Cherry Hill Mortgage Investment Corporation — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015. Financial amounts are in U.S. dollars; dollar figures below are in millions unless noted.
Business context
Cherry Hill is an externally managed residential mortgage REIT investing primarily in agency RMBS and servicing-related assets, including Excess MSRs. In May 2015, it acquired Aurora Financial Group, adding conventional Fannie Mae and Freddie Mac mortgage servicing rights (MSRs) and a licensed servicing business. The company reported 7,509,543 common shares outstanding at June 30, 2015.
Financial results and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Interest income | $6.199 | $6.137 | $12.671 | $12.148 |
| Net interest income | $4.853 | $5.131 | $10.090 | $10.195 |
| Total income, including investment and derivative gains/losses | $12.562 | $0.666 | $11.560 | $2.536 |
| Net income (loss) | $11.308 | $(0.655) | $8.874 | $0.079 |
| Net income (loss) attributable to common stockholders | $11.205 | $(0.652) | $8.793 | $0.078 |
| Diluted EPS | $1.49 | $(0.09) | $1.17 | $0.01 |
| Core earnings attributable to common stockholders (non-GAAP) | $3.568 | $3.788 | $7.338 | $7.696 |
| Core earnings per share (non-GAAP) | $0.48 | $0.50 | $0.98 | $1.03 |
Q2 GAAP results included $4.827 million of unrealized Excess MSR gains and $2.835 million of unrealized derivative gains; the filing attributes the derivative valuation increase to higher interest rates. These fair-value items substantially explain the contrast with Q2 2014. Core earnings, which exclude specified realized and unrealized items, declined year over year.
- Margins: RMBS weighted-average net interest spread was 1.46% at June 30, down from 1.67% at December 31, 2014. Q2 interest expense increased $0.340 million year over year as repo borrowings rose.
- Assets and equity: Total assets were $563.996 million, including $433.042 million of RMBS and $92.566 million of servicing-related assets. Total stockholders’ equity was $158.134 million, versus $160.318 million at year-end 2014. RMBS unrealized losses reduced other comprehensive income by $3.681 million in the first half.
- Debt and liquidity: Repurchase agreements were $384.386 million, at a 0.43% weighted-average rate after swaps, with a 55-day weighted-average remaining maturity. Notes payable were $10.700 million, including the Aurora-related warehouse and MSR facilities. Cash and cash equivalents were $15.105 million; restricted cash was $11.084 million. Management stated that available liquidity and expected operating cash flows should cover anticipated needs over the next 12 months.
- Cash flow, six months: Operating activities provided $4.793 million; investing activities used $19.265 million; financing activities provided $17.130 million. Cash increased $2.658 million to $15.105 million.
- Dividends: The company declared $1.01 per common share for the first half; $3.680 million was payable at quarter-end. The filing says distributions depend on board authorization, taxable income, cash availability, debt service, and other factors.
Material changes, outlook, and risks
- Aurora was acquired for approximately $3.919 million in cash consideration. The company recognized a provisional $0.174 million bargain-purchase gain; acquisition valuations remained subject to finalization. Aurora contributed $0.156 million of revenue from acquisition through June 30. Its MSR portfolio had approximately $712.3 million of underlying unpaid principal balance and a $7.046 million fair value.
- The company expected to transfer direct servicing of Aurora’s portfolio to Freedom Mortgage in September 2015, subject to required approvals. It was also pursuing additional state licenses and Ginnie Mae approval related to the change in control.
- Management said asset pricing had reduced available returns and that it intended to broaden investments, including potentially prime mortgage loans, to diversify and stabilize revenue. It described potential FHLBI advances as a future funding source; CHMI Insurance had joined the FHLBI but had no outstanding advances at quarter-end. No formal numeric earnings or dividend guidance was provided.
- Management expected interest rates to rise and anticipated lower recapture activity, while expecting overall prepayment rates to remain roughly constant. Key exposures include changes in rates and spreads, prepayment speeds, fair-value assumptions, credit performance, liquidity and margin calls.
- Repo facilities are short-term and generally uncommitted; a decline in collateral value can trigger additional collateral requirements. The company also depends on Freedom Mortgage for servicing and other operational support, and discloses related-party management arrangements.
- A proposed FHFA rule could exclude captive insurers from FHLB membership. If implemented as proposed, CHMI Insurance’s membership could end and any advances could become immediately due. The company reported no material legal proceedings and no off-balance-sheet arrangements.
Important facts for investors to verify
- Reconcile GAAP earnings with core earnings and assess the sensitivity of reported profit and equity to fair-value assumptions for derivatives and Level 3 servicing assets.
- Review the sustainability of the dividend relative to taxable income, recurring cash generation, funding costs, and the stated decline in core earnings.
- Track repo maturity, haircuts, collateral and margin-call capacity, and the status and refinancing or termination of the Aurora warehouse and MSR facilities.
- Confirm final Aurora purchase accounting, servicing-transfer timing, agency approvals, licensing progress, and whether the expected FHLBI funding strategy remains available.
- Note a cash-flow presentation discrepancy in the supplied filing text: the cash-flow statement reports $4.793 million of operating cash and $19.265 million of investing outflow for the first half, while MD&A cites approximately $4.1 million and $22.5 million, respectively.