Cherry Hill Mortgage Investment Corp quarterly report, Q2 FY2019

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Cherry Hill Mortgage Investment Corporation — Q2 2019 Form 10-Q

Reporting period: Three and six months ended June 30, 2019; filed August 8, 2019. Cherry Hill is an externally managed residential mortgage REIT investing primarily in mortgage-backed securities (RMBS) and mortgage servicing rights (MSRs). Dollar amounts below are in millions unless stated otherwise.

Financial performance and position

  • Q2 revenue and earnings: Interest income was $17.2 million and net interest income was $5.5 million. Net servicing income was $14.3 million. A $44.0 million unrealized MSR loss and $3.8 million unrealized derivative loss contributed to a $27.2 million net loss, or a $1.75 loss per common share. In Q2 2018, net income was $13.8 million and EPS was $0.91.
  • First-half results: Interest income was $34.2 million, net interest income $11.7 million and net servicing income $27.6 million. Net loss was $48.3 million, or $3.11 per common share, compared with net income of $49.1 million and EPS of $3.49 in the first half of 2018.
  • Non-GAAP core earnings: Core earnings attributable to common stockholders were $8.7 million, or $0.52 per share, in Q2; first-half figures were $18.7 million, or $1.12 per share. These measures exclude, among other items, fair-value changes on MSRs and derivatives and are not substitutes for GAAP results.
  • Margins: The period-end RMBS net interest spread was 0.84%, down from 1.31% at December 31, 2018; the reported spread includes RMBS asset yield less interest expense. The company’s broader period-end average net interest rate spread, including related swap benefits, was 1.55%, versus 1.72% at year-end.
  • Cash flow: For the first half, operating activities provided $36.2 million, investing activities used $372.4 million, and financing activities provided $353.8 million. Cash, cash equivalents and restricted cash ended the period at $57.5 million, up from $40.0 million at year-end.
  • Assets, debt and equity: Total assets were $2,539.4 million and total liabilities $2,133.4 million at June 30, 2019, versus $2,153.3 million and $1,789.3 million, respectively, at December 31, 2018. Repurchase-agreement borrowings rose to $1,942.5 million from $1,598.6 million; notes payable were $152.0 million, down from $157.5 million. Total stockholders’ equity was $406.1 million, compared with $363.9 million.
  • Portfolio: RMBS carrying value was $2,152.3 million, up from $1,770.1 million at year-end. MSRs were valued at $273.7 million, down from $294.9 million. MSR underlying unpaid principal balance grew to $27.8 billion from $24.8 billion.

Material changes versus comparable periods

  • Q2 interest income increased $5.2 million year over year, primarily from RMBS acquired using equity-offering proceeds. First-half interest income increased $8.8 million.
  • Q2 interest expense increased $4.4 million year over year, mainly due to higher repo borrowings and rates, partly offset by lower swap costs. First-half interest expense rose $7.5 million.
  • MSR fair value declined $44.0 million in Q2, versus a $0.4 million decline in Q2 2018; the first-half decline was $71.2 million, versus a $12.1 million gain in the first half of 2018. Management attributed the decline primarily to lower mortgage rates.
  • Derivative fair value losses were $3.8 million in Q2 and $12.1 million for the first half, compared with gains of $6.0 million and $25.6 million in the respective 2018 periods.
  • RMBS unrealized gains recorded in other comprehensive income were $25.5 million in Q2 and $57.5 million for the first half, which management linked to lower Treasury rates. No other-than-temporary impairment charges were recorded in 2019.
  • The company issued $48.4 million net of costs of Series B preferred stock in February 2019 and raised additional capital through common- and Series A preferred-stock ATM programs. Repo debt and the RMBS portfolio expanded during the period.

Outlook, risks and other notable items

  • Management said available liquid assets were sufficient for short-term recourse liabilities and expected cash on hand plus operating cash flow to cover anticipated liquidity needs for the next 12 months, including potential margin calls. This is management’s expectation, not a quantified earnings forecast; no specific financial guidance was provided.
  • Repo financing is uncommitted and short-term: the weighted-average remaining maturity was 60 days, the weighted-average rate 2.66%, and the average haircut 4.3% at June 30. Collateral declines can trigger margin calls and forced deleveraging.
  • Interest-rate, spread, prepayment and extension movements can affect funding costs, asset values, hedging effectiveness and MSR cash flows. MSRs are Level 3 fair-value assets whose valuation depends on unobservable assumptions, including prepayment speeds, discount rates, servicing costs and delinquencies.
  • The company relies on financing availability, counterparties and subservicers, and is exposed to borrower credit risk, geographic concentration, and REIT qualification requirements. California represented 12.5% of MSR underlying principal balance.
  • The Manager is affiliated with Freedom Mortgage through common control, and the management agreement provides for a fee based on adjusted stockholders’ equity. Related-party servicing and recapture arrangements also remain in place.
  • No material legal proceedings were reported; management reported effective disclosure controls and no material changes in internal control during the quarter. No subsequent event requiring disclosure was identified.

Investor facts to verify

  • Whether MSR valuations and the assumptions behind the $71.2 million first-half fair-value decline remain supportable as mortgage rates and prepayments change.
  • Repo renewal, borrowing-rate and collateral terms, and the company’s capacity to meet margin calls given short maturities and uncommitted facilities.
  • Whether cash generation and taxable income support common and preferred dividends; the filing reports $0.49 per common share declared in each of Q1 and Q2, while distributions remain subject to board authorization and available funds.
  • How the Series B preferred issuance and other equity proceeds are deployed, and the effect of higher leverage and preferred dividend obligations on common-stock returns.
  • How management’s liquidity assessment and non-GAAP core earnings compare with subsequent reported results; core earnings exclude significant fair-value movements.