This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk00: Thank you for standing by. My name is Cheryl and I will be your conference operator today. At this time, I would like to welcome everyone to the Cherry Hill Mortgage Investment Corporation second quarter 2022 conference call. The lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad If you would like to withdraw your question, again, press star 1. Thank you. Garrett Edson, you may begin your conference.
spk02: We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's second quarter 2022 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.chmireet.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.
spk07: Thanks, Garrett, and welcome to today's call. The entire mortgage REIT sector was impacted by numerous macro and geopolitical concerns in the second quarter. In addition, the Fed turned aggressively hawkish to combat inflation, as anticipated, and hiked rates twice during the quarter, 50 basis points in May and 75 basis points in June. Last week, we navigated yet another 75 basis point hike. We continue to believe the Fed will remain aggressive with respect to tightening monetary policy in the near term, given their focus on bringing inflation down towards their target levels. In response, the U.S. 10-year Treasury rose to 3.5% by mid-June, and we were positioned well for the higher rate environment. However, recession fears gripped markets towards the end of June, leading to a rally in rates that continued through July. This, coupled with mortgage spreads widening during the quarter, most meaningfully at the end of June, negatively impacted our book value for the quarter. Ultimately, the U.S. 10-year Treasury finished the quarter at 3.02%, 68 basis points above its closing level at March 31st. Our portfolio strategy has remained intact, pairing MSR with agency MBS. We are constructive on agency mortgage spreads given the significant widening this year and believe our positioning there has had a positive impact on performance year to date. We continue to actively adjust our investment portfolio to protect the business and remain less levered relative to historic norms in this dynamic macro environment to preserve book value. Julian will provide more details on our efforts shortly. For the quarter, Improving prepayment speeds continue to aid our Earnings Available for Distribution, or EAD, a non-GAAP financial measure. For the second quarter, we generated a GAAP net loss applicable to common stockholders of $17.6 million, or $0.92 per diluted share, and we generated EAD of $5.2 million, or $0.28 per share, exceeding our quarterly common dividend level of $0.27 per share. On an annualized basis, our dividend yield is hovering in the mid-teens based on the recent average of our closing price of our common stock. Importantly, EAD is just one of several factors we consider in setting our dividend policy. Book value for common share finished at $6.73 as of June 30th. As a reminder, our current book value performance per common share 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 approximately 4% quarter over quarter before taking into account any common stock issuances pursuant to our ATM program. We believe our NAV performance demonstrates that the actions we took during the first half of the year, along with our strategy of pairing RMBS with agency MSRs, contributed to mitigating risk and moderating the full impact of spread widening in agency RMBS. That said, we remain committed to stabilizing and growing our NAV and book value as we move ahead. We continue to believe the best approach to adding to our MSR portfolio is remaining selected given the macro environment, the competition, and robust pricing. During the second quarter, we acquired approximately 950 million new PB and MSRs via flow and bulk purchases. As we've said before, 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. At the end of the quarter, leverage was 3.4 times lower than the prior quarter as we remain mindful of the heightened market volatility in our current environment. We ended the quarter with $62 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile. Our recapture efforts remain solid, with a 12.1% recapture rate on our MSRs in the quarter despite the rise in mortgage rates. That said, recapture rates should continue to decline at these higher levels, though prepayment speeds net of recapture should continue to remain low. Looking ahead, we will continue to closely monitor MBS spreads, and at the appropriate time, we will look to raise our leverage toward more normalized levels. Our proactive decision to de-risk the portfolio and sell securities helped mitigate the impacts of the rise in rates and spread widening during the first half of 2022. We remain positioned for a bias towards further Fed tightening of monetary policy and a higher rate environment for the foreseeable future, as the economy tackles the highest inflation it has seen in over 40 years. In the meantime, we are keeping a firm hand on our balance sheet, and when we see attractive investment opportunities, we will continue to selectively invest. With that, I will turn the call over to Julian, who will cover more details regarding our investment portfolio and its performance over the second quarter.
