Cherry Hill Mortgage Investment Corporation (NYSE:CHMI) Q3 2024 Earnings Call Transcript

Cherry Hill Mortgage Investment Corporation (NYSE:CHMI) Q3 2024 Earnings Call Transcript November 12, 2024

Operator: Ladies and gentlemen, thank you for standing by. My name is Desiree, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cherry Hill Mortgage Investment Corporation’s Third Quarter 2024 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Garrett Edson of ICR. You may begin.

Garrett Edson: Thank you, Desiree. We’d like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation’s third quarter 2024 conference call. In addition to this call, we have issued a press release that was distributed earlier this afternoon and posted that press release and a third quarter 2024 Investor Presentation 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 our ability to complete the planned internalization of our management, interest income, financial guidance, IRRs, future expected cash flows as well as prepayment and recapture rates, delinquencies and non-GAAP financial measures such as earnings available for distribution 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, the Chief Investment Officer; and Michael Hutchby, the Chief Financial Officer. Now, I will turn the call over to, Jay.

Jay Lown: Thanks, Garrett, and welcome to our third quarter 2024 earnings call. The third quarter went somewhat as expected as the Fed utilized inflation indicators to go ahead and begin the rate cut cycle in September. While geopolitical unrest continued to persist, the market broadly looked past international troubles. Rates pushed lower with the yield curve, specifically the two-year, 10-year spread, turning positively sloped for the first time since July 2022. The U.S. 10-year ended the quarter at 3.78%, down 62 basis points quarter-over-quarter as the market aggressively positioned for significant rate cuts over the next 18 months. That exuberance has since faded as strong economic data has persisted and markets have since reduced those bets.

With the U.S. presidential election and the additional 25 basis point cut from the Fed last week in the rearview mirror, we are closely monitoring the impact of a second Trump presidency and its impact on both the economy and inflation. As we approach 2025, we expect to gain additional confidence that macro environment volatility will moderate. Our portfolio remained relatively consistent in the quarter with the mortgage market improving as spreads compressed and the curve both steepened. RMBS performance was mixed and coupon selection drove performance. Our MSR portfolio, consisting primarily of low note rate loans, performed well with prepayment speeds hovering in the mid-single digits. Julian will discuss this in more detail shortly. Looking forward, we continue to watch the Fed closely as well as political developments globally and expect to continue to pair MSRs with agency RMBS.

For the third quarter, we generated GAAP net loss applicable to common stockholders of $0.49 per diluted share, and we generated earnings available for distribution or EAD, a non-GAAP financial measure of $2.5 million or $0.08 per share. EAD for the quarter was impacted by approximately $0.045 per share of expenses related to the special committee’s efforts. As we’ve mentioned previously, EAD is just one factor the Board of Directors considers in setting our dividend policy and it is not the primary factor. Also considered is the existing market environment, portfolio return potential, our level of taxable income, including hedge gain impacts and the degree of certainty regarding forward investment return economics. Thus, while EAD may continue to remain under our dividend level in the near-term, we believe other factors are important when considering whether we can sustainably cover our dividend.

Book value per common share finished the quarter at $4.02 compared to $4.15 on June 30. Approximately $0.06 of the change in book value was attributable to the special committee and ATM issuance. Similarly, on an NAV basis, which includes preferred stock, when excluding special committee expenses and the ATM issuance, NAV was down approximately $2.1 million or 0.9% relative to June 30. We continue to hedge a portion of our basis risk with TBA, and we expect to lag our peer group when the basis tightens and outperform into wider spreads. Financial leverage at the end of the quarter rose to 5.3 times as we continue to stay prudently levered. We ended the quarter with $50 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile.

With respect to our previously announced internalization and strategic process more generally, we cannot comment at this time. And on today’s call, we will not discuss any information or developments or answer any questions relating to the internalization, the special committee or its strategic process. Looking ahead, we will continue to monitor the macro environment and are positioning our portfolio for further rate cuts. In the near-term, that means continuing to deploy capital into agency RMBS, which still presents a strong risk adjusted return profile and adjusting our hedge composition in order to take advantage of expected ongoing Fed easing, while maintaining strong liquidity and prudent leverage. 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.

Julian Evans: Thank you, Jay. There were not many macroeconomic surprises in the third quarter. Inflation met market expectations, and with that, was widely expected that the Fed would initiate a rate easing cycle. Perhaps the only surprise was that the Fed was intent on easing 50 basis points when the market believed the data warranted a 25 basis point ease. During the quarter, the mortgage basis tightened as nominal spreads tightened and volatility declined. The tightening was driven by the fact that the investor community became more certain that the FHLMC would change its policy from being on hold to an easing monetary policy stance. The interest rate curve both steepened on that belief. However, within the mortgage sector, not all mortgages were created equal.

