Cherry Hill Mortgage Investment Corp quarterly report, Q1 FY2018

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Cherry Hill Mortgage Investment Corporation — Q1 2018 Form 10-Q

Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are to December 31, 2017. Cherry Hill is an externally managed residential mortgage REIT investing principally in agency mortgage-backed securities (RMBS) and mortgage servicing rights (MSRs).

Financial performance and position

  • Income: Interest income was $13.4 million and interest expense $7.5 million, producing net interest income of $5.9 million. Net servicing income was $6.9 million. Total income was $40.1 million; net income was $35.2 million, or $2.64 per common share. Net income applicable to common stockholders was $33.6 million.
  • Non-GAAP core earnings: $7.9 million, or $0.52 per common share, versus $4.9 million, or $0.63, in Q1 2017. The filing cautions that core earnings excludes significant fair-value and realized items and is not a substitute for GAAP results.
  • Fair-value effects: A $19.6 million unrealized derivative gain and a $12.5 million MSR valuation gain contributed to earnings. RMBS had a $4.9 million realized loss. Other comprehensive loss was $31.0 million, largely reflecting a $35.9 million unrealized RMBS loss; total comprehensive income was $4.2 million.
  • Cash flow: Operating activities provided $16.6 million; investing activities provided $105.2 million, including $157.8 million of RMBS sale proceeds; financing activities used $124.9 million. Cash and cash equivalents declined $3.1 million to $24.3 million. Restricted cash was $35.2 million.
  • Assets, debt and equity: Total assets were $1.924 billion and stockholders’ equity $319.3 million. Repurchase-agreement borrowings were $1.501 billion and notes payable $74.7 million, for total debt of $1.575 billion. RMBS were $1.643 billion; MSRs were $188.1 million.
  • Funding spread: Period-end average asset yield was 3.67%, average cost of funds 1.81%, and average net interest rate spread 1.86%, including swap benefits. The reported RMBS portfolio net interest spread was 1.14%.
  • Distributions: Common dividends declared were $0.49 per share for the quarter. Preferred dividends declared were $0.5125 per Series A share; the preferred stock carries an 8.20% annual dividend rate.

Material changes versus Q1 2017

  • Net income rose to $35.2 million from $22.6 million, while GAAP earnings per common share fell to $2.64 from $2.91 (diluted Q1 2017 EPS was $2.90). The share count had increased substantially following 2017 equity offerings, and Q1 2018 also included preferred dividends.
  • Interest income increased $7.3 million, primarily from the larger RMBS portfolio funded by 2017 common and preferred stock offerings. Interest expense increased $5.1 million, mainly due to higher repo borrowings and rates, partly offset by lower swap cost.
  • Net servicing income increased to $6.9 million from $3.3 million. The company’s servicing-related assets increased to $188.1 million from $122.8 million, while RMBS declined to $1.643 billion from $1.841 billion.
  • Derivative unrealized gains were $19.6 million versus $1.1 million. In contrast, RMBS unrealized losses in other comprehensive income were $35.9 million versus a $1.4 million gain in Q1 2017.
  • Core earnings per common share declined to $0.52 from $0.63. Management attributed the change primarily to the absence of yield-maintenance payments and early-payoff protection associated with the MSR portfolio acquired in 2017.

Outlook, risks and notable items

  • Liquidity outlook: Management stated that cash on hand and operating cash flow were expected to cover anticipated needs over the next 12 months, including financing needs, potential margin calls and operating expenses. The filing provides no specific earnings or dividend guidance.
  • Financing: Repo agreements are uncommitted, short-term, and collateralized; their weighted-average remaining maturity was 52 days, with a 1.80% weighted-average rate and 5.2% average haircut. The company reported sufficient liquid assets to meet short-term recourse liabilities.
  • Facility amendment: On March 20, the MSR financing facility limit was increased from $25 million to $75 million and its revolving period extended to March 2020. Outstanding borrowings were $56.7 million at quarter-end; the company guarantees repayment.
  • Market and valuation risks: Rising rates can raise borrowing costs, affect RMBS values and alter asset-liability spreads; falling rates and faster prepayments can reduce MSR values. RMBS unrealized losses reduced equity, and MSR values rely on Level 3 discounted-cash-flow estimates with significant unobservable assumptions. Derivatives may not fully offset these exposures.
  • Other risks: Funding and collateral demands, counterparty and subservicer performance, borrower credit and prepayments, MSR liquidity, geographic concentration, REIT qualification, and dependence on the external manager. Management reported no material legal proceedings, no material changes to internal financial controls, and no off-balance-sheet arrangements.
  • Subsequent event: Beginning April 5, the company could sell up to $35 million of Series A preferred shares through an at-the-market program. It sold 100,000 shares through May 8 for approximately $2.5 million net of commissions.

Important facts for investors to verify

  1. How much reported earnings depended on derivative and MSR fair-value gains, and how sustainable those gains are relative to recurring spread and servicing income.
  2. Whether repo funding remains available on acceptable terms, and the company’s exposure to refinancing, collateral and margin-call demands.
  3. Whether the RMBS unrealized losses remain temporary and recoverable, and how changing rates and spreads affect book value.
  4. Whether MSR valuations and cash flows withstand changes in prepayment speeds, servicing costs and borrower performance.
  5. How the preferred-share ATM issuance, preferred dividends and common dividend level affect per-share earnings, capital and distributions.
  6. The terms and counterparty implications of the expanded MSR facility, and the company’s ongoing related-party management and servicing arrangements.