Cherry Hill Mortgage Investment Corp (CHMI) 2018 Q3 法說會逐字稿

This is the conference operator. Welcome to the Cherry Hill Mortgage Third Quarter 2018 Earnings Conference Call. (Operator Instructions) The conference is being recorded. (Operator Instructions) I would now like to turn the conference over to Michael Hutchby, Controller. Please go ahead.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's Third Quarter 2018 Conference Call. In addition to this call, we have filed a press release that was distributed earlier this afternoon 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 core and 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, President and CEO of Cherry Hill. Also present on the call today are Julian Evans, our Chief Investment Officer; and Marty Levine, our Chief Financial Officer.

And now I'll turn the call over to Jay.

Thanks, Mike, and welcome to today's call. We were very pleased with our third quarter performance. In our view, performance in the face of the rising rate environment and overall ongoing volatility in the marketplace further validates our long-term diversified strategy. The vast majority of our team's efforts this quarter involved the day-to-day grind of blocking and tackling required to result in a stable, steady-as-she-goes earnings report.

Since our IPO 5 years ago, we've consistently noted our long-term strategy was predicated on preserving capital while positioning ourselves to succeed across multiple interest rate environments and shine when rates begin to rise. While it took longer than anticipated for the Fed to tighten, our experienced team focused on actively managing our portfolio and positioning ourselves to take advantage when the tide shifted.

Today, we believe we're in the strongest position in our history. Including in the third quarter, we have now outearned our $0.49 quarterly common dividend for 12 straight quarters. Our MSR portfolio has grown by almost 700% in a span of less than 2 years, and as we've proven, our success is not tied to any 1 rate environment. I'm proud of our entire Cherry Hill team, and we continue to believe our best days are ahead of us.

For the third quarter, we generated core earnings per share of $0.55. Our results were driven by strong performances from both our RMBS and MSR portfolios as well as improved prepayment speeds across the board. Book value per share grew $0.26 quarter-over-quarter and currently stands at $19.62.

It was a successful quarter for Cherry Hill on all fronts. With the Fed seemingly committed to its tight monetary policy for the foreseeable future, our diversified strategy should continue to position us well.

During the third quarter, we purchased $3.9 billion in additional MSRs through our flow arrangement. By the end of the third quarter, the MSR portfolio stood at $22.4 billion, representing 39% of our equity capital. As we've previously stated, our current focus is on the acquisition of MSRs through our flow agreement as larger bulk offerings remain less attractive.

Also during the quarter, we entered into a $25 million MSR revolving credit facility secured by all of our existing and future Freddie Mac MSRs. That facility was subsequently upsized to $45 million, all of which has been drawn down. We also tapped our ATM programs during the quarter and issued preferred and common shares to provide us with net proceeds of approximately $9.4 million.

As 2018 comes to a close, we remain confident that our portfolio can produce further strong results while withstanding additional Fed tightening. Our positioning continues to strengthen each quarter, and we remain mindful of preserving our book value. Meanwhile, our management team will continue to use our investment experience to actively manage our portfolio and deploy capital at what we believe to be appropriate risk return levels, which will ultimately create further long-term shareholder value.

With that, I'll turn the call over to Julian, who will cover more detailed highlights of our investment portfolio and its performance over the quarter.

Thank you, Jay. For the third quarter, there were very subtle changes to the equity composition of our portfolio quarter-over-quarter. As shown on Slide 5 at quarter-end, servicing-related investments comprised solely of full MSRs represented approximately 39% of our equity capital and approximately 14% of our investable assets, excluding cash. Servicing assets remained flat as a percentage of equity versus the previous quarter as we utilized more MSR financing as well as pay downs of the RMBS to grow the servicing portfolio. Similarly, our RMBS portfolio accounted for approximately 59% of our equity, a slight uptick from the previous quarter. As a percentage of investable assets, RMBS represented approximately 86%, excluding cash at quarter-end.

As of September 30, we held MSRs with a UPB of approximately $22.4 billion and with a market value of approximately $282 million as highlighted on Slide 6. As Jay previously mentioned, we purchased an additional $3.9 billion UPB of MSR during the quarter and expect to continue to grow the portfolio in the fourth quarter.

Our MSR portfolio prepayment speed declined not only as mortgage and interest rates rose but also due to the slowing U.S. housing market during that period. Conventional MSR and government MSR CPRs averaged approximately 6.5% and 11.4%, respectively, down from 7.5% and 11.5% posted during the previous quarter.

