Cherry Hill Mortgage Investment Corp (CHMI) 2015 Q3 法說會逐字稿

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

(Operator Instructions)

As a reminder, this conference is being recorded.

I will now turn the conference over to your host, Michael Hutchby, Controller. Thank you, you may begin.

We'd to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's third-quarter 2015 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 has 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 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 earnings conference call for the third quarter of 2015.

As part of today's call, we posted a presentation on our website 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.

We have endured significant ups and downs this year. Despite the continuous threat of forthcoming interest rate hikes, no Fed actions have occurred to date. In fact, the US 10-Year Treasury at quarter end was lower by 13 basis points versus December 31, 2014.

Like many of our peers, we've worked hard to position ourselves for a higher interest rate environment. In the meantime, the lack of clarity from the Fed on it's monetary policy has certainly been a factor in the volatility of stock valuations. All eyes continue to be on when the Fed will become less accommodative in its monetary policy.

September, they seemed concerned about global economic conditions. In October, not so much. And based on the removal of that language, coupled with the strong employment data last week, we seem to be closer to some action this year. Coupled with the Fed holding off on a rate hike in September, the hedging environment in the third quarter was very challenging, with most spread sectors underperforming treasuries and swaps.

Although mortgages held their ground for most of the quarter, at quarter end, mortgages significantly under performed their hedges. As you have heard from many of our peers, this was a driving force in the reduction of book values for the sector this quarter.

Since a portion of our portfolio is invested in agency RMBS, we experienced similar challenges. For the third quarter, our book value declined by approximately 3.7%, or $0.78. That said, we believe our strategy in asset composition continues to highlight our ability to weather multiple economic and interest rate environments.

Despite the volatile environment, we are pleased with the continued execution on our long-term MSR strategy. We recently completed all of the necessary licensing requirements, and are now fully licensed to purchase MSR assets on a national level.

In addition, as we disclosed last week, we acquired a $1.4 billion bulk MSR portfolio, our first MSR acquisition. Due to the expiration of the draw period in September, we borrowed the remaining amount available on our $25 million loan facility in September, and then proceeded to use a significant portion of that amount to complete the MSR portfolio acquisition last month.

Overall, our strategy remains very much intact. As evidenced by our acquisitions over the last few months, we have been working diligently towards becoming a more operational business. We've always said that we are building our business for the long term, and the blocking and tackling we accomplished over the past year has laid the groundwork for us to execute on our operational strategy.

At the same time, we will continue to focus on investing in a prudent manner that emphasizes preservation of capital and quality of investments. We believe we are positioned well to take advantage of a rising rate environment, and have the foundation in place to pursue additional opportunities to generate sustainable attractive risk-adjusted returns.

Turning to our quarterly results, as shown on Slide 5, our third-quarter core earnings declined slightly quarter over quarter. We generated core earnings of $0.47 per share, and dividend eligible earnings of $0.49 per share. The difference between core earnings and dividend eligible income is largely due to the completion of our licensing efforts, and the transitioning of the servicing of the Aurora portfolio to Freedom as subservicer.

We anticipate that, as we grow our servicing-related assets portfolio, our core earnings will continue to be impacted by the acquisition expenses related to the purchase of these assets. The effects on dividend eligible income will be mitigated, because the MSR-related expenses only affect Aurora, which is a taxable REIT subsidiary. To the extent we are successful in our efforts to acquire additional MSRs, we expect there will be a continued positive spread between the dividend eligible income and core earnings that will support our dividend.

For the third quarter, we declared and subsequently distributed a $0.49 per share dividend to our shareholders. Slide 6 highlights our aggregate investment portfolio composition.

At quarter end, our servicing related investments, which include MSRs and excess MSRs, represented approximately 41% of our equity capital, and approximately 13% of our investment portfolio. The percentage change quarter over quarter in servicing related assets is attributable to drawing down the additional debts, and temporarily investing in agency RMBS, until the MSR acquisition settled in October.

