Cherry Hill Mortgage Investment Corporation — Q3 2017 Form 10-Q
Business context and period: The company is an externally managed residential mortgage REIT investing in agency residential mortgage-backed securities (RMBS) and mortgage servicing rights (MSRs). This unaudited report covers the quarter and nine months ended September 30, 2017; balance-sheet comparisons are with December 31, 2016. Dollar amounts below are in millions unless noted.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Interest income | $11.9 | $7.2 | $28.0 | $19.5 |
| Net interest income | $5.8 | $5.3 | $15.2 | $14.1 |
| Net servicing income | $4.7 | $1.7 | $12.5 | $3.9 |
| Net income (loss) | $6.9 | $5.5 | $27.8 | ($1.4) |
| Net income (loss) per common share | $0.49 | $0.72 | $2.43 | ($0.18) |
| Core earnings attributable to common stockholders per share, non-GAAP | $0.52 | $0.54 | $1.65 | $1.60 |
Q3 total income was $8.2 million, versus $7.1 million a year earlier; expenses were $1.9 million versus $1.7 million. Q3 net income included a $2.3 million unrealized loss on MSRs and a $1.7 million unrealized gain on derivatives. Nine-month results included a $6.7 million realized gain from the Excess MSR sale and a $5.5 million unrealized gain on MSRs. Core earnings are company-defined, non-GAAP, and exclude specified realized and unrealized items.
- Margins: The period-end average RMBS asset yield was 3.66%, cost of funds 1.85%, and net interest rate spread 1.81%, including benefits of related swaps. The separately reported RMBS portfolio net interest spread was 1.26%, down from 1.66% at December 31, 2016.
- Assets and equity: Total assets were $1,935.4 million, up from $792.9 million at year-end 2016; stockholders’ equity was $317.3 million, up from $156.0 million. RMBS were $1,754.4 million and servicing-related assets $97.1 million. MSRs represented approximately $9.7 billion of underlying unpaid principal balance; no Excess MSRs remained.
- Debt and liquidity: Repurchase agreements were $1,561.1 million and notes payable $34.5 million, for total debt of $1,595.6 million. Cash and cash equivalents were $33.9 million, with restricted cash of $28.0 million. Repo borrowings had a 1.37% weighted-average rate, 61-day weighted-average remaining maturity, and 5.1% average haircut. Management stated liquid assets covered short-term recourse liabilities and expected cash and operating flows to meet anticipated needs over the next 12 months.
- Cash flow: For the nine months, operating activities provided $28.0 million; investing activities used $1,104.4 million; financing activities provided $1,094.5 million. The large investment outflow primarily reflects portfolio expansion financed through borrowings and equity issuance.
- Capital and distributions: The company issued 5.175 million common shares in March, raising approximately $81.1 million net of underwriting discounts and commissions, and 2.4 million Series A preferred shares in August, raising approximately $58.1 million on the same basis. The preferred stock carries an 8.20% cumulative dividend on a $25 liquidation preference. Common dividends declared for the nine months totaled $1.47 per share; preferred dividends declared were $0.33 per share.
Material changes versus comparable periods
- RMBS holdings expanded to $1.75 billion from $671.9 million at year-end, funded in part by the common and preferred offerings and substantially higher repo financing. Management said offering proceeds were temporarily invested in RMBS pending redeployment into MSRs.
- Servicing income increased year over year, reflecting the larger MSR portfolio, including Ginnie Mae MSRs with approximately $4.5 billion UPB acquired in February. Excess MSRs were fully sold back to Freedom Mortgage, and the related NexBank term loan was repaid.
- Q3 interest expense rose to $6.1 million from $1.9 million, mainly due to increased repo borrowings and higher repo rates. The period-end RMBS spread narrowed year over year, while the broader period-end net interest spread including swaps was 1.81%.
- Q3 GAAP earnings per share fell to $0.49 from $0.72, while core earnings per share was $0.52 versus $0.54. Nine-month GAAP earnings turned positive, influenced by the Excess MSR sale and MSR fair-value movements.
Outlook, commentary, risks and unusual items
- No specific earnings, portfolio-growth, spread, or dividend guidance was provided. Management’s stated objective is attractive long-term risk-adjusted returns, primarily through dividends; it intends to redeploy a substantial portion of temporary RMBS investments into MSRs and may sell RMBS to fund acquisitions.
- Key exposures include interest-rate and spread changes, borrower prepayments and extension, MSR valuation assumptions, borrower credit and servicing advances, funding availability, repo margin calls, counterparty risk, and the liquidity of servicing assets. MSRs are Level 3 fair-value assets based on discounted-cash-flow models with significant unobservable inputs.
- Repo facilities are uncommitted and largely short term. A decline in collateral value may require additional margin or asset sales. A hypothetical 100-basis-point rate increase was estimated to reduce RMBS value, net of swaps, by approximately $37.5 million; this sensitivity is not a forecast.
- The company highlighted related-party arrangements: its external manager and Freedom Mortgage are affiliated with company shareholder Stanley Middleman. The management fee is 1.5% annually of defined stockholders’ equity; management stated related-party terms may not be as favorable as arms-length terms.
- Management reported no material legal proceedings, no material legal or regulatory claims requiring accrual, and no off-balance-sheet arrangements. Disclosure controls were deemed effective, with no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether and when capital temporarily held in RMBS is redeployed into MSRs, and the resulting portfolio mix and returns.
- Repo availability, borrowing costs, maturities, haircuts, collateral requirements, and the company’s capacity to withstand margin calls.
- MSR fair-value assumptions and sensitivities, including prepayment speeds, discount rates, servicing costs, and delinquency or uncollected-payment estimates.
- The sustainability of core earnings and dividends relative to GAAP earnings, taxable income, cash flows, and preferred dividend obligations.
- The economics and oversight of related-party management and servicing arrangements, including potential termination fees and servicer dependence.