Cherry Hill Mortgage Investment Corp (CHMI) 2021 Q3 法說會逐字稿

Welcome to today's Cherry Hill Mortgage Investment Corporation Third Quarter 2021 Earnings Call. (Operator Instructions) I would now like to turn the call over to your host, Mr. Garrett Edson. Mr. Edson, you may begin.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's Third Quarter 2021 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 or EAD 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; Julian Evans, Chief Investment Officer (technical difficulty)

Thanks, Garret, and welcome to today's call. The third quarter of 2021 saw a rebounding economy, but concerns remain about inflation and significant supply chain issues. We continue to actively position our portfolio toward a rising rate environment, while maintaining a strong balance sheet. However, while rates ended the quarter slightly higher than they were on June 30, we saw significant volatility intra-quarter. The 10-year dropped to a low of 1.17% in August and remained low until the tail end of the quarter. Given the absolute movement in rates intra-quarter, origination volumes remained high and prepayment speeds, while slightly lower quarter-over-quarter, remained elevated in both portfolios. In light of the positive economic unemployment data year-to-date, we believe rates have now stabilized at higher levels, persistent inflationary pressures as well as pending fiscal aid also should support this thesis over the near term. We expect this will be positive for our portfolio as we have positioned it for a steeper higher rate environment.

Beginning with this quarter, we retitled core earnings as earnings available for distribution or EAD. We believe this title is more indicative of how investors use this metric. In the third quarter, we generated EAD of $0.25 after giving effect to a onetime regulatory settlement payment by Aurora, our MSR holder, equivalent to approximately $0.03 per share.

Over the past 18 months or so, states have become more aggressive in attempting to license MSR holders. Although Aurora holds MSRs, it does not directly service the underlying loans or have any contact with the borrowers. All of these activities are (technical difficulty) licensed or exempt from licensing in the applicable states.

Notwithstanding the lack of any direct servicing activity by Aurora or impact on borrowers, states are aggressively asserting the need for licenses and assessing penalties. This onetime outsized payment firmly settles the issue with one of the more aggressive states. Excluding the effects of this onetime payment, EAD would have exceeded the quarterly dividend.

As we've noted before, EAD is just 1 of several factors we consider in setting our dividend policy. We continue to closely watch the interest rate environment, along with the impact, inflation and supply chain issues are having on a macro level, but we remain confident in the near-term sustainability of our dividend.

During the quarter, we continued purchasing MSRs through our flow program. Pricing has been robust as new entrants deploy fresh capital and others aggressively compete for a finite supplier product. We have been prudent in our approach to investing in this asset class in light of those factors. We expect the market for MSRs to remain competitive for the foreseeable future, and we will maintain our discipline with respect to deploying capital there. We continue to believe our ability to manage this asset cloud effectively exceeds those who speculatively enter and leave this space but are large or small.

Leverage was approximately half a turn lower to 3.2x from 3.6x at the end of the prior quarter. This was primarily driven by us not tapping our Fannie Mae MSR facility, pending replacement of that facility in October. We expect our leverage to gradually return to levels we saw earlier this year. Book value per common share finished at $9.07 as of September 30. The change in book value on a quarter-over-quarter basis was driven by a couple of factors. Most notably, the removal of the adverse market fee and corresponding behavioral model impact, low coupon RMBS underperformance and our hedge strategy not providing adequate protection at an aggregate portfolio level. Julian will provide more details on this shortly.

Part of the change in book value is a function of preferred stock, making up a significant portion of our overall equity profile. On a net asset value basis, which doesn't account for the difference in common or preferred equity. Our performance has been notably more effective. That said, we remain committed to drive improvement in our NAV and book value. We realize it is taking time but we would expect book value to begin to recover as we look to next year and beyond. Our recapture efforts remain strong with a 22% recapture rate on our MSRs in the quarter. We firmly believe retaining borrowers is instrumental to a successful investment strategy in servicing. Managing this effort will continue to be a focus of the company over time as the portfolio grows.

During the third quarter, we acquired approximately $720 million UPB of Fannie and Freddie MSRs, utilizing our flow purchases program. We believe this approach provides benefits as it mitigates the impact of spread widening on our portfolio. We ended the quarter with $63 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile.

As we move forward with respect to our portfolio and the overall environment, we believe rates have stabilized and are poised to head higher potentially aided by Fed policy tailwinds. Our team will continue to proactively manage our portfolio to ensure that we are positioned appropriately and able to take advantage of attractive investment opportunities. We remain constructive on the U.S. economy and expect to invest further in MSRs in anticipation of a bounce in interest rates that we believe should generate value for the company and our shareholders.

