Cherry Hill Mortgage Investment Corp (CHMI) 2020 Q4 法說會逐字稿

Greetings, and welcome to the Cherry Hill Mortgage Investment Corporation Fourth Quarter and Full Year 2020 Earnings Conference Call. (Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rory Rumore. Thank you, Rory. You may begin.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's Fourth Quarter and Full Year 2020 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; Julian Evans, the Chief Investment Officer; and Michael Hutchby, the Chief Financial Officer.

Now I will turn the call over to Jay.

Thanks, Rory, and welcome to today's call. 2020 was validation that we have the right team in place to handle the most challenging conditions and succeed longer term. I want to thank our team for all of their hard work and dedication to navigate our company through this unprecedented environment. We're very much looking forward to putting last year behind us.

Almost exactly 1 year ago, the world completely changed as COVID-19 hit our shores and caused massive sharp volatility in the worldwide economy.

Mortgage REITs across the board were forced to act expediently to save their companies as liquidity greatly tightened and asset valuations dropped precipitously. We have always proactively managed our portfolio, which enabled us to generate solid core earnings and preserve our book value in multiple interest rate environments.

However, the events that began last March proved to be our greatest challenge yet as we work to delever our portfolio and stabilize our company.

By executing efficiently and effectively, we positioned ourselves to maintain a stable liquidity profile, which proved to be a significant catalyst in recovering from the crisis.

By the third quarter, we had largely stabilized book value, and our focus was squarely on rebuilding value despite a record low interest rate environment and significantly elevated prepayment speeds in our portfolio.

For the full year, our book value performance compared to the broader hybrid REIT sector was very much in line with the group. As we sit here today, I'm proud to say that our team rose to the occasion. And while we enter 2021 bruised, the worst should be firmly behind us.

Rates have moved off their historic lows and continue to rise as the economic recovery progresses. This should enable us to benefit as we move forward with respect to our core RMBS and MSR portfolio strategies.

In the fourth quarter, we generated core earnings well above our distribution level while maintaining a strong liquidity position.

For the quarter, we produced core income of $0.37 per share while maintaining a dividend yield of 11%. We ended 2020 at 4x leverage, over half a turn lower than where we stood as of September 30.

We also ended the year with $84 million in unrestricted cash on the balance sheet. We believe our portfolio is well positioned relative to the current environment, allowing us to take advantage of investment opportunities that offer attractive risk-adjusted rates of return.

As the economy has continued to rebound, forbearance statistics have also improved further. As of the end of December 2020, borrowers and active forbearance remained just shy of 5.9% with approximately 28% of borrowers having made all payments due through December.

Forbearance statistics are stable post year and despite regulatory efforts to extend policies on foreclosures and forbearances. We continue to believe our bolstered liquidity position is sufficient to satisfy all our servicing advance obligations for the foreseeable future.

Book value per common share finished at $11.16 as of December 31. Broadly speaking, as others have noted, spread tightening benefited Agency RMBS at the expense of MSRs. While Agency REITs hedge with rate instruments, we rely on the MBS to partially hedge out our MSR portfolio. And this quarter, the correlation was negatively impacted.

The performance of our RMBS and hedge portfolios did not compensate for the weakness in the MSR portfolio. This was due in part to higher rates of prepayment in the portfolio as well as our positioning in both the coupon stack and story selection in RMBS pools.

Significant adjustments were made at year-end and into the current quarter, which we believe should improve performance. Our hybrid strategy of investing in RMBS combined with MSRs remains intact, with the majority of our invested capital still deployed in RMBS. Julian will provide some additional highlights on the portfolio shortly.

While highly elevated prepayment speeds in the fourth quarter for our Fannie and Freddie MSR portfolio weighed on performance, we have seen a steady rise in interest rates subsequent to year end, which should have a favorable effect on prepayment speeds post first quarter.

Although the fourth quarter numbers do not reflect the progress in recapture efforts due to servicing transfer delays, we have seen significant improvement in recapture efforts from our RoundPoint portfolio in the first quarter and expect those results will further improve over the next few quarters.

Currently, that portfolio is experiencing high teens recapture rates. In addition, during the fourth quarter, we acquired approximately $3 billion in Fannie and Freddie MSRs, utilizing our flow purchase program, which largely offset the runoff for the quarter.

