Cherry Hill Mortgage Investment (NYSE:CHMI)
Q2 2016 Earnings Conference Call
August 9, 2016 17:00 ET
Michael Hutchby - Investor Relations
Jay Lown - President
Julian Evans - Chief Investment Officer
Marty Levine - Chief Financial Officer
Michael Kaye - Citigroup
Greetings and welcome to Cherry Hill Mortgage’s Second Quarter 2016 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your host, Mr. Michael Hutchby. Thank you, Mr. Hutchby. You now have the floor.
We would like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation’s second quarter 2016 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 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 will turn the call over to Jay.
Thanks, Mike and thanks to everyone for your continued support of Cherry Hill. Since going public in late 2013 we have talked consistently about positioning ourselves for a rising rate environment to deliver strong long-term returns for shareholders. And finally coming into 2016, the initial expectations were for several rate hikes which would have dovetailed well with our strategy. Fast forward six months and instead of the rising rate environment we have been expecting, we are seeing near record low 10-year treasury rates and most experts are projecting a lower for longer rate environment. Despite the low rates and persistent volatility in the marketplace, our disciplined and targeted investment strategy has helped preserve book value while delivering strong core earnings for a second consecutive quarter. Our second quarter performance is a testament to the strength and flexibility of the investment portfolio that we have built over the last few years.
During the quarter, we grew our portfolio of servicing related assets as we closed on the acquisition of a $1.3 billion Fannie Mae MSR portfolio. We remain focused on securing liquidity to fund our MSR strategy, which we believe will serve us well when rates reverse course. We also executed a series of 30-day and 60-day repurchase trades with Freedom involving newly issued Ginnie Mae RMBS, which were then re-hypothecated to various existing counterparties. The spread between the MBS coupon we received and the financing rate we paid positively affected our NIM and our core earnings. These transactions generated attractive returns without exposing the company to significant interest rate or prepayment risk. That said, this strategy is market dependent and the arbitrage is unlikely to continue for an extended period of time.
We remain committed to maintaining the flexibility of our portfolio. This approach has served us well and it allowed us to be responsible with our invested capital and positions us to be able to move rapidly should circumstances in the marketplace change. We also expect to continue to evaluate servicing related asset purchases for our portfolio if they meet our risk return hurdles.
Turning to our quarterly results as shown on Slide 5, second quarter core earnings were $0.53 a share and dividend eligible earnings were $0.56 a share. The incremental earnings above historical norms were mainly due to the repo of transactions with Freedom that I described earlier. That said we were pleased with the performance of both our RMBS and our servicing-related assets portfolios and another quarter of lower interest rates. Subsequent to the second quarter, we entered into a joint marketing agreement with Freedom to protect and defend our Fannie Mae MSR portfolio. For the second quarter, we distributed $0.49 per share dividend to our shareholders and we have now distributed nearly $5.50 per share in dividends since we became a public company in late 2013. We are also happy to report that our book value for the second quarter rose 0.6% to $19.80. Although some strategies are market dependent and may not be sustainable in long-term, we continue to expect that we can maintain our current dividend level in the near-term.
With that, I will turn the call over to Julian who will cover some more detailed highlights of our investment portfolio and its performance over the quarter.
Thank you, Jay. We saw significant market volatility in June with global rates falling to record lows. For the first two months of the quarter, the rates markets were range bound, volatility was limited and credit spreads tightened. But as June approached, the pending Brexit vote unsettled global markets. The unexpected vote result led investors to expect lower global growth and placed the set on hold for an extended period. As a result, the U.S. tenure closed June at 147 down 80 basis points from the beginning of the year. Similar to other spread sectors, MBS spreads tightened from the wide in April and May but lagged both treasury and swap hedges as the quarter closed. Despite persistent Fed intervention, agency mortgages lagged as interest rates and mortgage rates continued their march lower by quarter end. Refinancing and prepayment risks clearly remained a concern with rates only slightly off their trough levels. And barring a shift in sentiment from the Fed in the coming months, we would expect prepayment risks to remain elevated in the near-term.
Moving forward, Slide 6 highlights our aggregate investment portfolio composition. At quarter end, our servicing related investments, which include MSR and excess MSRs represented approximately 49% of our equity capital and approximately 16% of our investable assets excluding cash. Servicing-related assets as a percentage of total assets increased two percentage points over the quarter. Our RMBS portfolio at quarter end comprised approximately 47% of our equity capital and approximately 84% of our investable assets, excluding cash.
As shown on Slide 7 through 9, the current carrying value of our servicing-related assets stood at approximately $97 million at quarter end despite rates falling to record lows, our servicing-related CRP held well. Full MSRs posted a CPR, a 12% CPR, while our excess MSRs posted a 16% CPR net of recapture. Total recapture on loans underlying our excess MSRs remain strong with approximately $621 million of loans being recaptured during the quarter with Pool 1 posting a 38% recapture rate and Pool 2 posting a 53% recapture rate. Overall, the excess MSR portfolio produced $6.2 million in cash flow, including $3.1 million in interest income. In addition, we grew our MSR investments in the quarter to approximately $30 million aided by our acquisition of a Fannie Mae MSR portfolio with an aggregate UPB of $1.3 billion.
