Cherry Hill Mortgage Investment Corporation — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; year-over-year comparisons are with Q1 2016 unless stated otherwise. Balance-sheet comparisons are with December 31, 2016. Cherry Hill is an externally managed residential mortgage REIT investing primarily in Agency RMBS and mortgage servicing rights (MSRs).
Financial performance and position
- Income: Interest income was $6.1 million and interest expense was $2.4 million, producing net interest income of $3.6 million, up from $3.5 million. Net servicing income increased to $3.3 million from $1.1 million.
- Profit: Net income was $22.6 million versus a $7.2 million net loss. Income attributable to common stockholders was $22.2 million, or $2.91 per basic share ($2.90 diluted), compared with a $7.1 million loss, or $0.94 per share, in Q1 2016. Results included a $12.3 million unrealized MSR gain and a $6.7 million realized gain on Excess MSRs; reported earnings therefore include significant valuation and transaction items.
- Core earnings: Management’s non-GAAP measure was $4.8 million attributable to common stockholders, or $0.63 per share, versus $4.2 million, or $0.55 per share. The company cautions that core earnings excludes gains and losses and is not a substitute for GAAP income or liquidity.
- Cash flow: Operating activities provided $259.0 million; investing activities used $464.0 million; financing activities provided $264.3 million. Cash and cash equivalents ended at $75.1 million, up from $15.8 million. Operating cash flow was substantially affected by a $251.6 million increase in payables for unsettled trades, so it should not be read as recurring operating cash generation.
- Assets and equity: Total assets were $1.318 billion, up from $793 million. RMBS were $1.139 billion versus $672 million, while servicing-related assets were $76.7 million versus $61.3 million. Total stockholders’ equity was $257.5 million versus $156.0 million.
- Debt and liquidity: Repurchase agreements totaled $773.3 million, up from $594.6 million; the MSR Financing Facility had $16.0 million outstanding, and the NexBank term loan was repaid. Repo agreements were short-term and generally uncommitted, with a 78-day weighted-average remaining maturity, a 1.04% weighted-average rate and a 5.2% average haircut. Restricted cash was $7.1 million. Management said available liquidity was sufficient for short-term recourse liabilities and expected cash and operating flows to cover anticipated needs for the next 12 months.
- Margins and dividends: At quarter-end, the reported average RMBS asset yield was 3.62%, average funding cost 1.67%, and average net interest rate spread 1.95%; the separate RMBS net interest spread was 1.42%. The company declared a $0.49-per-share dividend.
Material changes versus comparable periods
- The company sold its remaining Excess MSRs to Freedom Mortgage on February 1, 2017, and held no Excess MSRs at quarter-end. In the transaction, Freedom Mortgage transferred Ginnie Mae MSRs tied to approximately $4.5 billion of unpaid principal balance to Aurora. The company recorded a $6.7 million realized gain on Excess MSR investments and reported a $12.3 million unrealized gain on MSRs.
- RMBS grew significantly, reflecting purchases funded in part by the March 29 issuance of 5.175 million common shares. The offering generated approximately $81.1 million after underwriting discounts and commissions, before approximately $229,000 of expenses. At March 31, $257.8 million of Agency RMBS purchases remained unsettled.
- Servicing fee income rose to $4.6 million from $1.5 million, while servicing costs rose to $1.2 million from $0.4 million. Interest expense increased by $0.8 million, primarily because of higher repo borrowings and rates, partly offset by lower swap costs.
- Management reported a 1.95% quarter-end average net interest rate spread, down from 2.03% at December 31, 2016, as funding costs rose relative to asset yields. The RMBS net interest spread was 1.42%, down from 1.66% at year-end.
Outlook, risks and unusual items
- No quantified earnings, spread, investment or dividend guidance was provided. Management expected to redeploy a substantial portion of the recent equity proceeds from RMBS into MSR acquisitions, but timing depends on market conditions.
- Key exposures include interest-rate and spread movements, mortgage prepayment and extension speeds, MSR valuation assumptions, borrower credit performance, repo refinancing and margin calls, and the liquidity of servicing assets. The company does not use derivatives to hedge changes in MSR fair value; derivatives are used principally to manage interest-rate, duration and basis risk.
- MSRs are Level 3 fair-value assets valued using discounted cash-flow models and significant unobservable assumptions, including prepayment speeds, delinquencies, servicing costs and discount rates. Changes in assumptions may materially affect reported earnings and equity.
- Freedom Mortgage is a key subservicer and is affiliated with the external manager. The management agreement was negotiated between related parties; management fees were $892,000 for the quarter, and termination without cause may require a significant fee.
- The company reported no material legal proceedings, no off-balance-sheet arrangements and no material change in internal control over financial reporting. It stated that disclosure controls were effective.
Important facts for investors to verify
- How much of reported earnings came from MSR fair-value movements and the Excess MSR sale, and whether core earnings better reflects ongoing performance.
- Whether the $257.8 million of unsettled RMBS purchases were settled as expected, and the resulting effects on repo debt, collateral and liquidity.
- The assumptions supporting Level 3 MSR valuations, including prepayment speeds, servicing costs and discount rates, and the sensitivity of those values to changes in rates.
- Progress and terms of redeploying capital into MSRs, including servicing advances, EPO protection and subservicing arrangements.
- Repo renewal and counterparty capacity, margin-call exposure, and the sustainability of the $0.49 quarterly dividend relative to taxable income and cash available for distribution.