Cherry Hill Mortgage Investment Corporation — Q2 2016 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2016; comparisons are with Q2 2015 unless noted. Cherry Hill is an externally managed residential mortgage REIT investing in agency mortgage-backed securities (RMBS), excess mortgage servicing rights (Excess MSRs), and mortgage servicing rights (MSRs). Financial amounts below are in millions of dollars unless stated otherwise.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Interest income | $7.135 | $8.088 | $12.323 | $13.915 |
| Interest expense | $1.885 | $1.346 | $3.542 | $2.581 |
| Net interest income | $5.250 | $6.742 | $8.781 | $11.334 |
| Net servicing income | $1.073 | $0.062 | $2.166 | $0.062 |
| Net income (loss) attributable to common stockholders | $0.283 | $11.205 | $(6.780) | $8.793 |
| EPS, basic and diluted | $0.04 | $1.49 | $(0.90) | $1.17 |
- Q2 total income as reported was $1.806 million, versus $12.562 million a year earlier; six-month total income was a loss of $4.448 million, versus income of $11.560 million. Results include material fair-value changes in derivatives and servicing assets.
- Q2 period-end average net interest rate spread was 1.77%, compared with 1.67% at June 30, 2015. RMBS net interest spread was 1.72% at June 30, 2016, versus 1.46% at December 31, 2015.
- At June 30, total assets were $655.4 million, including $522.2 million of RMBS and $97.3 million of servicing-related assets. Total liabilities were $505.2 million; stockholders’ equity was $150.2 million.
- Debt comprised $456.1 million of repurchase agreements and $22.9 million under a term loan. Repurchase borrowing rates averaged 0.74%, versus 0.56% at year-end 2015; the term loan’s weighted average rate was 5.57%. The company had no FHLB advances at quarter-end.
- Cash and cash equivalents were $9.8 million and restricted cash was $15.9 million. Six-month operating cash flow was $18.4 million, investing cash flow was $(12.7) million, and financing cash flow was $(6.5) million; cash declined $0.8 million.
Material changes versus comparable periods
- Q2 common-stockholder earnings fell to $0.283 million from $11.205 million. Six-month results shifted to a $6.780 million loss from $8.793 million of income.
- Derivative and servicing-asset marks were a major drag: six-month unrealized derivative losses were $6.426 million, and servicing-related asset fair-value losses were $7.764 million. Servicing-asset losses were attributed primarily to modeled prepayment-speed changes; derivative losses were attributed to falling interest rates.
- RMBS fair-value gains recorded in other comprehensive income were $11.827 million for the first half, bringing accumulated other comprehensive income to $11.630 million. The filing attributes Q2 RMBS gains of about $4.5 million to a 29-basis-point decline in the 10-year Treasury rate.
- Servicing income expanded following Aurora’s MSR business growth: MSR unpaid principal balance was $3.6 billion at June 30, compared with $2.0 billion at year-end 2015. Q2 servicing fees rose to $1.574 million from $0.156 million.
- Repurchase agreements increased to $456.1 million from $385.6 million at year-end. FHLB advances were fully repaid; regulatory changes prevent the captive insurance subsidiary from taking new advances or renewing existing ones.
Outlook, risks, contingencies, and unusual items
- No formal earnings or dividend guidance was provided. Management said its long-term view of target assets was unchanged, but current asset pricing had reduced available returns. It plans to broaden investments to seek a more diversified and stable revenue profile; execution requires capital, and there is no assurance when or whether it can be raised.
- Management expected rising rates to reduce recapture activity, while lower voluntary prepayments could keep overall prepayment rates roughly stable. Servicing-related assets are not hedged against fair-value changes and are sensitive to prepayments, discount rates, servicing costs, and other model assumptions.
- Management stated that available liquidity was sufficient for short-term recourse liabilities and expected cash and operating flows to meet anticipated needs over the next 12 months. Repo financing is short-term and uncommitted, exposes the company to refinancing and margin-call risk, and is collateralized; weighted-average haircut was about 5%.
- The company relies on Freedom Mortgage for servicing and has related-party management and servicing arrangements. If the servicer fails or is terminated, Excess MSR value could be lost and MSRs could be affected. A Ginnie Mae acknowledgment agreement could require the company to cover certain payments if Freedom Mortgage fails; management assessed material-loss risk as remote and recorded no liability.
- Aurora’s Ginnie Mae change-of-control approval remained unresolved; the filing says approval is not assured. No legal proceedings were reported, and management said there were no material changes to previously disclosed risk factors.
- The company declared common dividends of $0.98 per share during the first half. Dividend decisions depend on board authorization, liquidity, taxable income, debt service, and other factors; GAAP earnings and taxable earnings may differ.
- Core earnings attributable to common stockholders, a non-GAAP measure, were $3.982 million ($0.53 per share) for Q2 and $8.014 million ($1.07 per share) for the first half. These differed substantially from GAAP results and exclude specified realized and unrealized items.
Important facts for investors to verify
- Reconcile core earnings to GAAP results and assess how much reported performance depends on exclusions and fair-value estimates.
- Review assumptions and sensitivities for Level 3 MSRs and Excess MSRs, especially prepayment speeds, discount rates, servicing costs, and uncollected payments.
- Monitor repo maturities, financing costs, collateral requirements, margin-call capacity, and replacement funding after loss of FHLB access.
- Track Ginnie Mae change-of-control approval and Freedom Mortgage’s servicing performance, financial condition, and related contingent exposure.
- Compare dividends with taxable earnings and cash generation, and assess related-party fees and the company’s ability to fund its planned diversification.