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spk01: Greetings. Welcome to the Cherry Hill Mortgage Investment Corporation fourth quarter 2021 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. And please note that this conference is being recorded. I will now turn the conference over to Garrett Edson, Investor Relations. Thank you. You may begin.
spk03: We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's fourth quarter 2021 conference call. In addition to this call, we have filed a press release that was distributed earlier this afternoon and posted to the investor relations section of our website at www.chmiread.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ from those discussed today. Examples of forward-looking statements include those related to interest income, financial guidance, IRRs, future expected cash flows, as well as prepayment and recapture rates, delinquencies, and non-GAAP financial measures such as earnings available for distribution, or EAD, and comprehensive income. Forward-looking statements represent management's current estimates, and Cherry Hill assumes no obligation to update any forward-looking statements in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the company's filings with the SEC and the definitions contained in the financial presentations available on the company's website. Today's conference call is hosted by Jay Lown, President and CEO, Julian Evans, the Chief Investment Officer, and Michael Hutchby, the Chief Financial Officer. Now, I will turn the call over to Jay.
spk00: Thanks, Garrett, and welcome to today's call. The fourth quarter of 2021 appeared as if it was going to be a breakout quarter for rates as we made progress through mid-November until COVID concerns returned in late November and remained a major factor through the end of the year. The Fed also signaled its timeframe for exiting its bond purchase program, which impacted mortgage spreads going into the end of the quarter. To top it off, the Fed backed off its transitory stance around inflation, as it was clear that inflation was going to be persistent. Ultimately, a key rate for our sector, the U.S. 10-year Treasury, finished the quarter essentially flat to the previous two quarters. Interestingly, though, Shorter dated rates did sell off through the quarter and the yield curve flattened with a two-year, 10-year spread tightening by over 40 basis points. Economic conditions domestically remained strong throughout the quarter and data, broadly speaking, did not disappoint. Volatility persisted through the quarter as well. This theme has continued into the first quarter of 2022 and rates have lifted off meaningfully in anticipation of a rate hike this week. Unfortunately, the events in Ukraine over the past couple of weeks have become a significant concern globally and are making for a volatile near-term economic environment. While we still believe rates will rise longer term, as the Fed has signaled a clear need to fight inflation, we are keeping a watchful eye on our portfolio and maintaining our strong liquidity. For the quarter, improving prepayment speeds continue to aid our earnings available for distribution, or EAD. In the fourth quarter, we generated gap net income applicable to common shareholders of $4.1 million, or $0.23 per share, and EAD of $0.32, exceeding our quarterly common dividend level. As a reminder, EAD is just one of several factors we consider in setting our dividend policy. Book value per common share finished at $8.56 as of December 31st. As other agency REITs have stated, mortgage spreads widened quarter over quarter, particularly in the higher coupons, and were responsible for a significant portion of the decline. The interaction between the hedges and the composition of the portfolio accounted for a portion of the decline as well. Julian will provide more details on the portfolio's performance shortly. As we noted on our prior call, our current book value performance is a function of preferred stock making up a significant portion of our overall equity profile. On a net asset value basis, which doesn't account for the difference in common or preferred equity, our performance in the quarter was more effective with NAV down 3.3% quarter over quarter before taking into account any stock issuances. That said, we remain committed to beginning to drive improvement in our NAV and book value in 2022. We remain constructive on the MSR segment of our business, given our view on interest rates over the near term. We have been disciplined in our approach to investing in MSRs, given sizable competition and robust pricing, which we expect to continue well into 2022. As prepayment speeds further decline in a higher rate world and behavioral modeling risk increases, we continue to believe the best approach remains being selective in adding or replenishing MSR assets. During the fourth quarter, we acquired approximately 1.2 billion UPB and Fannie and Freddie MSRs. We continue to believe the strategy of marrying MSRs with agency RMBS provides for attractive risk-adjusted returns and aids in protecting the portfolio from the full extent of current coupon spread widening. On our last call, we noted that we expected our leverage to gradually rise again. And at the end of the quarter, leverage was a modest half turn higher at 3.6 times from 3.2 times at the end of the prior quarter. The leverage increase was mainly driven by our utilization of the new Fannie Mae facility for MSR advances, as well as converting some TBA securities into specified pools during the quarter. Our recapture efforts remain strong. with a 23.1% recapture rate on our MSRs in the quarter. We expect that recapture rates will decline as mortgage rates rise, though prepayment speeds net of recapture should continue to improve. We ended the year with $64 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile. As we move forward in 2022, our expectation is for continued volatility as the Fed begins to tighten monetary policy. While higher rates should improve asset yields on reinvested capital, the pace of the tightening may result in a further flattening of the yield curve, impacting borrower costs, resulting in NIM compression for the aggregate portfolio. We believe the composition of our hedges and higher hedge ratio aids in mitigating some impacts from such Fed tightening. We believe there will be opportunities in agency RMBS as spreads normalize and rates begin to peak. As such, we are keeping a firm hand on our balance sheet, and when we see attractive investment opportunities, we will look to invest prudently. With that, I'll turn the call over to Julian, who will cover more details regarding our investment portfolio and its performance over the fourth quarter.