We expect to remain on offense this year when we see attractive yield levels. Longer term, our focus remains resolute on proactively managing our portfolio to ensure that we are in a position to take advantage of attractive investment opportunities when presented.

We believe there is a solid opportunity to invest further in MSRs in 2021 to generate attractive returns, and I look forward to sharing our progress with you in the quarters ahead.

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

Thank you, Jay. The fourth quarter was marked by political uncertainty and continued Fed accommodation as another wave of COVID cases and restrictive city lockdown policies hit the country.

In the fourth quarter, we remained proactive in terms of adjusting our positioning to maintain our strong cash position. But in recent weeks, the prospects for greater growth and renewed inflation has started to brew.

To start 2021, the U.S. economic and vaccine information has been solid. Vaccine distribution has picked up steam, COVID cases and hospitalizations globally as well as domestically have dropped. And the Georgia Senate elections, coupled with President Biden's early new stimulus plans have added fuel to the fire of an economy that was already heated up based on stimulus provided in the fourth quarter.

The before mentioned factors have laid a solid foundation for upward growth in 2021. We are observing the environment closely and expect to be opportunistic in making new investments this year.

As Jay mentioned, the fourth quarter was impacted by weakness in both the MSR and the RMBS portfolios. Increased amortization affected both portfolios. The MSR portfolio's weakness was partially offset by increased new MSR flow purchases.

In addition to amortization, the RMBS portfolio experienced softness as the portfolio is restructured. We experienced weakness in our specified pool collateral, and liquidity in the market faded.

Overall, CPRs in the portfolio remained solid, but the fourth quarter liquidity was limited at best. Servicing-related investments comprised of full MSRs at a UPB of approximately $22 billion and a market value of approximately $174 million at quarter end.

MSR investments represented approximately 36% of our equity capital and approximately 10% of our investable assets, excluding cash. Meanwhile, our RMBS portfolio accounted for approximately 40% of our equity. As a percentage of investable assets, RMBS represented approximately 90%, excluding cash at quarter end. Our conventional MSR portfolio averaged approximately 45% CPR for the fourth quarter. Speeds increased and remained elevated from the third quarter, given the historically low interest and mortgage rate environment.

Similar to the MSR portfolio, the RMBS portfolio CPRs increased for the fourth quarter. The weighted average CPR was approximately 19.7% and approximately 41% rise from the third quarter.

Despite the increased prepayment speeds, the RMBS feeds remain better than the Fannie Mae aggregate speeds for the quarter. Year-to-date, in 2021, we've seen CPR similar to the fourth quarter as homeowners take advantage of low interest and mortgage rates.

As of December 31, the RMBS portfolio, inclusive of TBAs, stood at approximately $1.6 billion. During the fourth quarter, we continue to reposition and delever our portfolio to maintain our liquidity position. At year-end, the 30-year securities position represented nearly 100% of our portfolio.

For the fourth quarter, we posted a 1.77% RMBS net interest spread versus a 2.23% net interest spread reported for the third quarter. The reduction in spread was a combination of higher prepayment speeds and additional swap expenses that were onetime charge in the fourth quarter.

As interest in mortgage rates rise, we believe amortization has the potential to improve as the year progresses for the RMBS and MSR portfolios. The current mortgage market has moved from being 80% refinanceable to 60% refinanceable given the movement in rates. The movement rates is a positive, but we think servicers will reduce margins to keep volumes elevated in the near term. As a result, improvements in amortization may show up in the second half of the year.

Repo costs should remain low as the Fed remains committed and allows inflation to run hotter than the historical norms to make up for periods when inflation has run too low previously.

At quarter end, the aggregate portfolio operated with leverage of approximately 4x. We ended the quarter with an aggregate portfolio duration gap of minus 0.4 years approximately.

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

Thank you, Julian. Our GAAP net income applicable to common stockholders for the fourth quarter was $6.4 million or $0.38 per weighted average share outstanding during the quarter, while comprehensive loss attributable to common stockholders, which includes the mark-to-market of our held-for-sale RMBS was $5.2 million or $0.31 per share.

Our core earnings attributable to common stockholders were $6.3 million or $0.37 per share. Our book value per common share as of December 31, 2020, was $11.16 compared to a book value of $11.74 as of September 30, 2020.