As rates lowered, the current coupon changed, and mortgages performance diverged. During the quarter, lower coupon 30-year mortgages performed best as the interest rate curve both steepened and investors had a need for duration as rates rallied. Higher coupon mortgages lagged and could not keep pace with the rally as lower interest and mortgage rates increased the potential for mortgages to be more refinanceable. The refinanceability of loans aided in the differential between lower and higher coupon mortgage performance. Post quarter-end, not only has the Fed eased an additional 25 basis points as of last week, but interest rates have subsequently risen on the potential policy changes of the new administration and Fed. Changes that occurred in the third quarter have reversed in the fourth quarter as spreads have widened and volatility has increased.

We expect that the potential of at least one more cut in 2024, and we will continue to monitor the Fed closely as well as the overall rapidly changing rate environment as we actively manage our portfolio. At quarter end, our MSR portfolio had a UPB of $17.6 billion and a market value of approximately $227 million. The MSR and related net assets represented approximately 42% of our equity capital and approximately 21% of our investable assets, excluding cash, at the end of the quarter. Meanwhile, our RMBS portfolio also accounted for approximately 42% of our equity capital. As a percentage of investable assets, the RMBS portfolio represented approximately 79%, excluding cash, at quarter-end. Prepayment speeds for our MSR and RMBS portfolios continue to remain relatively stable compared to the prior quarter despite the lower interest and mortgage rate environment that was experienced throughout the quarter.

Our MSR portfolio’s net CPR averaged approximately 5.5% for the third quarter comparable to the previous quarter. The portfolio’s recapture rate remained low at approximately 0.9%. As the incentive to refinance continues to be minimal for this portfolio given the portfolio’s loan rate, going forward, we will continue to expect a low recapture rate and a relatively low net CPR in the near-term given our portfolio’s characteristics. The RMBS portfolio’s prepayment speeds remain relatively low but are starting to rise. Over the next few months, we would expect the portfolio CPR to rise as the portfolio digests the lower mortgage rates that occurred during the quarter. As rates moved lower with the expectation of a Fed ease, mortgages were more refinanceable.

As of September, we started to see the effects of the lower mortgage rates. We would expect the lower mortgage rates to have a few more months of impact, and then we would expect prepayment speeds to decrease based on the subsequent rise in interest and mortgage rates post third quarter. For the quarter, the RMBS portfolio’s weighted average three month CPR was up modestly to approximately 5.4% compared to approximately 4.6% in the second quarter. As of September 30, the RMBS portfolio, inclusive of TBAs, stood at approximately $866 million up from $674 million at the previous quarter-end. Quarter-over-quarter, additional RMBS purchases were focused on higher coupons. The increase was due to investing additional cash as well as removing some TBA hedges.

For the third quarter, our RMBS portfolio net interest spread was 3.22%, effectively unchanged from the prior quarter. A slightly higher REPO cost due to financing more securities were offset by increased RMBS income from the purchases. Moving forward, we will continue to proactively manage our portfolio while continuing to shift our overall capital structure to add value for shareholders through improved performance and earnings. I will now turn the call over to, Mike for our third quarter financial discussion.

Michael Hutchby: Thank you, Julian. GAAP net loss applicable to common stockholders for the third quarter was $14.8 million or $0.49 per weighted average diluted share outstanding during the quarter, while comprehensive income attributable to common stockholders, which includes the mark-to-market of our available for sale RMBS, was $1.3 million or $0.04 per weighted average diluted share. Our earnings available for distribution attributable to common stockholders were $2.5 million or $0.08 per share. EAD is inclusive of approximately $1.4 million or $0.045 per share of expenses related to special committee work. Our book value per common share as of September 30 was $4.02 compared to a book value of $4.15 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, TBAs and treasury futures, all of which had a combined notional amount of approximately $1.1 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’ve 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 $5.1 million for the quarter, which included the $1.4 million of special committee related expenses. On September 13, 2024, our Board of Directors declared a dividend of $0.15 per common share for the third quarter of 2024, which was paid in cash on October 31.

We also declared a dividend of $0.5125 per share on our 8.2% Series A Cumulative Redeemable Preferred Stock and a dividend of $0.7152 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: Thank you. We will now begin the question-and-answer. [Operator Instructions] Our first question comes from the line of Mikhail Goberman with Citizens JMP. Your line is open.

