Cherry Hill Mortgage Investment Corporation — FY 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; filed March 16, 2018. Cherry Hill is an externally managed residential mortgage REIT investing primarily in Agency RMBS and mortgage servicing rights (MSRs). Unless noted, amounts below are in U.S. dollars.
Financial performance and position
| Metric | FY 2017 / Dec. 31, 2017 | FY 2016 / Dec. 31, 2016 |
|---|---|---|
| Total income | $56.8 million | $31.9 million |
| Net interest income | $22.2 million | $22.9 million |
| Net servicing income | $18.3 million | $5.0 million |
| Net income | $48.0 million | $25.2 million |
| Net income attributable to common stockholders | $45.5 million | $24.8 million |
| Diluted earnings per common share | $3.98 | $3.30 |
| Common dividends per share | $1.96 | $2.11 |
| Total assets | $2.051 billion | $792.9 million |
| Total liabilities | $1.728 billion | $636.9 million |
| Stockholders’ equity | $322.5 million | $156.0 million |
| Repurchase-agreement borrowings | $1.667 billion | $594.6 million |
| Notes payable | $39.0 million | $22.9 million |
| Cash and cash equivalents | $27.3 million | $15.8 million |
- Operating cash flow was $40.2 million; investing activities used $1.224 billion and financing activities provided $1.196 billion. The filing attributes the investment outflow mainly to portfolio growth and the 2017 capital raises.
- At year-end, RMBS were $1.841 billion, up from $671.9 million. MSRs were valued at $122.8 million, versus $31.9 million in 2016. MSR collateral unpaid principal balance increased to $11.711 billion from $3.262 billion.
- Year-end RMBS net interest spread was 1.27%, down from 1.66% in 2016. The fourth-quarter period-end spread was 1.81%, versus 2.03% at year-end 2016; these are distinct measures presented by the filing.
- Cash dividends declared were $0.49 per common share each quarter in 2017. Series A preferred stock carries an 8.20% annual dividend rate on its $25 liquidation preference.
Material changes versus the prior year
- Two offerings raised approximately $139.2 million net: $81.1 million from common stock issued in March and $58.1 million from Series A preferred stock issued in August. Proceeds were initially invested in RMBS.
- Repurchase borrowings increased substantially alongside RMBS investment. The average repurchase rate at year-end rose to 1.47% from 0.93% a year earlier, and average remaining maturity shortened to 46 days from 65 days.
- Cherry Hill sold its remaining Excess MSRs to Freedom Mortgage in February 2017, receiving $35.9 million in proceeds and, in connection with the transactions, $3.0 million in yield-maintenance payments over December 2016–November 2017. Aurora received Ginnie Mae MSRs tied to approximately $4.5 billion of loan UPB in the transaction.
- Annual net income rose, but included material fair-value and transaction items. MSR fair-value gains were $9.2 million; derivative results included a $6.6 million unrealized gain and a $5.6 million realized loss. Net interest income edged down as funding costs and repurchase borrowings increased.
- Common shares outstanding rose to 12.72 million from 7.53 million. The annual common dividend fell to $1.96 per share from $2.11.
Outlook, risks and unusual items
- Management said it expected cash on hand and operating cash flow to cover anticipated liquidity needs over the next 12 months, including potential margin calls and operating expenses. This is management’s expectation, not a guarantee.
- The company anticipated deploying a significant portion of RMBS paydowns, and potentially RMBS sale proceeds, toward MSR acquisitions. It said it did not expect market conditions or long-term financing availability to support executing its prime mortgage loan strategy in 2018.
- Key exposures include rising short-term rates and a flattening yield curve, mortgage prepayment and extension risk, MSR valuation sensitivity, and reliance on short-term, uncommitted repo financing. Repo lenders may demand additional collateral; failure to meet margin calls could force asset sales or lender foreclosure.
- MSR fair values depend on Level 3 models and unobservable assumptions, including prepayments, delinquency, servicing costs and discount rates. The filing reports that sensitivity to a 10% increase in discount rates reduced estimated MSR fair value by about 4% for conventional MSRs and 5% for government MSRs.
- Cherry Hill is externally managed and has significant relationships with Freedom Mortgage, which is controlled by the Manager’s founder. The filing describes potential conflicts of interest and a management fee based on adjusted stockholders’ equity, regardless of portfolio performance.
- The company disclosed no material legal or regulatory claims at year-end and no off-balance-sheet arrangements. The independent auditor issued an unqualified opinion on the financial statements; it did not provide an internal-control attestation because the company was an emerging growth company.
- The filing discusses potential REIT and tax consequences, including uncertainty around qualifying treatment of Excess MSRs and certain TBA transactions, and effects of the 2017 Tax Cuts and Jobs Act.
Important facts for investors to verify
- Review the sustainability of the $0.49 quarterly common dividend against taxable income, operating cash generation, financing costs and the company’s capital needs; common dividends are discretionary.
- Assess the rapid growth in repo-funded RMBS, short financing maturities, collateral haircuts and the company’s capacity to meet margin calls under stressed market conditions.
- Examine the assumptions supporting MSR fair values and the performance, servicing quality and recoverability of advances in the underlying loan portfolio.
- Evaluate the related-party arrangements with the Manager and Freedom Mortgage, including MSR transactions, subservicing and the equity-based management fee.
- Check the 2017 dividend table’s first-quarter payment date: it lists April 25, 2016, although the quarter is for 2017. The filing text does not clarify this apparent date inconsistency.
- Compare GAAP earnings with the company’s non-GAAP core earnings. Core earnings attributable to common stockholders were $25.5 million, or $2.22 per share, in 2017; the company cautions that its definition may not be comparable across issuers.