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 fourth quarter, we held interest rate swaps, swaptions, TBAs and 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-K as well as in the fourth 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 $3.1 million for the quarter. On December 10, 2020, we declared a dividend of $0.27 per common share for the fourth quarter of 2020, which was paid in cash on January 26, 2021. We also declared a dividend of $0.5125 per share on our 8.2% 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 January 15, 2021.

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

(Operator Instructions) Our first question comes from Kevin Barker with Piper Sandler.

Could you guys give us just maybe a little bit of update on how the first quarter is coming along, given we're through a good part of it? Just give us an idea like where book value sits and how you see the portfolio changing? I know you gave some color on more aggressiveness on the MSR investment and so forth. But just a little bit of update on what's going on in the first quarter.

Sure, Kevin. So we don't have all the information yet for February and MSRs yet. So the only thing I can give you is through January. And through January, inclusive of accounting for the dividend, it was a little over 1% down.

Okay. And then given your expectations for MSRs, I would assume that you're anticipating prepay speeds to come down pretty hard as we go through the second quarter into the third quarter? Just given the movement in rates, what do you anticipate as far as just a drop in CPRs given the levels that we're at today?

Are you saying you expect CPRs to (inaudible) again?

No. What are your expectations just given the move in rates that we've seen in the last few weeks for a decline in CPR?

I'm going to hand it over to Ray. He has a better grip on the portfolio for that.

Yes, I think coming in Q1, a lot of those locks would have already taken place in December, January. So Q1, probably not a whole lot of change there. Coming into Q2, I think with what we saw in February and the pop-up in rates, the thought would be that you could see a decline in CPRs into the, call it, the mid-30s, high 30s from where we're currently printing around the 45% mark that we had in Q4.

And then servicing costs came down a touch quarter-over-quarter, but we're relatively elevated for most of 2020, just given the forbearance programs and the decline in forbearance rates and the changes that are occurring with the expiration of some of these foreclosure moratoriums. Maybe sometime in the next few months, what are your expectations for servicing costs as we go into the back half of the year?

I mean I think a lot of that's going to depend on how much we have work out of the forbearance into either deferrals or reinstatements. For the next few months, I think the moratorium is ending sometime toward the end of Q2.

So in the next couple of months, I would suspect that for the most part, things will be similar to Q4. Not a whole lot of uptick in forbearance, but then again, we're not seeing a lot of exiting from forbearance, either since they've pushed back the forbearance time frames. Going into -- later in the year, I think the expectation would be that forbearances will start to clear up. you'll start to see the exits and the turnovers from loss mitigation. And that's where we might see some pickup in servicing costs dropping.

So would you expect like a spike in servicing cost just due to an increasing amount of foreclosures in the back half of the year, maybe early '22 before dropping back closer to like a normalized level?

Like how should we think about that?

No, because I think when you think about it. If you had -- even if you had 20% of your forbearance loans continue through the path of foreclosure, which I think is by many estimates would be a very high number. You're still looking at a substantial amount of forbearance loans, which are currently delinquent and are being charged higher delinquent cost. And those would all be wiped out as they go through either deferral or reinstatement.

So I think net-net, the impact would be an upside to subservicing costs decreasing. as it relates to the amount of forbearance loans dropping off even with some continuing on the path through foreclosure.

Yes. I would add that we've seen stabilization in the absolute level of forbearances. And so I wouldn't -- Ray, correct me if I'm wrong, I wouldn't anticipate significant increases in the cost of servicing given most of the loans that are in forbearance are already past that 90-day delinquency charge.

So I would expect that we wouldn't see a huge increase in forbearance costs related to servicing expenses until we get to a point where we're allowed to kind of move more aggressively towards deferral or to get them out.

Is that fair?

Yes, that's all right.

Our next question comes from Henry Coffey with Wedbush.

Congratulations on a solid quarter. In just listening both to the remarks you made to Kevin and the comments on the call, obviously, we're off to a good start, but it seems like there's a lot of good things to look forward to in the second half if servicing costs start to come down, if the rise in rates actually does create some slow speeds in the second half. Are there other sort of inputs that we should think about as rates rise and we start looking at the second half of this year?

I think speeds are really the thing that we think about the most. I mean you can see in the presentation that speeds have been elevated for the third party to be quoted now. And as we all know, there's a lag between origination and when you actually see the speeds come through when 1 closes.