spk06: Thank you, Jay. As Jay noted, the second quarter was marked by rapid rise in interest rates as the Fed worked to combat escalating inflation levels, including executing the first 75 basis point hike in nearly 30 years. The quarter also marked the start of the Fed outlining a plan and working to reduce its balance sheet. Throughout the quarter, we positioned our portfolio for a rising rate environment, as the U.S. 10-year rate rose to nearly 3.5 by the middle of June. Just as quickly, the U.S. 10-year fell in the final two weeks of the quarter and continued to move lower in July, despite the Fed hiking the Fed's funds rate another 75 basis points for a second consecutive month. The market continues to attempt to front-run the Fed, and for now seems to believe 3.5 is the ceiling for Fed funds, but until inflation appears to be tamed, the Fed will likely need to continue hiking rates. which may lead to a hard landing as the Fed tries to precariously balance curbing inflation without sinking the economy. At quarter end, our MSR portfolio had a UPV of 21 billion approximately and a market value of approximately 264 million. During the quarter, we purchased approximately 950 million UPV of new MSRs through our bulk and flow programs. At the end of the second quarter, the MSR portfolio represented approximately 40% of our equity capital and approximately 24% of our investable assets, excluding cash. Meanwhile, our RMBS portfolio accounted for approximately 40% of our equity. As a percentage of investable assets, the RMBS portfolio represented approximately 76%, excluding cash at quarter end. During the quarter, we continued to experience CPR improvements in both our MSR and RMBS portfolios. Our MSR portfolios net averaged CPR approximately 10 percent for the second quarter, down from approximately 13 percent net CPR in the previous quarter. The decline was mainly driven by the continued rapid rise in interest rates and the change in mortgage production coupons, which drove slower prepayment speeds in the quarter. The portfolio's recapture rate was lower at 12% versus 20% in the first quarter, which is expected as interest and mortgage rates rose, making the incentive to refinance less. Going forward, we should continue to expect a lower recapture rate but stable or improving net CPRs given the elevated levels of interest and mortgage rates. The RMBS portfolio's prepayment speeds exhibited similar themes. The portfolio's weighted average three-month DPR reduced to approximately 7% for the second quarter, compared to approximately 11% in the first quarter. As rates moved higher, mortgage securities became less refinanceable. As of today, the majority of the mortgage universe is out of the money in terms of refinancing. We would expect big payments to remain low as long as rates stay at these levels or move higher. As of June 30th, the RMBS portfolio inclusive of PBAs stood at approximately $831 million, compared to $941 million at the previous quarter end. The portfolio reduction was driven by the selling of securities, rising interest rates, as well as mortgage spread widening. Quarter over quarter, the size of the RMBS portfolio was reduced to lower basis risk and to protect book value as interest rates rose. In addition to reducing the size of the RMBS portfolio, we changed the portfolio's composition, moving into higher coupons, reducing spread duration for the portfolio. In addition, we took the opportunity to improve yields for the portfolio in the quarter. At the end of the second quarter, the 30-year securities position represented 93% of our RMBS portfolio, a similar percentage to the end of the first quarter. Shorter-duration securities made up 7% of the portfolio at quarter end. For the second quarter, we posted a 3.46 RMDS net interest spread versus a 3.06 net interest spread reported for the first quarter, driven by higher yields as we repositioned the portfolio coupled with a combination of better prepayment speed. The spread was also aided by lower net interest expenses due to our payer swaps its three-month LIBOR and SOFR reset to higher levels, which minimized the effects of higher repo costs. At quarter end, the portfolio leverage stood approximately 3.4 times at the aggregate level, and the portfolio was managed with a negative duration gap. Looking forward, we remain cautious, and we expect the investment markets to remain volatile and operate with limited liquidity. The Fed verbally remains committed to bringing inflation down from a 40-year high. Last week, the Fed raised the Fed funds rate, and we expect them to raise the Fed funds rate further in fiscal year 2022. Despite its efforts, inflation remains at elevated levels. Over the next several weeks, a battle in the markets will be waged between the Fed's commitment to inflation fighting and an economic slowdown, possible recession. Current markets are implying that the Fed will be able to handle inflation but give way to a pending recession in 2023 and start the process of easing monetary policy. The investment markets are attempting to front run or anticipating a Fed pivot, assuming the Fed will either moderate the size or the pace of the Fed's funds increases as well as never reach the upper bound of its rails. We expect the economy to slow. but that the feds remain committed to lowering inflation as inflation remains solidly above its target of 2%. I will now turn the call over to Mike for our second quarter financial discussion.
spk05: Thank you, Julian. Our gap net loss applicable to common stockholders for the second quarter was $17.6 million, or 92 cents, per weighted average diluted 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 $5 million, or 26 cents per weighted average diluted share. Our earnings available for distribution attributable to common stockholders were $5.2 million, or 28 cents per share. Our book value for common share as of June 30th was $6.73, compared to a book value of $7.27 as of March 31st, 2022. 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 second quarter, we held interest rate swaps, TBAs, and treasury futures, all of which had a combined notional amount of $1.3 billion. You can see more details with respect to our hedging strategy in our 10Q, as well as in our second quarter presentation. For GAAP purposes, we've 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 $3.1 million for the quarter. On June 17th, 2022, our board of directors declared a dividend of 27 cents per common share for the second quarter of 2022, which was paid in cash on July 26th, 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 July 15th, 2022. At this time, we will open up the call for questions. Operator?
spk00: To ask a question, please press star 1. Your first question is from Henry Coffey of Wedbush. Please go ahead. Your line is open.
spk04: Yeah, good afternoon, and thank you for taking my question. How do market conditions today compare to where they were at the end of June when we saw all these marks? I mean, have things calmed down a little bit? Are spreads narrowed? Are they widening? What is the general – how do we compare today to June 30th?
