Cherry Hill Mortgage Investment Corporation: Margin Of Safety
Summary
- Cherry Hill Mortgage Investment Corporation, a real estate finance company that acquires, invests, and manages a portfolio of mortgages.
- The economic slowdown has affected the business severely, as reflected in the stock price (corrected by ~50%).
- Bullish on Cherry Hill, as the company is moving towards conservatism.
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Cherry Hill Mortgage Investment Corporation (NYSE:CHMI) is a publicly-traded residential real estate finance company. The company focuses on acquiring, investing in, and managing residential mortgage assets in the United States. The company started its operation in 2013 following its initial public offering (IPO). The company generates most of its income from real estate-related properties, thus qualified as REIT and taxed accordingly.
The company operates in three segments:
- Investments in Residential Mortgage-backed securities (RMBS)
- Investments in Servicing-Related Assets
- Other Investments in Real assets.
The company's portfolio composition as on 31st March 2020.
Equity Investment Composition
Aggregate Investment Portfolio Composition
Performance Graph:
Cherry Hill is externally managed and advised by Cherry Hill Mortgage Management, LLC ("Manager" or "CHMM"). CHMM is responsible for the company's investment strategies and decisions and its day-to-day operations. The company for the past five years has performed in line with the related indices such as Russel 2000, SNL Financial REIT, and S&P 500.
Factors Impacting CHMI's Operating Result:
The company's income is generated primarily by the net spread between the income it earns on our assets and the cost of financing, also supported by the hedging activities.
The company's net income primarily includes:
- Actual Interest payments on RMBS.
- Net Servicing fees on Mortgage servicing rights (MSR)
Factor impacting its net income:
- Market Interest rates
- Prepayment speeds
- Servicing cost
The company has been very prudent in selecting and managing its portfolio with a focus on achieving a consistent spread. During the past few years, the company's average net yield spread has been stable.
Quarter Ended | Average Asset yield | Average cost of funds | Average Net Interest rate spread |
December 31, 2019 | 3.72% | 1.84% | 1.88% |
September 30, 2019 | 3.77% | 2.13% | 1.64% |
June 30, 2019 | 3.83% | 2.27% | 1.55% |
March 31, 2019 | 3.83% | 2.21% | 1.62% |
December 31, 2018 | 3.82% | 2.10% | 1.72% |
September 30, 2018 | 3.77% | 2.05% | 1.72% |
June 30, 2018 | 3.74% | 1.83% | 1.91% |
March 31, 2018 | 3.67% | 1.81% | 1.86% |
COVID-19 effect on the US Mortgage Industry and CHMI:
The global economy has been severely affected due to the spread of the novel coronavirus. The pandemic gripped the United States with ferocity and has not let go despite some states beginning to reopen for business.
The pandemic has led to overnight fund rates cut to zero by the Fed. Mortgage rates across the industry were suddenly under siege as liquidity tightened and margin calls on all asset classes forced many to deliver their portfolios. Further, the government wavered regarding mortgage loan forbearance programs before the CARES Act was signed into law, which exacerbated the fears of a mortgage collapse.
In response to the challenges, the company is opting the following strategies:
- Preference for Liquidity: The company is focusing on building ample liquidity to survive the slowdown in the economy. The company held approximately $90 million unrestricted cash.
- Deleveraging: The company has reduced the leverage on its aggregate portfolio from 6.1 times (in Dec-19) to 3.9 (As on 30th April 2020).
Like most of the mortgage and speciality finance REITs, Cherry Hill stock has also been severely affected by the economic slowdown caused by the COVID-19; the stock price has corrected more than 50% in the past few months.
So, why be bullish?
- ~50% correction in the stock price and stability in the net interest spread earned by the company in the past few years increase the margin of safety for investors
- The strong cash position likely will negatively impact earnings in the near future
- The Federal govt, through its lesson learned from the housing crisis in 2007-08, is keeping a close eye on the mortgage industry and, aggressively, taking actions in response to the slowdown caused by the COVID-19.
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Comments (13)
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