So it's been a good quarter so far relative to the primary rate rising in tandem with rates. And so you've seen that in the primary secondary spread. But there's still some fruit left on the tree for these guys to take. And we would expect -- I think we knew it in the presentation over the coming quarters that we would expect to see that.

But really speeds the other thing that we think about the most relative to interest income versus amortization and how that impacts earnings going forward as well as just broadly speaking, on the ARM-based side, just absolute yields and the leverage associated with the asset to get to an income level that we think is commensurate with the risk return.

But I mean, is it fair to say that it's not the first half of the story when we see any of these positive developments, but more like the second half or towards the back end of this year, given the factors that you just kind of pointed to?

So the 1 thing I would say is the following. I mean this is not the opinion of the company but mine. I'm not really sure you're going to see the seasonal impact that you did over the last number of years because people have the ability to move at any point in time given work from home and education from home.

So I have a view that the seasonals may not be as heavily impacted this summer, as you might think because the speeds have remained elevated throughout the year, just given the absolute low level of rates and the ability of people to refinance and to be mobile.

So I think from our perspective, we would say late second quarter is when we would start to see that decrease in speeds. And I have a lot of confidence in our recapture capabilities to further mitigate that. And I'm hopeful that our speeds net of recapture come down meaningfully.

Are there places in the portfolio where you're willing to really be aggressive? Or are there spots in the portfolio where you really want to put on the brakes and slow things down?

Across the 2 asset classes?

Yes. Yes.

It's a balancing act when it comes to these 2 asset classes. As I think we've all talked about over the last number of years. And so I don't think we want to get too in over the skis relative to the percentage of equity in MSRs.

But I think broadly speaking, today, we see the MSR space as a compelling opportunity. And we have been actively using our income from amortization to invest more into the MSR space than we have into the MBS space.

Is there any question about capital levels or anything that would cause a restraint to you executing where you want to execute?

Yes. I mean, capital is always a constraint, right? We want to maintain a fairly healthy balance sheet still. And so within the context of that, you can only do so much broadly speaking relative to the reinvestment that occurs every month.

If we add additional capital, yes, I would say the same holds true that we would probably allocate more of that capital into servicing than the assets.

Is -- would it be appropriate for you to raise more preferred or traditional straight term debt capital to do that or are we just not there yet?

Yes. Well, a, we're not there yet. But, b, I think given the movement in the company over the last year, I'd say we're pretty heavily -- we're pretty heavy on preferred say.

Our next question comes from Steve Delaney with JMP Securities.

Well, first, look, congrats on the strong core EPS and the dividend coverage. I mean you're showing a 10% yield on our comp table. And fourth quarter, you had 130% dividend coverage. So it seems to me the issue with Cherry Hill, it's certainly not earnings at this point, it's certainly not an attractive dividend.

You cut it like most everybody cut it, but it's -- that's life and COVID in 2020 for sure.

I guess my concern is the -- it's more structural. This is not like a 1-quarter thing. So you mentioned like in COVID last year. And I'm sure your numbers are right, Jay, about the book value decline in 2020 being in line. So obviously, most of the pains in the first quarter and anyone who had credit got destroyed in the first quarter.

What -- looking at your numbers, what surprises me a bit, one, you didn't have any credit, okay, for sure, but your book value, by my math, is down 19% over the last 3 quarters of the year. And we know which you own good fundamental assets and obviously, there's tons of liquidity in the agency space and repo is great.

I guess what I'm saying is, the market this year was very strange between primary and secondary rates. Gain on sale margins for the originators and Henry and Kevin and I and Trevor have been all over these IPOs, and that's been the story in the market and they, obviously, were extreme. And they have plenty of room to be very slow. And it seems like there's this big lag. There's a big lag between -- as the tenure moved up, as the FNCL moved up, the primary rates have not moved up and I guess, Ray can tell us this. But it seems to me that I assume the MSR models pay a lot of attention to primary rates.

And I guess -- what I guess I'm saying is 2020 has been a strange year because of refi volumes, a lot of other stuff. Is there an anomaly here that has made the last 12 months more complex for those who choose to pair Agency MBS with MSRs than you would expect over, say, a 5-year average? I'm just -- I'm looking at it and say this trade should work. But what's going on between the results and what's going on in the primary mortgage market?