spk07: Thank you, Jay. During the quarter, there were two diverging main themes that impacted the credit spread and interest rate markets. One was the Fed's announcement of pending policy changes based on elevated levels of inflation, and the other was the expedited rise of the latest COVID variant. Both themes increased market volatility and changed the shape of the U.S. yield curve, which impacted mortgage performance during the quarter. The Fed announcement was an admission that inflation was not transitory and an indicator to the markets that policy was changing. Not only was the Fed about to raise interest rates, but it also indicated that a reduction to their balance sheet was possible and might occur sooner than previously thought. At the same time, markets were reacting to another widespread COVID variant that threatened global growth. On paper, it might seem as though interest rate markets were calm during the fourth quarter as 10-year treasuries remained relatively steady. However, there was plenty of volatility that drove the U.S. 10-year as high as 170 and as low as 135, only to settle three basis points higher at 151. Despite the movement in the 10-year, two-year treasuries rose 46 basis points, flattening the spread between the two-year and the 10-year curve based on the Fed's announcement. The yield curve changed, rising volatility, and previously mentioned themes weighed on the mortgage sector and our portfolios. The middle of the coupon stack, as well as higher coupons, underperformed during the quarter. At quarter end, MSRs had a UPV of approximately $21 billion and a market value of approximately $219 million. During the quarter, we purchased $1.2 billion UPV of new MSRs through our flow programs, as Jay mentioned. At the end of the fourth quarter, the MSR portfolio represented approximately 42% of our equity capital. and approximately 14% of our investable assets excluding cash. Meanwhile, our RMBS portfolio accounted for approximately 39% of our equity capital. As a percentage of investable assets, RMBS represented approximately 86% excluding cash at quarter end. During the quarter, we experienced CPR improvements in both the MSR and RMBS portfolios. Our MSR portfolio net CPR averaged approximately 19% for the fourth quarter, down from approximately 22% net CPR in the previous quarter. The decline was driven by slower prepayment speeds in the quarter, as well as steady recapture rates. Similarly, the RMBS portfolio's prepayments slowed. The portfolio's weighted average three-month CPR reduced to approximately 12% for the fourth quarter, compared to approximately 17% in the third quarter. The fourth quarter CPR improvements were mainly driven by the fall seasonals, and those CPR improvements have rolled into the first quarter. However, the drivers of the slower CPR are different. First quarter improvements have been mainly impacted by the steady and quick rise of interest rates and mortgage rates, as well as some seasonals. As mortgage rates have moved higher, mortgage securities have become less refinanceable. According to Citigroup, approximately 12% of the mortgage universe is currently refinanceable. As of 12-31, the RMBS portfolio, inclusive of TBA, stood at approximately $1.4 billion, comparable to the previous quarter. Quarter over quarter, there were marginal improvements. as the 30-year security position increased slightly to 89%, up from 87%, at the expense of shorter-duration securities. 15-year securities and other collateral positions represented 11% of the portfolio at quarter end. During the quarter, we reduced our TBA holdings and initiated the move into specified pools as the RMBS role of specialness began to diminish. For the fourth quarter, we posted a 2.46 RMBS net interest spread versus a 2.26 net interest spread reported for the third quarter. Improved asset yields were aided by better prepayment speeds, which more than offset slightly higher interest expense. As we move forward in fiscal year 2022, expect improvements in amortization to remain as current interest and mortgage rates are higher than they have been for the past two years. As a result, the mortgage market is less refinanceable than it has been. In addition, rates should remain higher given the fact that the Fed and other global central banks are embarking on raising rate programs as well as stopping their asset purchase programs to combat improved economies and lofty inflation levels. Impending higher repo costs are expected to be the negatives. which should be minimized as interest rate hedges reset as three-month LIBOR and SOFR increases. At quarter end, the portfolio leveraged at approximately 3.6 times at the aggregate level. I will now turn the call over to Mike for our fourth quarter financial discussion.