Q&A Session

Mikhail Goberman: Hey, thank you. Good afternoon, guys. Hope everybody is doing well. If I could maybe start with a question on how you guys are thinking about the trade-off between agency MBS and MSR. I know you mentioned that you’re going to be continuing to twist the asset investment composition in the direction of agency MBS versus MSR. How do you guys think about that? And, also in terms of how you allocate capital, you’re going to continue to sort of balance the 42% each capital allocation to both segments going forward, given where you think the rate outlook is going between short rates and long rates. One of your competitors running an agency in MSR strategy as well recently kind of rebranded more towards the MSR side. So, I’m just wondering how you guys are thinking about that trade-off between the two asset classes going forward? Thanks.

Jay Lown: Hey, Mikhail. No problems, one of our competitors. So look, we look at total returns. And, while we accept that short dated rates are expected to move lower, which should improve the return prospects of the MSR portfolio on a levered basis. Broadly speaking, MBS still presents a better return profile than MSRs on a levered basis. And, I think that for us, at least, it’s primarily due to the fact where we think the MSR is currently priced and the associated yields with it. And so, maybe there is a difference of opinion on the yield around the asset, and how that impacts a levered return. But in the near-term, I think you would find that we would all agree here that at least in the current environment, MBS still presents a better risk adjusted return profile.

That doesn’t mean, by any stretch, that we don’t like the MSR asset or that we’re not interested in continuing to invest in it or that we think it should remain static. It just means that as a small company and someone who’s constantly looking to maximize returns, today, as things sit today relative to the return profiles of the two asset classes, we prefer MBS.

Mikhail Goberman: All right. Thanks, Jay. And in terms of leverage, I’ve noticed the pickup from 4.9 to more, I think, 5.3 printed. Is there room for moving it up a little bit further? Some of your peers are I think you’re at the lower-end of your peer group. So, is there any room to move it higher?

Jay Lown: Yes. So, that’s a good question. The start of the fourth quarter is a good reason why not fully extending your leverage is a prudent idea as rates sold off meaningfully and margin calls came in meaningfully on the RMBS portfolio. And as you know, margin calls come in on the MBS daily, and that doesn’t exactly always happen on the MSR side. So, from a cash management perspective, we like where we sit on leverage today, because we’re mindful of cash and we’re mindful of what happened approximately five years ago relative to things that you might not expect. And so, I think that if there were room to lever, it would not necessarily be on the MSR side. We could potentially take the MBS up a little bit, but we’re not really looking to fully maximize the available leverage on the MBS, in large part because to maintain liquidity in the event that the basis widens further or that rates rise materially from here. Does that make sense?

Mikhail Goberman: Yes, it does. Thank you. And, I guess if I could just close with our ubiquitous question of book value performance thus far in the fourth quarter? Thanks.

Jay Lown: That’s a new question.

Michael Hutchby: Yes. Hey, Mikhail. It’s Mike.

Mikhail Goberman: Hey, Mike.

Michael Hutchby: As of last Friday, we are estimating our book value per share down about 4% to 5% from quarter-end and that is of course before any fourth quarter dividend accrual as the Board has not yet met to approve a dividend for the quarter.

Mikhail Goberman: All right. Thank you, guys, and best of luck going forward.

Jay Lown: Okay. Thanks.

Operator: [Operator Instructions] Our next question comes from the line of Matt Howlett – B. Riley Securities. Your line is open.

Matt Howlett: Hey, Jay. Hey, everybody.

Jay Lown: Hey, Matt.

Matt Howlett: Hey, Jay. When I think about your EAD, when I look at it going forward, I think about three or four things. I think the first is, you’re going to pick up some interest savings with that floating rate preferred that’s going to go down or it’s going to reset down. And then, you’re going to probably pick up something on your MSR facilities, they’re going to reprice down. And then, I mean, I’ll say you don’t have to, but my guess is you’ll pick up a few cents from internalization and cost savings. So, if I look at your EAD, let’s say, it’s around $0.13 today, if you pro-forma for the one-time expenses, I mean, am I taking it the right way? And then also, you could take leverage up or some other things happen, I mean, you could even go beyond what I’m talking about. I guess, am I thinking about the EAD the right way?

Jay Lown: So, I won’t comment on the internalization part, but relative to the other two things you mentioned, I think you have that right. I think that as, short dated rates fall, the MSR portfolio should benefit from the cost to finance that asset, and that will that should work its way through EAD. And, as we look at our financial models for the company on a go-forward basis looking at the forward curve, over-time, we definitely see a pickup in EAD relative to the current environment, which supports sort of the thesis you’re presenting.