Sorry for the ramble, but I hope you get to essence of that.

I understand the question. Yes. So the first thing I'll say is a decent portion of the book value issues over the past 3 quarters was around the deferred tax asset. That's number one. So you'd have to, from my perspective, separate that out from the rest of the performance over the last couple of quarters, and I believe that was somewhere around 7% or something of the -- or 70% of the book value loss in the third quarter.

In the third quarter, yes.

So relative to that, I would say within the servicing space, I think that the servicing behavioral models were -- have been slow to change over the course of the last 9 months relative to just actually seeing the speeds come in. And so that's 1 thing that's difficult to hedge for because you can't anticipate changes in behavioral models relative to how the third-party evaluators think about the asset.

In the fourth quarter, as both I and Julian noted, the mix became just a little bit more difficult relative to things around pay-up stories and just speeds. And if I were to answer your question just very short, I would say, given the absolute low level of rates and given the degree of refinance ability within the servicing portfolio and the fact that originators have enjoyed incredibly high margins over the last, let's just call it, 9 months or so, that has been a dynamic that, broadly speaking. Over the last 7 years, we have not seen or dealt with because in a normal environment when rates move because the originators should have fully included all that into their margins at the time.

They would move their rates in tandem with real rates moving, treasury rates. And so what we found, and you can see it just in terms of looking at the primary, secondary spreaders that it's been -- it widened and then tightened. And broadly speaking, the originators had a lot of wiggle room before they needed to change rates just based on the amount of low-hanging fruit.

And I think that once you get to a certain point in the 10-year, whether [that's $150 million, $175 million,] that number is coming up quickly, whereas we've seen and you've seen originators feel the need to adjust their origination rates and their primary rate to compensate for the loss in margin.

And Ray, correct me if I'm wrong, but we are definitely starting to see that. And I believe that once you hit a number somewhere between [150 and 175] in the 10-year, you'll start to see a more normalized environment where originators will start to move the primary rate in a manner that's more consistent with historical norms.

But you're absolutely right. Last year was just based on the absolute level that rates hit on the low side and the absolute historic margins that you've seen covering the originators, it created a dynamic that we had not seen.

I think that's important to note. That's why I brought it up. And it seems to me that in a normalization in 2021, there is this lag effect that the originators eventually will -- there'll be rationalization in pricing. And the MSR asset should perform better relative to rates in 2021 rather than 2020. And I'm not asking you to make a declarative statement on that. But I would point to the fact that last Friday, the 30-year fixed, the MBA 30-year rate was [167] over the 10-year. And on March 31 of last year, it was 277.

Now obviously, the 10-year crash, but it was 207 at the end of 2019. So I wish you all the best for this year. We'll be watching closely and good luck with everything you're trying to accomplish.

Our last question comes from Eric Hagen with BTIG.

Can you guys share some color around how lower coupon-specified pools have performed since the end of December? And do you feel like durations have fully extended on the portfolio of 2.5 at this point? Or do you think there's some more?

And then maybe you could share some color around just the growth yield you think you're getting on new purchases of MSR?

This is Julian. Low coupons, I would say, from an excess return standpoint versus treasuries or even swaps have underperformed, specifically 1.5 and 2s and 2.5s. I think there's a breakage when you kind of get above 3s. There has been some outperformance in terms of those coupons on an excess return standpoint.

Obviously, everything is down on a total return standpoint and lower coupons being hurt more from an all-in total return standpoint. So just from dollar prices falling as rates have moved higher. I think -- and that has continued. There has been some firming up over the last couple of days as rates are trying to find some footing. But we still see -- we have seen weakness there from a year-to-date perspective, mainly in February. is when we saw that -- the weakness.

It started in January, rolled into February. And I would say early March, there's been still some weakness, but a little bit of firming up from that particular standpoint.

Great. Good color. And how about the MSR component?

Yes, I would say some -- for us, and we haven't really been active in the bulk market because we've seen some pretty steep pricing there over the past month or so. But in the flow space, we're still seeing unlevered returns in the 8% to 9%, which for us is -- continues to be attractive.

There are no further questions at this time. I would like to turn the floor back over to Jay Lown for any closing comments.

Thank you, operator. At this time, the call has ended, and we appreciate your continued interest in Cherry Hill, and we look forward to updating you next quarter. Have a great evening.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.