Cherry Hill Mortgage Investment Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Dollar amounts are in millions unless otherwise indicated. Cherry Hill is an externally managed residential mortgage REIT investing in Agency RMBS and servicing-related assets, including Excess MSRs and MSRs.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Interest income | $6.508 | $6.244 | $19.179 | $18.392 |
| Net interest income | $4.865 | $5.080 | $14.955 | $15.275 |
| Net income (loss) | $(5.170) | $2.814 | $3.704 | $2.893 |
| Net income (loss) per common share | $(0.68) | $0.37 | $0.49 | $0.38 |
| Core earnings attributable to common stockholders (non-GAAP) | $3.536 | $3.781 | $10.875 | $11.477 |
| Core earnings per share (non-GAAP) | $0.47 | $0.50 | $1.45 | $1.53 |
Q3’s GAAP loss largely reflected adverse fair-value movements: unrealized derivative losses were $4.986 million, and servicing-related asset valuation losses were $3.079 million across Excess MSRs and MSRs. By contrast, RMBS unrealized gains of $3.363 million were recorded in other comprehensive income. Net interest income declined year over year in both the quarter and nine-month period as higher funding costs offset increased interest income. Net servicing income was a loss of $0.119 million in Q3.
At September 30, RMBS were $580.1 million and servicing-related assets were $85.6 million, including $79.0 million of Excess MSRs and $6.5 million of MSRs. Total assets were $702.2 million; total equity was $152.5 million, down from $160.3 million at December 31, 2014. The RMBS weighted-average net interest spread was 1.31%, versus 1.67% at year-end 2014.
Cash flow, debt and liquidity
For the first nine months, operating activities provided $16.0 million; investing activities used $164.2 million, principally reflecting RMBS purchases; and financing activities provided $148.5 million. Cash and cash equivalents were $12.7 million at September 30, with $15.1 million of additional restricted cash.
Debt totaled approximately $534.1 million: $440.7 million in repurchase agreements, $67.4 million in FHLBI advances and $26.0 million in notes payable. Repurchase agreements had a 0.49% weighted-average rate and 49-day weighted-average remaining maturity; FHLBI advances had a 0.53% rate and 145-day average remaining maturity. The $24.8 million Term Loan bears a weighted-average rate of 5.5675% and matures in April 2020. The $1.3 million MSR Facility was extended to November 30, 2015. Management stated it expected available cash and operating cash flow to cover anticipated needs, including financing and possible margin calls, over the next 12 months.
The company declared common dividends of $1.49 per share during the nine-month period. The filing emphasizes that distributions depend on taxable income, cash availability, debt service and board authorization; GAAP earnings, taxable earnings and dividends may differ.
Material changes and management commentary
- In May 2015, the company acquired Aurora Financial Group for approximately $3.9 million in cash, adding a licensed Fannie Mae/Freddie Mac servicer and MSRs on loans with approximately $690.3 million of unpaid principal balance at September 30. The acquisition produced a provisional $0.174 million bargain-purchase gain; valuations remained subject to adjustment.
- RMBS carrying value increased to $580.1 million from $416.0 million at December 31, 2014. Repurchase borrowings also increased, and the company added FHLBI advances and term-loan financing.
- Management said lower asset pricing had reduced available investment returns. It intended to broaden investments to pursue a more diversified and stable revenue profile, while noting that execution requires capital and is not assured. No quantitative earnings or dividend guidance was provided.
- Management expected rising rates to reduce recapture activity, while potentially slowing voluntary prepayments; it expected overall prepayment rates to remain roughly constant. The filing identifies interest-rate, spread, prepayment, valuation, funding, liquidity and borrower-credit risks.
Risks, contingencies and unusual items
- FHLBI membership risk: a proposed FHFA rule could exclude captive insurers, potentially terminating the subsidiary’s membership and making outstanding advances immediately due. The company had $67.4 million of advances at quarter-end.
- Dependence on Freedom Mortgage: it services the loans underlying the company’s Excess MSRs and subservices the acquired MSR portfolio. Failure to perform, loss of agency approval or financial distress could materially harm the company. The company also remains liable to relevant agencies as servicer of record for the subserviced MSRs.
- Freedom Mortgage informed the company it anticipated a structured settlement with HUD OIG in Q4 2015 concerning FHA origination quality-control and training matters. The filing said expected payments were not anticipated to materially impair Freedom Mortgage, but final terms were uncertain.
- Under an acknowledgement agreement, the company could be required to make certain Ginnie Mae-guaranteed security payments if Freedom Mortgage fails to pay; management assessed material-loss risk as remote and recorded no liability. No material company legal proceedings were reported.
- Servicing-related assets are Level 3 fair-value estimates sensitive to assumptions such as prepayment speeds, discount rates, delinquencies and servicing costs. The company recorded no RMBS other-than-temporary impairment in the periods presented.
- After quarter-end, Aurora agreed to acquire MSRs on approximately $1.4 billion of Fannie Mae/Freddie Mac loans, with servicing transfers expected in December 2015. The filing also notes Ginnie Mae approval of the Aurora change in control was still being pursued, with no assurance of approval.
Important facts for investors to verify
- Whether derivative valuation losses and servicing-asset marks persist, and how they affect GAAP results versus non-GAAP core earnings.
- Availability, renewal terms and collateral requirements for short-term repo and FHLBI funding, including the effect of any FHLBI membership rule change or margin calls.
- Final Aurora purchase-accounting valuations, Ginnie Mae change-of-control approval, and the financing and performance of the subsequent MSR acquisition.
- Freedom Mortgage’s servicing and financial condition, the status and final terms of the HUD OIG matter, and the company’s exposure under agency acknowledgement and subservicing arrangements.
- Whether distributions remain supported by taxable income and cash generation; core earnings are non-GAAP and exclude significant realized and unrealized items.