Our RMBS portfolio at quarter end comprised approximately 51% of our equity, and approximately 87% of our investment portfolio. As shown on Slides 7 through 9, our servicing-related investments experienced a decline in value during the third quarter, primarily due to the drop in interest rates. The current carrying value of the portfolio stood at approximately $85.6 million at quarter end. Our recapture agreement resulted in approximately $427 million of loans recaptured during the quarter, with Pool 1 posting a 25% recapture rate, and Pool 2 posting a 58% recapture rate.

Freedom continues to look for ways to protect and defend our portfolio in a competitive origination environment. Our Aurora portfolio performed in line with expectations in its first full quarter, with a CPR of 9%. An uptick in delinquencies that we saw shortly after the transfer of the direct servicing of the Aurora portfolio to Freedom in September has since reversed itself.

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

Thank you, Jay.

As of September 30, the RMBS portfolio stood at approximately $580 million, excluding net TBAs, as shown on Slide 10. Up from $433 million at the end of the second quarter.

During the quarter, the RMBS portfolio's growth was chiefly driven by the temporary deployment of the term debt proceeds, pending settlement of the MSR acquisition in October. At the same time, we also deployed the servicing income on the MSRs, the amortization of the excess MSRs, and the monthly P&I on the RMBS into new RMBS. The additional RMBS securities' characteristics were similar to the RMBS in our existing portfolio.

Post quarter end, the RMBS position was reduced to acquire the MSR portfolio in late October. At quarter end, our RMBS portfolio's leverage stood at 6.5 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. As shown on Slide 11, the RMBS portfolio's collateral composition remained primarily comprised of loan balance collateral at quarter end.

Compared to previous quarters, a majority of the new securities were positioned in [story] collateral, with low pay-up premiums; $150,000 max, $175,000 max loan balance, and geo-collateral stories. We avoided purchases of expensive collateral stories pending the settlement of the MSR acquisition.

For the quarter, the portfolio posted a weighted average three-month CPR of approximately 7.8%, and a weighted average six-month CPR of approximately 8%. Our portfolio's prepayment speeds continue to outperform Fannie's aggregate prepayment speeds. The primary and secondary spread for mortgages widened during the quarter, suggesting that originators were willing to increase production, but not at the expense of margins.

For the quarter, we posted a 1.31% net interest margin, versus 1.46% net interest margin for the second quarter. The number is slightly misleading, because of the temporary deployment of proceeds of the term debt in RMBS. Prior to investing the term debt proceeds, the average net interest margin for the first two months of the quarter was approximately 1.4%, lower than the second quarter, and driven by increased financing costs.

During the quarter, the aggregate portfolio operated with leverage of 3.5 times, and a negative duration GAAP. As shown on Slide 12, we ended the quarter with an aggregate portfolio duration GAAP of minus 1.32 years. The portfolio's gap is driven by the composition of the RMBS portfolio, associated hedges, and the fact that 41% of the portfolio's equity was composed of servicing-related assets, including excess MSRs and full MSRs, during the third quarter of 2015.

Before I turn the presentation over to Marty Levine, our CFO, who will discuss in more detail the Company's financials, I will reiterate today's theme that the third quarter can best be described as volatile and choppy for all rates and credit markets. Similar to other spread sectors, mortgage nominal spreads widened, versus treasury and swap hedges.

Throughout the quarter, no spread sector was immune. A decline in the book value was because of our swap hedges outperforming RMBS into the rate rally. Since early October, we have seen a slight reversal, but markets are fluid and can change by next reporting.

I will now turn the call over to Marty Levine for our third-quarter financial discussion.

Thank you, Julian.

For the quarter ended September 30, our net interest income was $4.9 million. The excess MSRs, MSRs, RMBS and derivatives combined saw a net decrease in asset value of approximately $5.7 million for the quarter. Our GAAP net loss, applicable to common stockholders for the third quarter, was $5.1 million, or $0.68 per share.