As of September 30, the RMBS portfolio stood at approximately $1.8 billion, slightly down from June 30 as the majority of RMBS cash flows were redeployed in the servicing assets as shown on Slide 7. At quarter-end, our RMBS portfolio's composition was similar to the previous quarter. 30-year securities position stood at 72%, and the remaining assets represented 28% of the portfolio.

In the third quarter, the RMBS portfolio continued to perform well, posting a weighted average 3-month CPR of approximately 6 5/8%, an improvement from the previous quarter and once again, outperforming Fannie Mae aggregate prepayment speeds. Overall, the portfolio continued to benefit from its collateral composition.

For the third quarter, we posted a 1.18% RMBS NIM versus a 0.94% NIM for the second quarter. The increase in NIM was driven by the portfolio's composition and improved amortization costs based upon better prepayment speeds, which more than offset rising financing costs. In the near term, we continue to expect our NIM to fluctuate based upon rising REPO costs, some of it, which will be offset by the received portion of our swap portfolio and its 3-month LIBOR resets.

During the quarter, the aggregate portfolio operated with leverage of 4.7x and a negative duration gap. We ended the quarter with an aggregate portfolio duration gap of minus 1.4 years. Going forward, we expect to continue to evaluate and alter the portfolio if necessary.

I'll now turn the call over to Marty for a third quarter financial discussion.

Thank you, Julian. Our GAAP net income applicable to common stockholders for the third quarter was $25.8 million or $1.62 per weighted average share outstanding during the quarter, while our comprehensive income attributable to common stockholders, which includes the mark to market of our held-for-sale RMBS, was $12.7 million or $0.80 per share. Our core earnings were $8.8 million or $0.55 per share.

As Jay mentioned, our book value as of September 30 was $19.62, an increase of $0.26 per share or 1.3% from June 30. We use 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 and swaptions or short TBAs, all of which had a combined notional amount of $1.52 billion. 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 $2.8 million for the quarter, of which approximately $443,000 was related to our taxable REIT subsidiary. On September 6, 2018, we declared a dividend of $0.49 per common share for the third quarter, which was paid on October 30, 2018, as well as a dividend of $0.5125 per share on our 8.2% Series A Cumulative Redeemable Preferred Stock, which was paid on October 15, 2018. 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.

Thanks, Marty. At this time, we'll open up the call for questions. Operator?

(Operator Instructions) Our first question comes from Tim Hayes of B. Riley FBR.

My first one, can you just give us an update on how much of the RMBS portfolio is non-Agency security at this point? And then maybe just a little bit of color around how that strategy has progressed and how it will continue to progress over the coming quarters.

Currently, the -- about 7% of the portfolio is in non-Agency. It has actually progressed, I would argue, on the slower side. We did buy some additional securities in the third quarter. It wasn't so much that we thought that some of the securities that we were buying from a return perspective didn't meet some of the hurdles that we had. I think we just chose to put the additional capital and cash that we had into MSRs over the quarter. So we made an asset allocation decision. I think as we move forward, it will continue to evolve around that, making an asset allocation decision, kind of figuring out whether we like MSRs better than we like non-Agencies as well as whether we like them better than RMBS or Agency RMBS from that perspective. We do find the securities to be a decent alternative to 15-year collateral. However, we do think 30-year collateral may be a better play than non-Agency collateral so far.

Okay. And could you maybe size that for us a little bit in terms of just the returns you'd expect on 30-year collateral versus -- the non-Agency versus the MSRs?

In terms on -- let's say, Agency 30-year collateral, I would probably say, is somewhere between 13% and let's call it, 15% taking out for -- adjusting for REPO. And I would say on the non-Agency collateral, you're looking at something that's about 11% to 12% adjusting for financing. In terms of the MSR, we are seeing double digits there as well. Call that somewhere between...

Low double digits.

Okay. That's really helpful. And then I just want to confirm, I believe you said it earlier but just all the MSR acquisitions this quarter were from the flow sale agreement with RoundPoint.

Yes.

Got it. And then I think on your last call, you had said that MSR acquisitions were on pace to exceed last quarter's level, but they came in, I think, flat. So just wondering if the pricing grids changed much or maybe why that didn't end up coming to fruition.

Yes. That's -- it is a fair question. We did say that. At the time, we were getting an overallocation from our flow partner. They got an additional round of capital win, and they had some additional money to spend that they were allocating to us in previous months. So I think, on a go-forward basis, I would say $1 billion to $1.3 billion is probably a good run rate, $1 billion to $1.3 billion PAT. And again, look, we're partners, so we try to behave like partners.

Your next question comes from Trevor Cranston of JMP Securities.

