Cherry Hill Mortgage Investment Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless otherwise noted. Amounts are in U.S. dollars; financial statement amounts are converted from thousands to millions.
Business context
Cherry Hill is an externally managed residential mortgage real estate investment trust. It invests primarily in mortgage servicing rights (MSRs) and residential mortgage-backed securities (RMBS), financing much of its RMBS portfolio with short-term repurchase agreements and using derivatives to manage interest-rate and duration exposure.
Financial results and condition
| Metric | Q3 2018 / September 30, 2018 | Comparable period or prior date |
|---|---|---|
| Interest income | $15.3 million | Q3 2017: $11.9 million |
| Net interest income | $6.1 million | Q3 2017: $5.8 million |
| Net servicing income | $11.0 million | Q3 2017: $4.7 million |
| Net income | $27.5 million; $1.62 per diluted common share | Q3 2017: $6.9 million; $0.49 per share |
| Net income applicable to common stockholders | $25.8 million | Q3 2017: $6.2 million |
| Nine-month net income | $76.6 million; $5.09 per diluted common share | 2017: $27.8 million; $2.43 per share |
| Nine-month core earnings, non-GAAP | $22.2 million; $1.57 per common share | 2017: $18.2 million; $1.65 per share |
| Total assets / equity | $2,233.5 million / $388.2 million | December 31, 2017: $2,050.7 million / $322.5 million |
| RMBS / servicing-related assets | $1,839.0 million / $282.0 million | December 31, 2017: $1,840.9 million / $122.8 million |
| Debt | $1,680.4 million in repurchase agreements and $129.3 million in notes payable | December 31, 2017: $1,666.5 million and $39.0 million, respectively |
| Cash and restricted cash | $21.4 million and $39.7 million | December 31, 2017: $27.3 million and $29.2 million |
| Nine-month cash flows | Operating +$52.0 million; investing −$210.4 million; financing +$152.4 million | Cash decreased $5.9 million to $21.4 million |
Changes, outlook, and risks
- Q3 net income rose substantially year over year, reflecting higher servicing income and positive unrealized derivative and MSR valuation changes. Those valuation gains are significant contributors to GAAP earnings and may fluctuate; they should not be treated as recurring cash earnings.
- For the nine months, higher net income included $34.4 million of unrealized derivative gains and $18.4 million of unrealized MSR gains. RMBS fair-value losses reduced other comprehensive income by $52.3 million, taking accumulated other comprehensive loss to $55.2 million.
- The servicing portfolio expanded: underlying unpaid principal balance was $22.4 billion at September 30, versus $11.7 billion at year-end 2017. MSR carrying value rose to $282.0 million, including $18.4 million of nine-month fair-value gains.
- At quarter-end the RMBS net interest spread was 1.18%, versus 1.27% at December 31, 2017. The reported period-end average net interest-rate spread was 1.72%, down from 1.91% in Q2 2018. Management attributed higher interest expense mainly to increased repo borrowings and rates, partly offset by lower swap costs.
- Repo borrowings averaged a 2.26% rate, compared with 1.47% at year-end 2017; weighted-average remaining maturity was 47 days. Repo financing is uncommitted, and collateral calls or reduced lender availability could pressure liquidity. Management stated current liquidity was sufficient for short-term recourse liabilities and expected cash and operating flows to meet anticipated needs over the next 12 months.
- Management described plans to deploy a significant portion of RMBS paydowns, and potentially proceeds from RMBS sales, into MSR acquisitions. No numerical earnings, dividend, or portfolio guidance was provided.
- Freedom Mortgage gave notice that its subservicing agreement will terminate effective April 5, 2019. The filing says servicing transfer is expected in the first half of 2019. This may affect operations and MSR value; the related recapture agreement also ends with the subservicing agreement.
- Key risks include changes in interest rates and mortgage spreads, prepayment and extension speeds, MSR valuation assumptions, counterparty and financing availability, borrower credit performance, and the ability to maintain REIT and Investment Company Act status. MSRs are Level 3 assets valued using models with significant unobservable inputs.
- The company raised common equity in June 2018 and operated common and preferred at-the-market programs. Common shares outstanding increased to 16.2 million from 12.7 million at year-end 2017. Dividends declared for the first nine months were $1.47 per common share and $1.5375 per preferred share.
- There were no material legal proceedings reported, no off-balance-sheet arrangements, and management reported effective disclosure controls. The filing’s risk factors section reported no new risk factors.
Important facts for investors to verify
- How much of reported earnings and book value depends on noncash derivative gains, MSR fair-value estimates, and RMBS marks; compare GAAP results with the company’s non-GAAP core earnings.
- Whether the RMBS spread and funding costs continue to compress, and the company’s sensitivity to further rate increases, spread widening, or collateral calls.
- How the April 2019 Freedom Mortgage servicing transition will be executed, including replacement subservicing, transfer costs, and any effect on recapture opportunities.
- Whether MSR valuations and cash flows support the expanded portfolio, given model sensitivity to prepayments, discount rates, delinquencies, and servicing costs.
- Dividend coverage and capital dilution: compare distributions with taxable income, recurring cash generation, and proceeds from equity issuance.