Cherry Hill Mortgage Investment Corp annual report, FY2019

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Business context and reporting period

Cherry Hill Mortgage Investment Corporation (CHMI) filed its Form 10-K for the fiscal year ended December 31, 2019. The externally managed residential mortgage REIT invests primarily in agency and other residential mortgage-backed securities (RMBS) and mortgage servicing rights (MSRs). It seeks returns through investment income and distributions, using leverage and derivatives to finance and manage risk. The figures below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.

Financial performance and position

  • Revenue and operating income: Interest income was $73.3 million, up from $57.7 million in 2018; interest expense rose to $48.6 million from $34.5 million, leaving net interest income of $24.8 million versus $23.2 million. Net servicing income increased to $56.4 million from $40.2 million.
  • Profit and per-share results: The company reported a $43.5 million net loss, compared with $37.8 million net income in 2018. Loss applicable to common stockholders was $52.1 million, or $3.11 per diluted share, versus income of $32.0 million, or $2.18 per share, in 2018. The 2019 loss was driven principally by a $106.8 million unrealized decline in the fair value of servicing-related assets and $23.2 million of net realized and unrealized derivative losses.
  • Non-GAAP measure: Core earnings attributable to common stockholders were $33.8 million, or $2.01 per diluted share, versus $33.0 million, or $2.25, in 2018. Management cautions that this measure excludes realized and unrealized gains and losses and may not be comparable across issuers. The MSR amortization method was refined beginning in Q3 2019; prior periods were not restated.
  • Cash flow: Operating activities provided $69.7 million, versus $62.0 million in 2018. Investing activities used $757.1 million, mainly for RMBS purchases and MSR acquisitions; financing activities provided $739.1 million. Year-end cash and cash equivalents were $24.7 million and restricted cash was $67.0 million.
  • Assets, debt, and equity: Total assets were $2.96 billion, compared with $2.15 billion at year-end 2018; stockholders’ equity was $411.6 million, versus $363.9 million. Repurchase agreements totaled $2.34 billion and notes payable were $167.0 million, for reported borrowings of approximately $2.50 billion. Repo borrowings had a 2.06% weighted-average rate, 42-day weighted-average remaining maturity, and 4.3% average haircut.
  • Portfolio and margins: RMBS carrying value was $2.51 billion, up from $1.77 billion. MSRs had a $291.1 million carrying value and serviced loans with $29.1 billion aggregate unpaid principal balance. The reported RMBS net interest spread was 0.73% at year-end, down from 1.31% a year earlier. Separately, management reported a 1.88% quarter-end average net interest rate spread for Q4 2019, including swap benefits.
  • Dividends and capital: Common dividends were $1.78 per share for 2019, down from $2.11 in 2018; quarterly common dividends were reduced to $0.40 per share in the second half of 2019 from $0.49 earlier in the year. The company issued $48.4 million net proceeds from Series B preferred stock and repurchased 235,950 common shares for about $3.5 million.

Material changes versus 2018

  • Net income swung to a loss as the servicing-related asset fair-value decline increased to $106.8 million from $3.6 million in 2018. The MSR portfolio’s reported cost basis was $397.9 million versus a $291.1 million fair value at year-end.
  • Interest and servicing income grew with a larger investment and servicing portfolio, while financing costs also increased. RMBS borrowings rose by approximately $739 million year over year.
  • RMBS unrealized gains recorded in other comprehensive income were $79.8 million in 2019, compared with a $35.5 million loss in 2018. Accordingly, comprehensive income was $36.3 million despite the GAAP net loss.
  • MSR unpaid principal balance increased from $24.8 billion to $29.1 billion, while MSR fair value declined slightly from $294.9 million to $291.1 million.

Outlook, risks, and unusual items

  • Management expected cash on hand and operating cash flow to cover anticipated liquidity needs for the next 12 months, including portfolio financing, potential margin calls, and operating expenses. This is management’s expectation, not a guarantee.
  • CHMI said it remained interested in prime residential mortgage loans but did not anticipate that market conditions or available long-term financing would permit execution of that strategy in 2020. Its strategy remains subject to market conditions and REIT and Investment Company Act requirements.
  • Key risks include short-term, uncommitted repo funding and refinancing needs; margin calls and collateral requirements; interest-rate, spread, prepayment, and extension risk; and significant sensitivity of MSR values to model assumptions. A hypothetical 100-basis-point rate increase was estimated to reduce RMBS fair value by 1.63%, net of swaps, at year-end.
  • MSRs also depend on third-party subservicers and Agency approvals. Freedom Mortgage, an affiliate of the manager’s founder, services the company’s Ginnie Mae MSRs; related-party relationships, management fees, and potential conflicts are disclosed risks. The management agreement charges 1.5% annually of defined stockholders’ equity and can carry a termination fee.
  • The company reported no material legal or regulatory claims known as of December 31, 2019, no off-balance-sheet arrangements, and no subsequent events requiring additional disclosure. The auditor gave an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded controls were effective.

Important facts for investors to verify

  • Review the drivers and valuation assumptions behind the $106.8 million MSR fair-value loss, including prepayment, discount-rate, delinquency, and servicing-cost assumptions.
  • Reconcile GAAP losses with core earnings and assess the impact of the revised MSR amortization method and preferred dividends on common-stockholder returns.
  • Check the sustainability of the reduced common dividend against taxable income, cash generation, financing costs, and REIT distribution requirements.
  • Assess repo renewal and collateral exposure, MSR facility terms and maturities, restricted cash, and the company’s capacity to meet potential margin calls.
  • Monitor MSR servicing performance and the related-party arrangements with the Manager and Freedom Mortgage, including the status of Ginnie Mae servicing.