you got on the excess side.

Yes, sure. It is very different. We are currently evaluating leverage opportunities around MSRs, but typically what we see being offered in terms of leverage in the MSR space is advance rates anywhere between 50% and 60%. That's pretty much what we see out there.

Got it. Thanks a lot, guys.

Thank you

(Operator Instructions)

Michael Kaye, Citigroup.

Good morning, I recall you needed some more licenses in order to acquire MSRs on a national basis even after Aurora. It sounds like, I don't know if you've got them already, but it sounds like you are going ahead to buy MSRs now. Did you basically get all the licenses that you need at this point?

Hey, Mike. How are you. I will let Marty handle that one.

Hi, Mike. We have all the paperwork in, and we have gotten all but the three. I don't want to insult any states, but I will call them minor states left to get. And we are actively bidding on the MSRs to transact in the fourth quarter.

Great. I know last quarter you talked about what your thought was return for (inaudible) file for full MSRs. I think you were thinking -- conforming high single digits, Ginnie Mae, low double digits. Is that still consistent with what you're seeing in the market now?

It is really unchanged from where we were in Q1. For the most part, the market is in a state right now that, yields haven't really been moved to one side or another.

Okay, great. Just one final question, on the dividend, just to make sure I am perfectly clear. In terms of the trajectory of the dividend going forward, do you think, given your desire to add more MSRs, given the relative yield of MSRs versus [agency] MBSD. Do think the current dividend level of $0.49 could be maintained if you add more MSRs?

Thanks for the question. We tried to be pretty descript in the speech. Given the current composition of the portfolio, married with our strategic plans which include MSRs, we do today, think that the level of the dividend that we set is sustainable.

Great. Thank you.

Ladies and gentlemen, there are no further questions at this time. I would like to turn the floor deck over to Mr. Lown for closing remarks.

Thank you for joining us today on our call and we look forward to updating you on our progress on our third-quarter 2015 earnings call. Have a great day.

Thank you ladies and gentlemen. This does conclude our teleconference for today.