Cherry Hill Mortgage Investment Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. Unless otherwise noted, financial amounts below are in millions of dollars. Cherry Hill began operations on October 9, 2013 after its IPO; Q1 2013 results therefore reflect a pre-operating company and are not meaningfully comparable.
Business context
Cherry Hill invests primarily in residential excess mortgage servicing rights (Excess MSRs) and agency mortgage-backed securities (Agency RMBS). It uses short-term repurchase financing for RMBS and relies on an external manager and Freedom Mortgage, both controlled by the same individual. The company intends to operate as a REIT.
Financial results and position
| Metric | Q1 2014 or March 31, 2014 | Comparison or context |
|---|---|---|
| Interest income | $6.011 | $5.064 net interest income after $0.947 interest expense |
| Total income | $1.870 | Includes $3.443 unrealized derivative loss, $0.349 realized RMBS loss, and $0.670 unrealized Excess MSR gain |
| Expenses / net income | $1.136 / $0.734 | $0.730 attributable to common stockholders; basic and diluted EPS were $0.10 |
| Agency RMBS net interest spread | 1.59% | Up from 1.43% at December 31, 2013; weighted-average asset yield 3.02% and interest expense 1.42% |
| Assets / liabilities / equity | $438.210 / $276.653 / $161.557 | At March 31, 2014 |
| Investments | $308.855 Agency RMBS; $107.887 Excess MSRs | Agency RMBS were $286.979 and Excess MSRs $110.306 at year-end 2013 |
| Repurchase debt | $269.981 | Up from $261.302 at year-end; weighted-average rate 0.37%, remaining maturity 43 days, and haircut 5.5% |
| Cash and restricted cash | $12.707 and $3.139 | Unrestricted cash was $10.375 at year-end 2013 |
| Cash flows | Operating +$13.058; investing −$16.208; financing +$5.482 | Cash increased $2.332 to $12.707 |
| Dividend | $0.50 per common share declared for Q1 | Paid April 29, 2014; $3.755 was payable at March 31 |
Material changes and management commentary
- Net income was $0.734 million versus a $0.035 million loss in Q1 2013, but the prior-year period preceded operations and is not a useful operating comparison.
- RMBS carrying value rose about $21.9 million from year-end, while Excess MSR carrying value declined about $2.4 million. RMBS unrealized losses improved: accumulated other comprehensive loss narrowed from $5.033 million to $1.678 million.
- Management attributed the $0.670 million net Excess MSR fair-value gain mainly to lower-than-modeled prepayments in Pool 1, partly offset by higher expected delinquencies in Pool 2. Pool 2’s recapture activity had been higher than anticipated.
- Management said it had sufficient liquid assets to meet short-term recourse liabilities and expected cash plus operating cash flow to cover anticipated needs over the next 12 months, including current portfolio financing, flow MSR purchases, potential margin calls, and operating costs. This is management’s expectation, not a guarantee.
- The company stated it had no material legal proceedings, no off-balance-sheet arrangements, and no material changes to previously disclosed risk factors. Management reported disclosure controls were effective.
Outlook, risks, and unusual items
- No numerical earnings or investment guidance was provided. The company intends to continue building its Excess MSR and RMBS portfolio and may consider prime jumbo loans and other residential mortgage assets, subject to market conditions.
- Interest-rate, spread, prepayment, extension, and financing risks are central. Repurchase agreements are short-term and uncommitted; falling collateral values can trigger margin calls or force asset sales. Agency RMBS debt-to-equity was approximately 6.3:1.
- Excess MSRs are Level 3 assets valued using discounted cash-flow models and significant unobservable assumptions, including prepayment, delinquency, and discount rates. Changes in assumptions can materially affect reported earnings and asset values. A 10% increase in modeled prepayment rates was associated with a 3% decrease in estimated Excess MSR fair value; a 10% increase in discount rates was associated with a 5% decrease.
- Excess MSRs depend on Freedom Mortgage continuing to service the loans. If the servicer is terminated, the company’s rights to the related excess servicing amounts may terminate. The company also disclosed potential payment obligations under agency acknowledgment agreements, though management considered material loss remote and accrued no liability.
- The manager and Freedom Mortgage are affiliated with the company’s controlling individual. The management agreement charges an annual fee of 1.5% of stockholders’ equity and may require a termination fee in specified circumstances. The filing cautions that related-party terms may be less favorable than arm’s-length terms.
- REIT qualification depends on satisfying technical tax requirements and distributing required taxable income. Failure to qualify could result in material taxes and loss of REIT status for subsequent years.
Important facts for investors to verify
- Whether the $0.50 quarterly dividend is supported by recurring taxable income and cash generation, rather than fair-value movements or financing activity.
- How sensitive Excess MSR valuations and cash flows are to prepayments, delinquencies, discount rates, and actual recapture performance.
- Repo counterparties, renewal terms, collateral haircuts, and the company’s capacity to meet margin calls under stressed markets.
- Ongoing dependence on Freedom Mortgage for servicing and investment opportunities, including the protections available if servicing or the related-party relationship changes.
- The terms and valuation support for new Excess MSR purchases, including the 2014 pools and independent-director approval process.