As of June 30, the RMBS portfolio stood at approximately $522 million as shown on Slide 10, an increase from $508 million as of March 31. At quarter end, the portfolio composition remained consistent to the prior quarters’ composition. 30-year fixed rate whole pools represented 60% of the portfolio. The 20-year and 15-year fixed rate whole pools as well as shorter duration assets represented 40% of the RMBS portfolio at quarter end.
As shown on Slide 11, loan balance collateral remains the primary focus of the RMBS portfolio. For the quarter, the portfolio posted a weighted average 3-month CPR of approximately 7%, which was a slight increase from 6.4% in the previous quarter. On past calls, we have noted that we expected CPRs to rise given the sustained lower for longer interest rate environment that we are currently witnessing and we would expect prepayment speeds to remain elevated and so the Fed and other central banks shift their policies.
For the second quarter, we posted a 1.43 RMBS NIM, net of our Freedom repo transactions versus a 1.73 NIM for the first quarter. The NIM is a return to the norm similar to the 1.46 NIM we posted in the fourth quarter of 2015. The current NIM was limited by additional repo and mortgage amortization costs. In the second quarter financing costs averaged 72 basis points versus averaging 63 basis points in the first quarter. We expect our NIM to fluctuate around historical numbers in light of the higher expected prepayment speeds and repo costs.
During the quarter, the aggregate portfolio operated with leverage of 3.19 times in a negative duration gap. As shown on Slide 12 we ended the quarter with an aggregate portfolio and duration gap of minus 2.89 years. The composition of the RMBS portfolio associated hedges and the fact that 49% of the company’s equity was invested in servicing related assets including the excess MSRs and the full MSRs during the second quarter of 2016 drove the portfolio’s duration gap.
I will now turn the call over to Marty for our second quarter financial discussion.
Thank you, Julian. Our GAAP net income applicable to common stockholders for the second quarter was $0.3 million or $0.04 cents per share while our comprehensive income attributable to common stockholders which includes the mark to market of our held for sale RMBS was $4.7 million or $0.63 per share. Our core earnings as detailed on Slide 24, was $4 million or $0.53 per share, while our dividend eligible income was $0.56 per share. While we have now recorded a couple of quarters of elevated core earnings, we believe that our core earnings will normalize back towards their previous levels going forward. As we noted on prior calls, we expect there will continue to be a slight difference between core earnings and dividend eligible income due to ongoing portfolio acquisition expenses. But importantly, we expect to generate enough dividend eligible income to allow us to sustain our current dividend for at least the near-term.
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, TBAs and treasury futures with a combined notional amount of approximately $453 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 $1.5 million for the quarter, of which approximately $147,000 was related to our taxable REIT subsidiary.
For the quarter our total operating expense ratio as a percentage of average equity was 4%. On June 16, 2016, we declared a dividend of $0.49 for the second quarter which was paid on July 26, 2016. Our goal remains to distribute regular quarterly dividends of all or substantially all our taxable income to holders of our common stock and to the extent authorized by our Board of Directors.
Now I would like to turn the call back to Jay for closing remarks.
Thanks Marty. Overall, we are pleased with our second quarter performance given the persistent low interest rate environment. We will continue to focus on maintaining flexibility in our investment strategy and most of all generating consistent earnings while preserving your invested capital.
We will now open up the call for questions, operator?
Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. [Operator Instructions] And our first question comes from the line of Mr. Michael Kaye from Citigroup. Please proceed with your question.
Thank you. Just the repo strategy you talked about with Freedom and how much of your core EPS was attributable to that this quarter?
Hey Mike, it was about $0.04 to $0.05, of which we…
Of which we would have made $0.02 if it was without that trade. In other words we invest – we allocated about $10 million worth of capital for two months to the trade and we would have made $0.02 as opposed to the $0.04 to $0.05 that we did make.
Okay, so a big delta between the $0.02 and the $0.04 to $0.05?
Okay. And can you just talk a little bit about your cap – how you are thinking about capital plans at this point, I know you – you attempted to do some preferred issuance late last year, I mean could you revisit that at this point to give you some more firepower or is it just more reallocation between agency and MSRs at this point?
At this point it’s the latter. We continue to think about ways to grow the company, but we have not announced any plans to do anything either in the preferred space or anything else.
And just strategically or I believe Fannie and Freddie license they don’t have a Ginnie Mae license, is that something you could pursue at some point upon – you would probably do more with Freedom if you had that Ginnie Mae license?
Yes. We continue to work with Ginnie to get that approval. We are looking forward to ultimately getting that approval and we would like to have all three.
I mean do you still formally look at the flow from Freedom?
On a formal basis around excess we aren’t really doing that on a regular basis these days, no.
Okay, alright. Thank you very much.
[Operator Instructions] There are no further questions at this time. I would like to turn the conference back over to management for any closing remarks.
Thank you. Thank you for joining us today on the call. We look forward to updating you on our progress on our third quarter earnings call. Have a good afternoon.
Ladies and gentlemen, this does conclude our teleconference for today. We thank you for your time and participation. And you may disconnect your lines at this time. Have a wonderful rest of the day.
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