Follow-up question on the MSRs. So sounds like they all -- all the new acquisitions came from the flow agreement in 3Q. I guess we've heard from some of your peers over the last 2 or 3 weeks that they've seen an increase in supply in the bulk market as some originators have sort of struggled to remain profitability and might be looking to sell some of their assets. Just curious if you guys are seeing that and if you -- and if that has caused any change in how you guys are looking at the bulk market versus the flow for new acquisitions.

Sure. So we agree that we've seen an uptick. So clearly, you're talking about a few friends of ours. But we definitely have seen an uptick in the pace of volume around bulk. I wouldn't say it's a huge uptick. I believe there are some large portfolios that might be coming out to market shortly, but as a general statement, those portfolios have traded extremely -- I'm not going to say the word rich, but they were very wealthy. And I think when you're bidding in this sector and you're managing your risks and bidding around a very disciplined model, it's tough to kind of think about the bulk space when there's a technical imbalance in the market. And I definitely believe that today there's a technical imbalance between buyers and sellers relative to the space, even though, to your point, there's been more supply. So we have seen yields on bulk portfolios come into levels that we just feel more comfortable playing in the flow space. I understand some guys have said that they don't see a meaningful difference between the flow and the bulk yields, but we do.

Got it. That's very helpful color. Then on the financing side, so obviously, you guys entered into the new agreement in the third quarter. Can you talk generally about what you're seeing in the financing market in terms of if there's any meaningful improvement in terms or the rates that you guys are getting for financing the MSRs?

I think the short answer to that is yes. I think that The Street is providing more liquidity. I think that the advance rates are creeping up and the haircuts are dropping. So as a general statement, it's encouraging to see more liquidity in the space relative to being able to finance the asset, and I think some of our peers would agree with that. We are not at a size yet where we have contemplated tapping a structured financing transaction, but we feel that between the options available to us, both with the broker/dealers and with the regional banks, that we can continue to grow the portfolio.

Got it. Okay. And then last thing for me, your book value obviously held up very well during the third quarter. Can you give an update on sort of how you performed in the fourth quarter today given the volatility we've seen in the rates in some of the spread markets?

Yes. I'll let Marty talk briefly to that. We're a little unique given the asset classes we have. But Marty, why don't you just quickly touch base?

It's really too early for us to tell at this point in the quarter, but we believe that the portfolio is constructed to protect book value through a rising rate environment. So it has performed that way in the last 5 years, and we expect it to continue.

Okay. I guess, so independent of the rate side because, obviously, you guys have a negative duration gap now, have you guys seen meaningful widening in Agency spreads? And could you maybe just sort of quantify a little bit on -- in terms of how much exposure, you think, you have to widening Agency spreads net of the MSRs?

Yes. I'll kind of comment on it. This is Julian. Basically, the Agency spreads have widened out about 10 basis points through the quarter when you look at it from that perspective, and I would say it's kind of our exposure -- I mean, if you look at our hedges, we're probably about 90% kind of hedged if you use the combination of swaps, swaptions as well as some TBAs, shorts that we have in the portfolio, but I would definitely say it's probably affected us by 1% or 2%.

(Operator Instructions) Our next question comes from Henry Coffey of Wedbush.

What is the governor on the dividend? Obviously, you're -- there's no reason to increase it given the way the market's valuing the stock, but you obviously have taxable earnings. Are your taxable earnings easy to quantify? Or are they notably lower than your GAAP results or your core results? I was just wondering how we should think about whatever set of upward pressure that may be on the dividend not because you choose to but because of the issue around taxable earnings.

Well, in the past and up until last year, I can tell you that the -- we have to pay out 90% of our earnings.

Right, of your taxable earnings not your capital...

Taxable earnings. And yes this -- the taxable earnings and the core are -- although they're not exactly equal quarter-to-quarter or at least not on the ballparks that we do, but overall for a year, it's coming out pretty close.

So if you continue to book this level of -- this impressive level of core earnings, would you opt to pay the excise taxes? Or would you bump up...

No, we wouldn't pay the taxes. That's for sure. We would give out -- I think, 2 years ago, we gave out an extra $0.05 because we were going to be under our 90%.

So you admit that you guys are special, but that sounds like an intelligent way to do it.

That's -- if we were coming to that.

If it comes to that.

If we were to come to that, Henry, yes, we would manage it as a special dividend, yes.

(Operator Instructions) This concludes the question-and-answer session. I would like to turn the conference back over to Jay Lown for closing remarks.

Thanks. And thank you for joining us on today's call, everyone. We look forward to updating you soon on our fourth quarter results. Have a great night.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.