spk04: Thank you, Julian. Our gap net income applicable to common stockholders for the fourth quarter was $4.1 million, or 23 cents per weighted average share outstanding during the quarter, while comprehensive loss attributable to common stockholders, which includes the mark-to-market of our held-for-sale RMBS, was $4 million, or 22 cents per share. Our earnings available for distribution attributable to common stockholders was $5.8 million, or 32 cents per share. As a note, for the fourth quarter of 2021, we enhanced the calculation of unrealized gain or loss on investments in MSRs used to calculate EAD by backing out hedging income or expense, financing interest expense, and any administrative service and costs. We believe this change better presents EAD generated by investments in MSRs with EAD generated by investments in RMBS. Our book value per common share as of December 31st was $8.56. compared to a book value of $9.07 as of September 30th. We use a variety of derivative instruments to mitigate the effects of increases in interest rates on a portion of our future repurchase borrowings. At the end of the fourth quarter, we held interest rate swaps, swaptions, TBAs, and treasury futures, all of which had a combined notional amount of $2 billion. You can see more details with respect to our hedging strategy in our 10-K as well as in our fourth quarter presentation. For GAAP purposes, we have not elected to apply hedge accounting for our interest rate derivatives. And as a result, we record the change in estimated fair value as a component of the net gain or loss on interest rate derivatives. Operating expenses were $3.5 million for the quarter. On December 9th, our board of directors declared a dividend of 27 cents per common share for the fourth quarter of 2021. which was paid in cash on January 25th, 2022. We also declared a dividend of 51.25 cents per share on our 8.2% Series A cumulative redeemable preferred stock and a dividend of 51.5625 cents on our 8.25% Series B fixed to floating rate cumulative redeemable preferred stock, both of which were paid on January 18th, 2022. At this time, we will open up the call for questions. Operator?
spk01: Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
spk06: One moment, please, while we poll for questions. Our first question comes from the line of Mikael Goberman with JMP Securities.
spk01: You may proceed with your question.
spk02: Hello, everybody. Thanks for taking the call. Question. Almost done, amazingly, with the first quarter here, mid-March. Wondering if you could provide a book value update where we are right now.
spk00: Hey, Mikael. How are you?
spk02: Good. How are you guys doing?
spk00: Great. So... Yeah, I appreciate the fact that it's March 15th. And for the first two months of the first quarter, we show NAV down roughly 6.5%, and book value per common share down 12%, and that's before accounting for the common dividend. And I'd highlight that NAV, I'd highlight the NAV because, as you know, NAV comprises both common and preferred shares. And we believe that's the driver for the earnings power of the company and thus the dividend. And despite the inherent leverage that I would say is embedded in the composition of our capital structure, I think we're doing a good job weathering the storm around all the mortgage spread widening so far.
spk02: Gotcha. Good to hear. And I saw you guys had your 10K come out just now. With respect to that DTA, I see it's at the end of the At the end of the year, still around 20 million, can we expect a similar amount, I guess, the quarter closing in a couple of weeks?
spk06: I'll let Mike take that.
spk04: Well, the DTA fluctuates in large part by changes in the mark-to-market value of the MSRs. And so to the extent that the mark-to-market of the MSRs fluctuates, increases, there would be a portion of a decrease in a DTA associated with that markup. But obviously, at this point in the period, we don't have insight into those numbers just yet. But broadly speaking, that's how it should work.
spk02: Okay. And one more, if I can. Just a kind of upper-level view of how you guys are thinking about portfolio construction uh thus far through the first quarter and of course going forward given what the fed is about to do all the uncertainty in the market how are you guys thinking about the mix of uh agency mbs versus msrs and what kind of coupons uh within the agency mbs thank you sure so uh
spk00: As we mentioned in the prepared remarks, speeds have dropped, and the need to replenish the portfolio to keep it at the current size obviously drops as well. What I tried to imply in the remarks is we don't need to go out and buy a ton, and given that approximately 40% of the equity is in the asset, what we do in terms of thinking about adding to that is really more a function of value in addition to just the mix itself. And I think everybody on this call would tell you that they think that the asset class is at least fairly valued and potentially full valued. So we're going to continue to stick to the flow program. We spatter in some bulk sales, but I wouldn't expect any meaningful changes to the composition of the portfolio outside of potentially reducing some exposure to the RMBS sale through the asset class during the quarter as a result of trying to protect and further spread widening. In terms of coupons, I'll let Julian talk about that.
spk07: Yeah, I would say throughout the quarter, I mean, we've slowly progressed to higher coupons. But I would say that if you look over the performance of the first quarter, just the mortgage basis in general, it has widened somewhere between 40 and 45 basis points. But I would say all coupons have underperformed during the quarter. It hasn't just been one specific coupon. You could say in January it was lower coupons, and then in February it's been the middle of the coupon stack. So I wouldn't necessarily say there's been anywhere to really hide in terms of this quarter in terms of – of mortgages. But I would say in general, we have moved up in coupon and continue to progress in that manner.
spk02: Okay. Thanks a lot, guys. Best of luck going forward in a pretty difficult environment for MBS. Thanks. Thanks.
spk01: Thank you. As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the queue. You may press star 2 if you would like to remove your question from the queue.
spk05: One moment while we pull for more questions.
spk01: At this time, there are no further questions, and I'd like to pass it back over to management for any closing remarks.
spk00: Great. Thank you. Thank you all for joining us on our fourth quarter of 2021 call, and we look forward to updating you in May for first quarter of 2022. Have a good evening.
spk01: This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.
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