Matt Howlett: Got you. Okay. And then, what was REPO? What are you rolling since the last cut? I’m just curious where the REPO rates are now and what you’re rolling for at?

Jay Lown: Yes. So, post the Fed rate cut in the neighborhood of 4.80%?

Matt Howlett: Yes. Okay. Okay. That, and it was what, 5% well over 5%, right?

Jay Lown: Yes. 5%, 5.05%.

Matt Howlett: Okay.

Jay Lown: Yes, somewhere between 5%, 5.05% at the end of the quarter. Yes, prior to the Fed rate cut.

Matt Howlett: Okay, good. All right. So, I’m thinking about those, right. So, when you think about, I appreciate the comments you guys are always risk averse and you’re thinking about. I want to hear your thoughts on like the dynamic, okay, there’s going to be all this debt issuance, that deficit is going to grow and therefore the yields could really spike. I think that’s what you’re kind of saying. You’re kind of thinking of that. It’s obviously a big train of thought that yields could go much higher under Trump because of deficit and spending. And then, the other thought is how much are they going to cut next year? What do you think? I’d love to hear your comments on both ends of the curve.

Julian Evans: Hi, Matt, this is Julian. We could spend an hour just chatting about this. But in the max of time, I would just say, look, it’s really unknown. We know the policies are going to be stimulative. We just don’t know to the extent that they’re going to be stimulative and how they’re going to fund a lot of the policies or finance the policies. So yes, I would expect it to be stimulative, but what actually of the promises that get through, I don’t think we’ll have very conclusive evidence of that until it gets put into some type of budget. In terms of the Fed, look, I think the Fed is going to be thinking of a couple of things here. One, I do expect them to ease in December. And then, I think next year will be up to the data.

Previously, they were obviously on board to possibly doing four eases. I think the December dot plot will show something different. It may show three instead of the four. I don’t think it will maybe move to where investors are thinking currently in terms of two or possibly even one next year. But I think at the end of the day, what policies come out of the new administration will kind of tie the Fed’s hands of how much they can and cannot ease. If the policies don’t live up to all the promises, campaign promises, that will give the Fed the potential room to ease more as long as inflation is moving in the right direction, continuing to move lower. If not, then I would expect the Fed to either do pause for an extended period or potentially not ease during one of the quarters going forward.

Go ahead.

Matt Howlett: No, you guys, look, you guys have, I’ll say this, you guys have been certainly ahead of you’ve called what the Fed has done for a while now. So, sort of my, I should listen to what you have to say. So, I guess, and just for summary, if we could continue to get this widening, the steepening in the curve, this is a great thing for Cherry Hill and the RMBS strategy and even the MSR strategy. Is that the right way to think about it? I mean, if this widening continues, deepening continues to happen, it’s a really good thing?

Jay Lown: Yes. Matt, I think that we’re set up for a twist, and we continue to be set up for that twist.

Matt Howlett: Yes.

Jay Lown: Obviously, that’s dynamic, and the last three plus weeks have been fairly volatile with respect to how the curves moved and the shape of the curve over the course of that time frame. But, we continue to believe that long dated rates could be at this level are slightly higher, and that, short dated rates should fall. There’s a lot of noise over the last three or four weeks relative to things related to the election, fiscal and monetary policy on a go-forward basis and who’s in the seat of the President. But, we’re trying to, kind of, table that noise and stick to what our long-term thesis is relative to where we think the curves finally ends up. And, that hasn’t changed over the last quarter or so. You’re not always right on a day-to-day basis, but we still remain committed to that thesis.

Matt Howlett: We really look forward to seeing your performance in that type of environment. You guys have managed through the cycle so well. And that’s, I’d be at a loss if I didn’t ask this last question. I know you don’t want to talk about the internalization, but can you give us when this will timing, when you like to regard this will be over? Any sense on, this is a transformational event for the company. You’re going to be one of the few mortgage REITs that’s internalized. Any sense on when investors can expect this to be over?

Jay Lown: Yes. I really don’t, and I’m not prepared to answer anything related to that on the call tonight.

Matt Howlett: No. Look, I figured I’d ask. I appreciate the solid results, and we look forward to what’s to come. Thanks, Jay.

Jay Lown: No worries.

Operator: And, that concludes the question-and-answer session. Mr. Jay Lown, I turn the call back over to you.

Jay Lown: Thanks, operator. Thank you, everybody, for joining us on our third quarter 2024 call. Have a great evening. Talk to you soon.

Operator: Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.