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

Thank you, Jay. In the third quarter, the U.S. economy continued to rebound nicely, thanks to sizable consumer demand with most pandemic protocols relaxed. At the same time, inflation was clearly beginning to weigh on many Americans with inflation metrics that haven't been seen in decades. At first, interest rates did not rise in concert with inflation and, in fact, materially declined into early August. However, by the end of the quarter, we started to see inflation have an impact as the U.S. tenure ended the quarter slightly higher than where it stood on June 30. Although interest rates have stabilized at these higher interest rate levels for now, the portfolio was still impacted by the lower interest rates we saw for the vast majority of the quarter as prepayment speeds remained elevated. Looking forward, we continue to believe interest rates will progress higher over time, and we will remain opportunistic as we continue to pursue investments while closely monitoring inflation and supply chain issues that are impacting the global economy.

At quarter end, MSRs had a UPB of approximately $21 billion and a market value of approximately $211 million. During the quarter, we purchased $720 million UPB of new MSRs through our flow programs. At the end of the third quarter, the MSR portfolio represented approximately 43% of our equity capital and approximately 13% of our investable assets, excluding cash.

Meanwhile, our RMBS portfolio accounted for approximately 39% of our equity. As a percentage of investable assets, RMBS represented approximately 87%, excluding cash at quarter end.

Our MSR portfolio averaged approximately 22% net CPR for the third quarter, down from approximately 27% net CPR in the previous quarter driven by gradually slower prepayment speeds as well as a steady recapture rate.

We saw mortgage fees decline further as rates began to decline towards the end of the quarter and into October. Meanwhile, the RMBS portfolio's weighted average 3-month CPR also improved slightly in the third quarter to approximately 17% compared to approximately 18% in the second quarter.

During the quarter, we increased our exposure to 30-year securities. As of September 30, the RMBS portfolio inclusive of TBA stood at approximately $1.4 billion, which is comparable to the previous quarter. The repositioning of the RMBS portfolio helps liquidity improves overall RMBS prepayment speeds increases carry as well as allows for further investments in MSRs.

Quarter-over-quarter, we increased our 30-year securities position from 83% the previous quarter to 87% of the portfolio this quarter. 15 years securities and other collateral positions were reduced to 13% of the portfolio to finance the increase in 30-year securities.

For the third quarter, we posted a 2.26% RMBS net interest spread versus a 2.32% net interest spread reported for the second quarter. Higher interest expense was mostly offset by lower mortgage amortization, which benefited from better prepayment speeds.

As interest rates have started to rise, mortgage volumes should begin to taper off from previous highs, and we should expect the trend to continue into 2022 should rates continue their current trajectory, which would allow for improved prepayment fees in the future. In the near term, we continue to expect repo costs to remain low as the Fed allows growth and inflation to run hotter than the historical norms to compensate for periods when inflation has run too low previously.

Quarter end, portfolio leverage stood at approximately 3.2x at the aggregate level.

I'll now turn the call over to Mike for our third quarter financial discussion.

Thank you, Julian. Our GAAP net loss applicable to common stockholders for the third quarter was $6.2 million or $0.36 per weighted-average share outstanding during the work while comprehensive loss attributable to common stockholders, which includes the mark-to-market of our held-for-sale RMBS, was $4.6 million or $0.27 per share. Our earnings available for distribution attributable to common stockholders were $4.2 million or $0.25 per share after giving effect to the onetime payment equating to approximately $0.03 per share that Jay referenced earlier. Our book value per common share as of September 30 was $9.07 compared to a book value per common share of $9.63 as of 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, swaptions, TBAs, a short position on treasury futures and options on treasury futures, all of which had a combined notional amount of $2 billion. You can see more details with respect to our hedging strategy in our 10-Q as well as in our third quarter presentation.

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 $3.7 million for the quarter. On September 17, our Board of Directors declared a dividend of $0.27 per common share for the third quarter of 2021, which was paid in cash on October 26. We also declared a dividend of $0.5125 per share on our 8.2% (sic) [8.20%] Series A Cumulative Redeemable Preferred Stock and a dividend of $0.515625 on our 8.25% Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, both of which were paid on October 15.

At this time, we will open up the call for questions. Operator?

(Operator Instructions)

(technical difficulty)

So the new metric is really just operating earnings minus the fair value adjustments, and that's your -- that's what you're thinking is the basis for paying the dividend?

EAD is really just a name change from core earnings previously. It's the same formula as we've had for core earnings up to this point.

And then, of course, on this regulatory charge, does that mean that I don't want to get into specific states because they're always listening. But there's usually a list of like state #1, then the state #2 is most aggressive on this stuff. Do they all queue up and see a money-making opportunity? Or is this a problem with limited scope?

Yes. No, sure. That's a good question. So there were a handful of states that we had conversations with that we're much, much, much more reasonable with respect to kind of how to be productive about the situation and each state was different relative to whether it was a clear or unclear. And we just had 1 state out of that group that really decided to press these to, and that was the last state that we dealt with, which we settled in October, currently, we don't have any others. Can I tell you that any others will never come up. No, but we are spending an enormous amount of time trying to make sure that we're ahead of the curve now relative to what states are thinking. And this is a money conversation. I just want to emphasize that we don't service the loans directly and don't have any contact with borrowers. So this is about them getting fees for us being licensed and paying them manually.

