Cherry Hill Mortgage Investment Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Cherry Hill is an externally managed residential mortgage investment company and REIT, investing primarily in RMBS and mortgage servicing rights (MSRs). Dollar amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Interest income | $12.0 | $10.0 | $25.4 | $16.1 |
| Net interest income | $4.7 | $5.7 | $10.6 | $9.4 |
| Net servicing income | $9.1 | $4.5 | $16.1 | $7.8 |
| Net income (loss) | $13.8 | $(1.7) | $49.1 | $20.9 |
| Net income (loss) attributable to common stockholders | $12.4 | $(1.5) | $45.9 | $20.6 |
| GAAP diluted EPS | $0.91 | $(0.12) | $3.49 | $2.03 |
- Q2 net interest income declined despite higher interest income: interest expense rose to $7.3 million from $4.3 million, principally from additional repo borrowing and higher repo rates.
- Q2 servicing fee income rose to $11.5 million from $5.5 million as the MSR portfolio expanded; servicing costs also increased to $2.4 million from $1.0 million.
- Net income benefited from a $6.0 million unrealized derivative gain in Q2, compared with a $4.6 million loss a year earlier. For the first half, unrealized derivative gains were $25.6 million versus a $3.6 million loss. These fair-value changes are significant contributors to reported earnings.
- First-half common-stockholder income also included $12.1 million of unrealized MSR gains and a $5.0 million realized RMBS loss. Q2 had a $0.4 million unrealized MSR loss. No OTTI was recorded in Q2; approximately $45,000 was recorded in the first half.
- Management-reported core earnings attributable to common stockholders were $6.8 million, or $0.50 per share, in Q2 versus $6.7 million, or $0.53, in Q2 2017. First-half core earnings were $13.4 million, or $1.02 per share, versus $11.6 million, or $1.14. Core earnings are a non-GAAP measure and exclude specified realized and unrealized items.
- Q2 comprehensive income attributable to common stockholders was $4.5 million, reflecting $8.0 million of other comprehensive loss on RMBS. First-half RMBS-related other comprehensive loss was $39.0 million.
Balance sheet, funding and liquidity
- At June 30, total assets were $2.185 billion, including $1.861 billion of RMBS and $231.5 million of servicing-related assets. Stockholders’ equity was $373.7 million, versus $322.5 million at December 31, 2017.
- Cash and cash equivalents were $23.9 million and restricted cash was $23.6 million. First-half operating cash flow was $39.6 million; investing cash flow was negative $171.5 million and financing cash flow was positive $128.5 million. Cash declined $3.4 million from year-end.
- Repo borrowings were $1.693 billion, up from $1.667 billion at year-end; weighted-average repo rate rose to 2.12% from 1.47%, with a 57-day weighted-average remaining maturity. The company reported a 4.6% weighted-average repo haircut and pledged $1.765 billion of RMBS.
- Notes payable were $79.3 million, up from $39.0 million, primarily reflecting increased MSR financing. The company amended its Fannie Mae MSR facility in March, increasing its maximum from $25 million to $75 million; $61.7 million was drawn at quarter-end. Total repo and note borrowings were approximately $1.773 billion.
- Management said available liquidity was sufficient for short-term recourse liabilities and expected cash on hand and operating cash flow to meet anticipated needs over the next 12 months, including potential margin calls. This is management’s expectation, not a guarantee.
- The RMBS period-end asset yield less cost of funds was 1.91% (3.74% less 1.83%); the portfolio net interest spread was 0.94%, down from 1.27% at December 31, 2017. Management reported that the average net spread at quarter-end included swap benefits.
Material changes, outlook and risks
- In June, the company issued 3,088,857 common shares and raised approximately $53.8 million after underwriting discounts and commissions, before expenses; proceeds were invested in RMBS. It also sold 168,212 Series A preferred shares through its ATM program. Common shares outstanding were 15,818,577 at June 30.
- The portfolio continued shifting toward MSRs: MSR unpaid principal balance grew to $19.1 billion from $11.7 billion at year-end, while MSR fair value rose to $231.5 million from $122.8 million. Management expects a significant portion of RMBS paydowns, and potentially proceeds from RMBS sales, to support future MSR purchases. No specific earnings or portfolio guidance was provided.
- Common dividends declared were $0.98 per share for the first half; preferred dividends declared were $2.53 million. Series A preferred stock carries an 8.20% annual dividend rate on its $25 liquidation preference. Dividends remain subject to board authorization, available cash and debt obligations.
- Interest-rate, spread, prepayment and extension risks are central: higher short-term rates can raise financing costs, while slower prepayments can extend RMBS and hedge exposures. MSR fair values are particularly sensitive to modeled prepayment, discount-rate and servicing-cost assumptions; MSRs are not hedged against fair-value changes.
- Repo facilities are short-term and uncommitted, exposing the company to refinancing, collateral and margin-call risk. MSRs are less liquid and rely on subservicers and counterparties. The servicing portfolio is geographically concentrated in California (15.2% of underlying UPB). Most RMBS are agency-backed, but certain risk-sharing CMOs include unrated or below-investment-grade exposures.
- Fair-value sensitivity is material: management estimated that a 100-basis-point rate increase would reduce RMBS portfolio value by about $36.2 million, net of swaps, under its stated scenario. Such sensitivities are hypothetical, not forecasts.
- On July 31, after quarter-end, the company entered a $25 million Freddie Mac MSR revolving facility and drew the full amount at signing. The facility has a 364-day term, renewal options and potential capacity to request an additional $25 million.
- The filing reports no material legal proceedings, no material changes in internal control, and no risk-factor changes in this quarter’s 10-Q. Management cautions that REIT qualification, financing availability and fair-value estimates remain important risks.
Important facts for investors to verify
- Whether recurring earnings and dividend coverage are supported by core operating income rather than derivative and MSR fair-value movements; review the company’s non-GAAP core-earnings reconciliation.
- Repo refinancing terms, counterparty exposure, collateral haircuts and liquidity under adverse market or margin-call scenarios.
- Assumptions and third-party support for Level 3 MSR valuations, including prepayment speeds, discount rates and servicing costs.
- Deployment and returns on recent equity proceeds, including the pace and financing of planned MSR acquisitions.
- The implications of the 2018 increase in borrowing costs and the decline in RMBS net interest spread for future earnings and distributions.