Our core earnings, as detailed on Slide 24, were $3.5 million, or $0.47 per share, while our dividend-eligible income was $0.49 per share. The GAAP between core and dividend-eligible income was mainly caused by our licensing efforts, which have now been completed, as well as ongoing MSR portfolio acquisition expenses, which may continue for the foreseeable future.

As we continue to grow the MSR portfolio, there may continue to be a gap between our core earnings and dividend eligible income. For the third quarter, our comprehensive loss, which includes the mark-to-market of our health-to-sell RMBS, was $2.1 million, or $0.28 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 third quarter, we held interest rate swaps, swaptions, and TBAs, with a combined notional amount of $438.8 million. 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 rate derivatives.

For the quarter, operating expenses were $1.3 million, of which approximately $90,000 was related to our licensing efforts and other infrastructure costs relating to Aurora. For the quarter, our total operating expense ratio as a percentage of average equity was 3.4%. On September 10, 2015, we declared a dividend of $0.49 per share for the third quarter, which was paid on October 27.

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 the call back to Jay for closing remarks.

Thanks, Marty.

Our shift towards the more operational business is in full swing, with the acquisition of our first MSR portfolio, along with the completion of all of our licensing requirements. Although the macro environment is challenging, we believe our long-term investment strategy remains very much on pace.

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

(Operator Instructions)

Michael Kaye, Citi.

(Inaudible) a little bit more detail on that acquisition of $1.4 billion. What did the unlevered returns look like; what would the levered returns look like; any sort of estimate at this point?

Hey, Mike, how are you doing?

Great.

So, it is going to be hard for me to go into specifics about the returns, but what I can tell you about the portfolio is we thought it was a good first portfolio to start with. The counter-party was a bank, which was appealing to us -- 95%-ish retail.

It's essentially about two-year seasoning, with very low delinquencies, less than 0.5%. I think we've told you guys before that unlevered returns in the sector for Fannie/Freddie type collateral were somewhere in the 8%-ish range, and I think today that still holds true.

Great. Could we just talk -- you said you called the rest of the NexBank loan, and then you put in Agency RMBS. Was there any drag from doing that to earnings this quarter?

I don't believe that it was a drag on earnings, no. In fact, I think it was a good investment while we worked on completing the transaction.

Great. If I just looked at your equity composition, I know that temporary -- a little bit lower MSR servicing-related assets, just temporary, but I think after the IPO you were closer to 70% servicing? How do you see the migration going from agency to servicing? Where do you want to get that? Where do you want to eventually get that, and do you think that could cause any risk to the dividend as you shift?

I think that is a number of questions in one. But, one, you are absolutely right, when we started about two years ago it was approximately 70%. And as rates dropped from 3% to 2%, we were pretty careful about how we deployed capital from amortization, et cetera.

At the same time, the excess MSR trade became less desirable, based on things like the absolute level of returns, and lack of sellers, as well as leverage. And so what we did, as you know, is spent a lot of our time going through the appropriate motions to get licensed to be able to buy full MSRs. And so far, we have now two portfolios -- two Pools or portfolios of MSRs that we have acquired that we believe are the first step at us becoming more servicing-centric again, as we think rates now start to head higher.

The ideal percentage of that portfolio, I guess, is fluid; certainly more than it is today. But we are looking forward to analyzing and acquiring servicing-related assets in the near term.

I think you said you used most of the drawdown in the NexBank already. You have any firepower to do more acquisitions from that NexBank loan? And if you did want to -- if you are basically -- mostly deploy that capital, where is the shift going to come from? Are you going to be able to leverage more, or is it just going to be basically shifting from RMBS back into servicing?

We do have a few million left of the NexBank transaction. With respect to deploying more capital outside of that, we continue to work on thinking about how to leverage the full MSR to be able to meet the return hurdles for our shareholders, and we are looking forward to being able to do something around that.

Okay, thank you.

Steve DeLaney, JMP Securities.

Hey, good evening, everyone. Thanks for taking the question. Sorry to be redundant, but I'm -- the same topic that you just went through, but I would like to ask it with respect to the '40 Act.

