Cherry Hill Mortgage Investment Corporation — FY2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020; the filing also reports fourth-quarter results. Amounts below are in U.S. dollars; financial statement amounts are generally rounded to millions.
Business context
Cherry Hill is an externally managed residential mortgage REIT investing principally in mortgage-backed securities (RMBS) and mortgage servicing rights (MSRs). Its results depend on mortgage servicing income and the spread between investment yields and funding costs. The company operates under REIT and Investment Company Act asset restrictions.
Financial results and position
| Metric | FY2020 / Dec. 31, 2020 | FY2019 / Dec. 31, 2019 |
|---|---|---|
| Interest income | $49.0 million | $73.3 million |
| Interest expense | $16.3 million | $48.6 million |
| Net interest income | $32.7 million | $24.8 million |
| Net servicing income | $43.3 million | $56.2 million |
| GAAP net loss | $53.2 million | $50.7 million |
| Net loss attributable to common stockholders; diluted EPS | $62.1 million; $(3.67) | $59.2 million; $(3.53) |
| Core earnings attributable to common stockholders; per diluted share | $30.1 million; $1.78 | $33.9 million; $2.02 |
| Operating cash flow | $61.2 million | $69.7 million |
| Total assets | $1.593 billion | $2.945 billion |
| Total debt: repo borrowings plus notes payable | $1.261 billion | $2.505 billion |
| Total stockholders’ equity | $312.6 million | $399.4 million |
Year-end unrestricted cash was $83.9 million, up from $24.7 million; restricted cash was $46.3 million. RMBS net interest spread at year-end was 1.77%, versus 0.73% a year earlier. The fourth-quarter average net interest rate spread was 2.46%, versus 1.93% in fourth-quarter 2019. Fourth-quarter 2020 net income was $9.0 million and diluted EPS was $0.38; fourth-quarter 2019 net income was $4.5 million and diluted EPS was $0.12.
Material changes versus the prior comparable period
- To restore liquidity and reduce leverage after severe market dislocation in March 2020, Cherry Hill sold Agency RMBS. RMBS carrying value fell to $1.228 billion from $2.508 billion; repo debt declined to $1.150 billion from $2.338 billion.
- MSR carrying value fell to $174.4 million from $291.1 million, while underlying unpaid principal balance fell to $21.6 billion from $29.1 billion. The company recorded a $141.9 million unrealized loss on servicing-related assets, primarily reflecting valuation changes and portfolio runoff.
- The company sold all remaining CMOs in fourth-quarter 2020 and sold its Ginnie Mae MSR portfolio to Freedom Mortgage in June. The sale generated approximately $15.8 million of proceeds and an $11.3 million realized loss; proceeds helped repay the related MSR term and advance facilities.
- Net interest income increased despite lower interest income, as interest expense declined more sharply with lower borrowing balances and financing rates. Net servicing income decreased, with servicing fee income lower and servicing costs higher.
- Common dividends were reduced: the previously declared first-quarter dividend of $0.40 per share was paid partly in common stock and partly in cash; cash dividends of $0.27 per share were paid for each of the remaining 2020 quarters. Total common dividends declared were $1.21 per share.
Outlook, commentary, risks and unusual items
- Management said cash on hand and expected operating cash flow should cover anticipated liquidity needs over the next 12 months, including current portfolio financing, potential margin calls and operating expenses. It gave no specific earnings, dividend or investment guidance.
- Management retained elevated unrestricted cash because of uncertainty around the economic recovery and COVID-19. At year-end, 5.9% of borrowers on Aurora-serviced loans were in active forbearance; 28% of those borrowers continued regular payments.
- Key risks include short-term repo funding and margin calls, volatile mortgage spreads and interest rates, borrower prepayments and delinquencies, and subjective Level 3 MSR valuations. A 10% increase in the modeled MSR prepayment rate would reduce estimated conventional MSR fair value by about 9%, all else equal.
- MSR fair value is based on discounted cash flow models with significant unobservable assumptions. The auditor identified MSR valuation as a critical audit matter and used valuation specialists; the financial statement audit opinion was unqualified.
- A subservicer reported in March 2021 that a third-party vendor breach exposed personally identifiable information of some borrowers underlying Cherry Hill’s MSRs. The company reported no operational impact to its systems and said the subservicer represented that its servicing capacity was not materially affected.
- Cherry Hill disclosed an unresolved SEC staff comment concerning whether deferred tax assets require a valuation allowance; it said it believed its response addressed the comment in all material respects. The filing reports no material legal or regulatory proceedings and no off-balance-sheet arrangements.
- Related-party considerations include the external manager’s fee of 1.5% of adjusted stockholders’ equity and Freedom Mortgage’s roles as manager-affiliated service provider, subservicer, and buyer of the Ginnie Mae MSRs. The manager agreement includes a potentially significant termination fee.
Most important facts for investors to verify
- Whether liquidity and financing access remain adequate as short-term repo agreements mature and collateral values or haircuts change.
- How MSR valuations, prepayment assumptions, borrower forbearance and servicing costs evolve, and whether reported fair values are realized.
- Whether core earnings and recurring net interest and servicing income can support common and preferred dividends; GAAP losses and core earnings exclude different valuation and realized items.
- The status and financial implications of the SEC deferred-tax-asset comment, and the consequences of the reported borrower-data breach.
- The terms and related-party implications of the manager, Freedom Mortgage and subservicer arrangements, including the manager agreement’s renewal and termination provisions.