Cherry Hill Mortgage Investment Corp quarterly report, Q2 FY2017

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Cherry Hill Mortgage Investment Corporation — Q2 2017 Form 10-Q

Reporting period: Three and six months ended June 30, 2017; balance-sheet comparisons are with December 31, 2016. Amounts are in U.S. dollars unless stated otherwise. The company invests in residential mortgage-backed securities (RMBS) and mortgage servicing rights (MSRs), and is externally managed.

Financial performance and position

  • Quarter: Interest income was $10.0 million and interest expense $4.3 million, producing net interest income of $5.7 million. Net servicing income was $4.5 million. GAAP net loss attributable to common stockholders was $1.5 million, or $0.12 per share, compared with income of $0.3 million, or $0.04 per share, in Q2 2016.
  • First half: Net interest income was $9.4 million and net servicing income $7.8 million. GAAP net income attributable to common stockholders was $20.6 million, or $2.03 per share, versus a $6.8 million loss, or $0.90 per share, in first-half 2016. The 2017 result included a $6.7 million realized gain on the sale of Excess MSRs and a $7.8 million unrealized gain on MSRs; it should not be viewed as solely recurring earnings.
  • Core earnings: The company’s non-GAAP measure was $6.7 million, or $0.53 per share, for Q2, unchanged per share from Q2 2016; first-half core earnings were $11.6 million, or $1.14 per share, versus $8.0 million, or $1.07 per share. Management cautions that this measure excludes significant realized and unrealized items and is not a substitute for GAAP earnings or liquidity.
  • Margins: At June 30, the reported average RMBS asset yield was 3.68%, cost of funds 1.78%, and net interest rate spread 1.90% (including swap benefits). A separate RMBS portfolio measure showed a 1.78% net interest spread.
  • Assets and funding: Total assets were $1.523 billion, up from $792.9 million at year-end, including $1.378 billion of RMBS and $74.5 million of servicing-related assets. Total liabilities were $1.267 billion; repurchase agreements were $1.197 billion and notes payable $35.5 million. Stockholders’ equity was $255.6 million.
  • Liquidity and cash flow: Cash and cash equivalents were $30.5 million and restricted cash $19.3 million. For the first half, operating cash flow was $28.4 million, investing cash flow was negative $703.2 million, and financing cash flow was positive $689.5 million. Financing included $80.9 million of net common-stock proceeds and increased repo borrowings.
  • Distributions: The company declared common dividends totaling $0.98 per share for the first half and paid $9.9 million in dividends during that period. The filing notes that distributions depend on board authorization, available cash, results, and REIT requirements.

Material changes versus comparable periods

  • Q2 moved from a small GAAP profit in 2016 to a loss in 2017. The filing attributes pressure in part to derivative losses and lower MSR fair value; Q2 realized and unrealized derivative losses totaled $6.4 million, and the MSR fair-value loss was $4.5 million.
  • First-half GAAP results improved substantially, but included the Excess MSR sale gain and MSR fair-value movements. Net interest income rose to $9.4 million from $8.8 million, while net servicing income rose to $7.8 million from $2.2 million.
  • In March 2017, the company issued 5.175 million shares, raising approximately $81.1 million after underwriting discounts and commissions, before expenses. Shares outstanding increased to 12.71 million from 7.53 million at year-end. Proceeds were temporarily invested in RMBS pending redeployment into MSRs.
  • The company completed the sale of its remaining Excess MSRs to Freedom Mortgage in February 2017, receiving Ginnie Mae MSRs with approximately $4.5 billion of underlying unpaid principal balance. It reported no Excess MSRs at June 30.
  • RMBS holdings and related repo financing expanded significantly. Repo debt increased from $594.6 million at year-end to $1.197 billion; the weighted-average repo rate rose from 0.93% to 1.19%, while the period-end net interest spread measure increased from 1.66% to 1.78%.

Outlook, risks, and unusual items

  • No numerical earnings or dividend guidance was provided. Management said cash on hand and operating cash flow were expected to cover anticipated liquidity needs over the next 12 months, including operating costs, financing needs, and potential margin calls; longer-term needs may require additional borrowing, equity issuance, or asset sales or refinancing.
  • Management expected a substantial portion of the stock-offering proceeds to be redeployed into MSRs; until then, the portfolio composition was expected to remain changed, with proceeds temporarily invested in RMBS.
  • Key exposures include short-term, generally uncommitted repo financing; collateral haircuts and margin calls; changes in interest rates, spreads, prepayment speeds and asset fair values; and borrower credit and liquidity risk in MSRs. Repo borrowings had a 58-day weighted-average remaining maturity and a 5.6% average haircut at quarter-end.
  • Interest-rate hedges may be imperfect if prepayments differ from assumptions. The company also depends on Freedom Mortgage for servicing and has related-party management arrangements. Its manager receives a fee equal to 1.5% annually of defined stockholders’ equity; the filing states the related-party terms may not be as favorable as arm’s-length terms.
  • Servicing-related assets are Level 3 fair-value estimates using unobservable assumptions, including prepayment speeds, servicing costs, delinquency levels and discount rates. Changes in assumptions could materially affect reported earnings and asset values. RMBS unrealized losses were described as primarily market-related and temporary; the company recorded approximately $77,000 of other-than-temporary impairment in the first half.
  • The filing reported no material legal proceedings, no off-balance-sheet arrangements, and no material changes in internal control over financial reporting. Disclosure controls were reported effective.

Investor verification priorities

  • Assess how much of first-half GAAP income and core earnings is repeatable after the Excess MSR sale gain, yield-maintenance income, and fair-value changes.
  • Track redeployment of offering proceeds into MSRs and the effect on servicing income, asset concentration, and funding needs.
  • Review repo renewal, rate, haircut, counterparty and margin-call exposure alongside the company’s short-term liquidity resources.
  • Examine MSR valuation assumptions and sensitivity to interest rates, prepayments, servicing costs and delinquencies.
  • Confirm future dividend declarations against taxable income, cash generation, financing obligations and board decisions; the filing provides no forward dividend commitment.