So, rather than just -- whether the equity allocation is 70% or 65%, looking at your purchase, I'm just assuming that the outlay $1.4 billion, approximately 1% or so -- I don't think you disclosed the actual cost or the investment amount. But a lot of UPB for a relatively modest cost basis.

I'm trying to get at how much flexibility do you have with respect to your '40 Act exemption, in terms of having to hold on to the agency hold Pools? Obviously, I think everyone is enthused about the transition to more servicing assets, and I'm just trying to get a sense for how much more flexibility you have with respect to the '40 Act. Thank you, Jay.

No problem, Steve. So, I think the biggest thing to think about within the context of that is the servicings now and the taxable REIT subsidiary. And so, when we had just excess, we had essentially two assets, and there was no TRS. And so we had the ability to go into the low- to mid-70%s in terms of percentage of equity, and not trip those tests.

With respect to the TRS, because that has its own tests, I would tell you that it is less than that. It's somewhere -- the last time we checked, in the 60%s, that we would be safe. But that's a fluid number just based on a lot of things around what else we invest in.

Okay, got it. So, the structure -- it sounds like it has given you some incremental flexibility --

Absolutely.

-- to reduce that allocation. Okay, great, thanks.

(Operator Instructions)

Paul Miller, FBR Capital.

Hey, Jay. I've been travelling so I don't have the date in front of me, but are you saying that your recapture rate is in the 50% range right now?

I think the way we broke it out was: Pool 1, which is a fixed-rate Pool, and had a weighted average gross -- and the weight's still somewhere in the 3.5% range, at about a 25% recapture rate. And then Pool 2, which, as you know, is the ARM portfolio, does continue to have recapture in the high 50%. And I expect that Freedom will continue to work that portfolio hard, especially now with the threat of rising rates. But I would say that (multiple speakers) go ahead.

On the 25% (multiple speakers) go ahead, I'm sorry.

I would just say that in a rising interest rate environment, we would expect that the fixed-rate portfolio would recapture -- it would continue to drop, but those loans would be less than the money in danger of refinancing away.

And then, correct me if I'm wrong, but on the FHA product, even with higher rates, with the change in policy, there's still a huge incentive for those to refi, am I correct?

Another good question -- that Pool 1 was originally 50% FHA and 50% VA. So, the vast majority of what we own in terms of excess is VA, in terms of loans.

But within the context of the FHA MIP reduction, we saw a lot of the refinancing for that in the first two quarters of this year. I think what we saw in the third quarter was a very competitive origination environment, as originators determined what [margin] they were willing to work for within the context of continuing to try to go after that fixed population of loans.

Then -- I guess this is what, November; we've been through a month of TRID. I know you're not really originating, but have you seen any of the CPR rates have any impact with TRID, or is it -- you haven't seen any of that impact flow through yet?

We should get that soon. But what I can tell you is -- which shouldn't be a surprise based on any information that the industry has released -- is that origination volume has slowed as a result of the more cumbersome process around TRID. And I think that has been heavily discussed in most of the industry publications so far.

It was an enormous undertaking. They had a year to do it, but there are a lot of parties involved in the process now around vendors, and I think that's probably a significant exposure for most originators.

And then, for your recapture rates, is it treated a little bit differently, TRID? Or is it easier to do TRID when you are refi-ing, you have all the data -- than if you don't have the customer? (Multiple speakers) I'm just wondering, is it easier on your own servicing book under the new disclosure, or is it still a pain in the butt?

I believe it's the same difficulty -- the process -- there's less documentation, so theoretically you could say that refinances are easier if it is streamlined in nature. But as a general statement, the amount of people or parties that touch the system now are [more into it]; even though there are only two forms, the process is harder. And as you would expect, even though most people were fundamentally prepared, volumes are high, and I think as a general statement, the industry is experiencing some overhang related to that.

Hey, guys, thanks a lot.

Sure.

Thank you. We have no further questions in queue at this time. I would like to hand the floor back over to management for any closing remarks.

Thank you, everyone, for joining us on the call today. We do look forward to updating you on our progress next quarter. Have a good evening.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.