Cherry Hill Mortgage Investment Corporation — Q1 2019 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2019; filed May 9, 2019. Cherry Hill is an externally managed residential mortgage REIT investing primarily in mortgage servicing rights (MSRs) and residential mortgage-backed securities (RMBS). Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial and operating performance
- Revenue and earnings: Interest income was $17.0 million, up from $13.4 million; net interest income was $6.2 million, versus $5.9 million. Net servicing income rose to $13.4 million from $6.9 million. These increases were more than offset by $42.9 million of net realized and unrealized losses on derivatives and MSRs. Net loss was $21.1 million, compared with net income of $35.2 million; loss attributable to common stockholders was $22.6 million, or $1.36 per share, versus income of $33.6 million, or $2.64 per share.
- Core earnings: Company-defined non-GAAP core earnings attributable to common stockholders were $10.0 million, or $0.60 per share, compared with $6.6 million, or $0.52 per share. This measure excludes significant fair-value and derivative items and is not a substitute for GAAP results.
- Cash flow: Operating activities provided $13.4 million; investing activities used $220.4 million, largely reflecting RMBS purchases and MSR acquisitions; financing activities provided $219.9 million. Cash, cash equivalents and restricted cash totaled $52.9 million at quarter-end, up from $40.0 million at year-end.
- Margins: Quarter-end average net interest rate spread, including benefits of related swaps, was 1.62%, down from 1.72% at December 31, 2018. The RMBS net interest spread was 1.25%, versus 1.31% at year-end. The company attributed higher interest expense to increased repo borrowings and rates, partly offset by lower swap costs.
- Assets and equity: Total assets were $2.39 billion, up from $2.15 billion at year-end. RMBS were $1.99 billion and MSRs $304.0 million. Total stockholders’ equity was $414.3 million, up from $363.9 million; accumulated other comprehensive loss narrowed to $6.4 million from $38.4 million, mainly due to RMBS valuation gains.
- Debt and liquidity: Repurchase agreements were $1.785 billion, up from $1.599 billion; notes payable were $160.7 million, up from $157.5 million. Total debt was approximately $1.946 billion. Repo borrowings carried a 2.74% weighted-average rate and 78-day weighted-average remaining maturity, compared with 2.54% and 38 days at year-end. Management said available liquid assets covered short-term recourse liabilities and expected cash plus operating flows to meet anticipated needs over the next 12 months, including potential margin calls.
- Distributions and capital: Common dividends declared were $0.49 per share for the quarter. The February Series B preferred offering raised approximately $48.4 million net; proceeds were invested in RMBS and MSRs. Series B pays a fixed 8.25% rate through April 2024 and then a floating rate tied to three-month LIBOR plus 5.631%. Series A preferred shares were also issued through the ATM program.
Material changes versus the prior comparable period
- Results swung from $35.2 million net income in Q1 2018 to a $21.1 million net loss in Q1 2019. MSR fair-value changes moved from a $12.5 million gain to a $27.2 million loss; derivative results moved from a $19.6 million unrealized gain and near-zero realized result to $8.3 million unrealized and $7.5 million realized losses.
- Net servicing income nearly doubled, reflecting higher servicing fee income, while interest expense increased by $3.2 million to $10.7 million.
- RMBS unrealized losses in accumulated other comprehensive income improved by $32.0 million during Q1. Management attributed this gain primarily to a 25-basis-point decrease in the 10-year U.S. Treasury rate.
- RMBS carrying value increased to $1.99 billion from $1.77 billion at year-end; MSR unpaid principal balance grew to $27.53 billion from $24.85 billion. The MSR portfolio’s carrying value increased modestly despite the quarter’s valuation loss, reflecting acquisitions and paydowns.
Outlook, commentary and risks
- No specific earnings or dividend guidance was provided. Management expects to fund longer-term needs through cash flows, borrowings, equity issuance if available, and asset sales or refinancing. It expects some RMBS paydowns to be redeployed into MSRs.
- Key exposures include interest-rate and spread movements, mortgage prepayments and extensions, MSR valuation assumptions, borrower credit, financing availability, and repo margin calls. Repo facilities are uncommitted and most borrowings mature within a year.
- MSRs are Level 3 fair-value assets, valued using discounted cash flows and significant assumptions including prepayment speeds, delinquency, servicing costs and discount rates. Changes in these assumptions can materially affect reported earnings and equity.
- Freedom Mortgage gave notice to terminate its Ginnie Mae subservicing agreement, expected to take effect in Q2 or Q3 2019. Servicing was to transfer to another subservicer; the joint marketing recapture agreement with Freedom Mortgage would also end.
- The company is externally managed under a related-party agreement; management fees are 1.5% per annum of defined stockholders’ equity. The filing notes the agreement was negotiated between related parties and may be less favorable than an unaffiliated arrangement.
- The company reported no material legal proceedings, no material changes in internal control, and no material off-balance-sheet arrangements. It stated that it expected to maintain REIT qualification; failure to qualify could result in material tax consequences.
Important facts for investors to verify
- Whether the substantial Q1 MSR and derivative valuation losses persist, and how MSR model assumptions compare with realized performance.
- Repo renewal terms, collateral haircuts, counterparty exposure and the company’s capacity to absorb adverse market moves or margin calls.
- Execution and costs of the Ginnie Mae servicing transfer, and any effects on servicing income or MSR recapture activity.
- Whether recurring earnings and taxable income support common and preferred distributions; GAAP loss, core earnings and REIT taxable income are different measures.
- Use and returns on Series B proceeds, the cost of preferred dividends, and the company’s leverage as assets and borrowings grow.