Yes, I figured that part. In terms of the impact of the removal of the 50 basis points, we did see a couple of other people write-down MSRs based on that. The perpetual adjustments negatively on the fair value side. How close -- when do we get to a point where you've written your MSRs down to the point where it -- unless they're going to go away in a year, it doesn't matter that the fair value process is kind of run itself out. And what does that look like under the current interest rate situation.

Well, so I definitely can't speak for what the FHFA or any other regulatory matters will do relative to changing the goalposts relative to how they think about the asset. But broadly speaking, outside of -- anything that's outside of our control, we feel as though the asset has been and continues to be marked appropriately and at fair value. And broadly speaking, the asset on a fair value basis was not necessarily "marked down" quarter-over-quarter. But the impact of that had -- definitely had a negative, I guess, impact to the final valuation relative to how the models treat the asset with respect to lifetime speeds, et cetera.

The chart that you showed in your deck suggests that forbearance is just an evaporating problem for you all. Brian, my associate has done some work. And the one thing that sticks out is that delinquencies are high and foreclosures are low. If those 2 correct, is that going to have an effect on your portfolio performance sometime next year? Or are foreclosures going to kind of roll through in a very smooth and orderly fashion and not have an impact?

(technical difficulty)

I'll let Ray take over for a second, but (technical difficulty)

Where in our degree of comfort relative to how it's impacting our portfolio, we've seen (technical difficulty).

Relative to this whole issue and get increasingly more confident that this problem is very, very much behind us and that -- and it's very manageable.

I also know, broadly speaking, that the new Fannie Mae MSR line that we have in place has room for servicing advances, which increases our ability to kind of manage through anything related to forbearance.

As it relates to the part of the question about the pig through the snake, Ray, do you want to just give your opinion on 2022 and beyond.

Yes. I mean I think that for the most part, most of these guys will work out through the normal means of deferral or modification. There'll be some small portion that does go through to liquidation. But keeping in mind that while they were on forbearance, they couldn't be dual-tracked. So the forbearance time lines would essentially start once they've gone through the workout and determined that they don't qualify under a deferral or modification or some other plan that would put them back on current. So I suspect that given the state foreclosure time lines, the amount that do end up going that route won't actually find resolution until either late 2022 or early 2023.

Our next question comes from Mikhail Goberman.

Just a question on the book value -- sequential book value drop. Could you give perhaps a little more color on that? And also as it relates to the future of the DTA.

Sure. We'll start with the DTA.

Sure. So the DTA will continue to fluctuate over time as the MSRs are marked up or marked down. So as MSRs are marked up, that would create a DTL in the current period, which would eat away at the current DTA. And so over time, you would expect as MSRs are written up, the DTA will continue to shrink.

And on the first question, just help me out and restate that again, please.

Sure. And I just wanted to get some color on what exactly drove the sequential book value? Was it 5.5% roughly?

That's right. And when you say sequential...

The drop. The drop in book value quarter-to-quarter.

Right. So as I mentioned in the speech, it was a combination of things over the quarter. The shape of the yield curve definitely had an impact. As I mentioned in the speech, we are set up more for a bear steepener relative to the yield curve, relative to how these 2 assets want to interact together and how the hedges protect us.

We still believe that there is an impending rise in interest rates as a lot of other things that we mentioned in the speech come to fruition, and that may take a little longer relative to fiscal policy, et cetera. But we remain positioned for that environment. And that definitely did have an impact relative to how the portfolio interacted together. I will say that the changes in the model and our analytics around yield book, definitely, as we mentioned, had an impact relative to the final fair value on the MSR portfolio relative to how the model treated the asset over the prior quarter. And what am I missing?

Some of the lower coupon TBA positions also hurt the portfolio as rates rose turning. We hit a low, obviously, of 1.18 on the 10-year and then rose sequentially after that, and that had an impact on the portfolio as well.

Yes. I would add that, as I'm sure others mentioned, the MSR definitely does help against spread widening on the lower coupon TBAs, but it doesn't cover it completely. From price perspective, no matter what happens, if you have spread widening on TBAs, I would say that a REIT that has MSRs in it will definitely fair better than a pure agency REIT, but it doesn't cover all of that.

Got it. And with that in mind, I could ask 1 more. Could you perhaps provide some color on where book value is now. We're almost halfway through the quarter.

Yes. So we don't have the MSR valuations and everything around that asset back in yet. So I can't give you a partial read on that. I won't give you a partial read on that. It takes us usually to about the 12th or the 15th to get everything back on the MSR portfolio. So I'd like to refrain on that one.

Sure. I understand.

And at this time, we have no further questions. I would like to turn the call back to Jay for closing remarks.

Thank you, operator. Thank you very much for joining us today for the third quarter 2021 earnings call, and we look forward to updating you early next year for fourth quarter. Have a great evening.

This concludes today's conference call. Thank you for attending.