Cherry Hill Mortgage Investment Corp quarterly report, Q3 FY2019

Cherry Hill Mortgage Investment Corporation — Q3 2019 Form 10-Q

Reporting period: Three and nine months ended September 30, 2019. The company invests primarily in residential mortgage-backed securities (RMBS) and mortgage servicing rights (MSRs), using leverage and derivatives to finance and manage its portfolio.

Financial performance and position

Amounts below are in millions, except per-share data and percentages.

Metric	Q3 2019	Q3 2018	Nine months 2019	Nine months 2018
Net interest income	$6.7	$6.1	$18.5	$16.6
Net servicing income	$14.6	$11.0	$42.2	$27.1
Net income (loss)	$(3.0)	$27.5	$(51.2)	$76.6
Net income (loss) applicable to common stockholders	$(5.4)	$25.8	$(57.3)	$71.7
GAAP diluted EPS	$(0.32)	$1.62	$(3.42)	$5.09

Q3 total income was a loss of $5.4 million, driven mainly by a $37.5 million unrealized decline in servicing-related asset fair value. This outweighed $14.6 million of net servicing income, $6.7 million of net interest income and $12.6 million of realized derivative gains.
For the first nine months, the $108.7 million unrealized MSR fair-value loss and $14.2 million unrealized derivative loss contributed to the $51.2 million net loss. The company recorded a $15.0 million tax benefit, primarily at its taxable REIT subsidiary.
Q3 comprehensive income was $12.6 million, including $15.6 million of other comprehensive income from RMBS valuation gains. Nine-month comprehensive income was $21.8 million.
Non-GAAP core earnings attributable to common stockholders were $7.0 million, or $0.41 per diluted share, in Q3, versus $8.8 million, or $0.55, a year earlier. Nine-month core earnings were $25.7 million, or $1.53 per diluted share, versus $22.2 million, or $1.57. The company refined its MSR amortization method for this reporting period; prior quarters were not restated.

Balance sheet, leverage and cash flow

At September 30, total assets were $2.876 billion, total liabilities $2.466 billion and total equity $409.6 million. RMBS were $2.483 billion and MSRs $255.8 million, down from $294.9 million at December 31, 2018.
Repurchase-agreement borrowings were $2.267 billion, up from $1.599 billion at year-end. Additional notes payable were $158.0 million; total debt was approximately $2.425 billion. Repo borrowings had a 2.36% weighted-average rate, 54-day average remaining maturity and 4.3% average haircut.
Cash and cash equivalents were $21.4 million and restricted cash $48.7 million. Nine-month operating cash flow was $50.1 million; investing used $694.2 million and financing provided $674.1 million. Cash, cash equivalents and restricted cash totaled $70.1 million at period-end.
Management stated it expected available cash and operating cash flow to cover anticipated needs for the next 12 months, including potential margin calls and operating expenses. This is an expectation, not a guarantee.
The RMBS net interest spread at quarter-end was 0.87%, versus 1.31% at December 31, 2018. The broader period-end average spread, including swap benefits, was 1.64% in Q3, versus 1.55% in Q2.

Material changes versus comparable periods

Interest and servicing income expanded alongside portfolio growth: RMBS carrying value rose to $2.483 billion from $1.770 billion at year-end, while MSR unpaid principal balance increased to $27.864 billion from $24.847 billion.
Interest expense increased 36% year over year in Q3 to $12.6 million, principally due to increased repo borrowings and higher repo rates, partly offset by lower swap costs. Nine-month interest expense rose to $35.1 million from $24.1 million.
Mortgage-rate declines increased prepayments and accelerated MSR runoff/amortization, contributing to the sharp MSR valuation losses. Conversely, RMBS unrealized gains lifted accumulated other comprehensive income to $34.7 million from a $38.4 million deficit at year-end; management attributed the nine-month RMBS gain in part to a 101-basis-point decline in the 10-year Treasury rate.
Common dividends declared were reduced to $0.40 per share for Q3 from $0.49 per share in each of the first two 2019 quarters and in Q3 2018. Series A preferred dividends were $0.5125 per share; Series B dividends were $0.5156 per share for Q3.
The company issued $50 million liquidation-preference Series B preferred stock in February. It also replaced its prior Fannie Mae MSR facility with a new facility providing up to $200 million of capacity, of which $100 million was committed; $84.4 million was outstanding at quarter-end.

Outlook, risks and unusual items

No quantified earnings or dividend guidance was provided. Management said it anticipated deploying a significant portion of RMBS paydowns into MSR purchases and could sell RMBS to fund those acquisitions.
Key risks include interest-rate and spread movements, faster-than-expected mortgage prepayments, MSR valuation sensitivity, repo refinancing and margin-call exposure, and reliance on financing that is generally short-term and uncommitted. MSR valuations are Level 3 and depend on assumptions including prepayment speeds, discount rates, delinquencies and servicing costs.
MSR fair value is particularly sensitive to prepayments: the company’s sensitivity analysis estimated that a 10% increase in conventional voluntary prepayment assumptions would reduce conventional MSR fair value by about $15.0 million, all else equal.
Most RMBS were agency-backed. Management considered unrealized RMBS losses temporary and recorded no other-than-temporary impairment charges in the 2019 periods presented. Certain loss-share CMOs were unrated or below investment grade.
The company is externally managed under a related-party agreement at 1.5% annually of defined stockholders’ equity; the agreement includes potential termination fees. Freedom Mortgage, affiliated with the manager’s controlling beneficial owner, services the company’s Ginnie Mae MSRs.
An October 2019 amendment added $10 million of borrowing capacity for Ginnie Mae servicing advances. No material legal proceedings were reported. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.

Most important facts for investors to verify

Whether MSR fair-value losses and prepayment assumptions stabilize, and how actual portfolio runoff compares with model estimates.
Repo funding availability, renewal terms, haircuts and collateral/margin requirements, given $2.267 billion of short-term repo debt.
The sustainability of the reduced $0.40 common dividend relative to taxable income, cash generation and financing obligations.
Core earnings calculations and the effect of the revised MSR amortization method; this non-GAAP measure is not a substitute for GAAP results and may not be comparable across issuers.
Execution and terms of the replacement Fannie Mae MSR facility, other MSR financing, and any subsequent changes to liquidity or leverage.