spk06: Hi, Henry. This is Julian. If it's just in terms of, like, mortgage spreads, it's been a volatile couple days since – well, I guess since the end of – if you want to go since the end of June, they've tightened in pretty reasonably, I would say. maybe 15 to 20 basis points tightening in to the end of July. And post-July, we are fluctuating around. So yesterday were wider. Today they're tighter. So call it relatively flat for the start of August here. But from a net spread... Go ahead.
spk04: I'm sorry. I'm sorry. Keep going.
spk06: Well, from a spread perspective, RMBS is tighter from the end of June.
spk04: So should we expect to see positive fair value marks coming through or more of what we've seen in the last two quarters?
spk07: Are you talking about company-wide, Henry, or are you more just talking about RMBS?
spk04: Both. Both. I mean, obviously, we've had a couple of other REITs reports, so we understand what's going on. Yeah, sure.
spk05: Mike, you want to give Henry a... Yeah, through July 31st, we see book value per share up about 2%, and that is, of course, excluding any accrual for a dividend, as the board has not yet met to approve a dividend for the quarter.
spk04: All right, thank you.
spk00: Your next question is from Mihail Govmin of JMT Securities. Please go ahead. Your line is open.
spk01: Hi, good afternoon, gentlemen. I hope everybody's well. A quick two-parter from me. Could you guys talk maybe for a little bit about how you see the agency RMBS versus MSR relationship? pair off trade working from a capital allocation standpoint going forward? And also, is there any appetite to maybe take up leverage from this point on? Thanks.
spk07: Sure. So to the first question, which I think was how do we think about the allocation of capital relative to the percentage of equity to each strategy? I think one of the things that we've done is we've taking down leverage on the RMBS side throughout the year just given our view on where spreads could go and some of the volatility in the space as rates backed up what I think we would call meaningfully through the quarter. And during that process speeds for the MSR portfolio have remained low. So the desire to grow that portfolio versus maintain its size I would tell you that we have chosen to more maintain the size of the portfolio and the percentage of equity in each asset class. I think primarily one because of the, what I would call just, you know, the MSR market being a little bit on the rich side today relative to where we think the value is in terms of the newer production and our view that we think that spreads should normalize. on the RMBS side, and we would look to increase our activities on that side of the house.
spk04: Got it.
spk07: Thank you for that. As it relates to the leverage question, I think we have a view that spreads are starting to normalize. I think you've heard other people say the same, and we've seen some people raise capital with the intention of deploying capital into the agency space. You know, we are constructive on the RMBS space today. We think that there's value there, but we are very mindful of the volatility day-to-day in the market relative to all things geopolitical, macroeconomic, and anything related to what the Fed may or may not say on any given day.
spk04: Thanks, Shea. Sure.
spk00: Your next question is from Matthew Howlett of B. Reilly. Please go ahead. Your line is open.
spk03: Oh, hey, Jay. Thanks for taking my question. On MSR evaluations, I mean, at this point, do MSR values, can they keep going up or do they just sort of have one, they only kind of go one way from here? And then what's the, you know, a lot of the servicers talk about escrows. I'm assuming you get the escrows on the MSRs. I mean, is that going to have an impact if federal funds continues going higher?
spk07: So I'll take the last part first. Escrows are a component of the valuation, and clearly as rates rise, that becomes a larger part of the valuation. And we are very focused on that relative to how we think about the MSR valuation in the aggregate. So I would say that escrows have become they become a more meaningful impact to the valuation, you know, versus rates at, you know, versus 10-year or 50 basis points short or fed funds at zero. So, yes, you know, as rates rise, those become a larger portion of the valuation of the asset class. The first part of your question is probably a little bit more involved because that really depends on the collateral composition of the portfolio. If your portfolio is largely lower coupon MSRs, then I think clearly what we've seen as rates rise, the benefit and the correlation to the two assets sort of stabilizes and it becomes less correlated. But I think as you add more MSRs that are more current coupon, those those assets clearly can rise and fall just purely based on paying more in the money. So does that answer your question somewhat? Our portfolio today is somewhat barbelled, so we have a portion of the portfolio at, let's just say, three and a quarter and below, and a portion of the portfolio that we probably see at 375 and above. It really wasn't a lot for us in the three and a quarter to 375. So from that perspective, there is room for the portfolio to grow in value, but again, not so much in the lower coupons. Gotcha. That's very helpful.
spk03: And then I heard your comments about the market's still volatile and you want to keep some dry powder. How much of this – I didn't hear you make any comments in terms of the Fed. Do you believe the Fed will start selling again? mbs i mean it's sort of been slow to start running it off i mean how much is that going to have an impact do you think that we we could go a lot wider and is that what you're waiting for if they do start selling yeah so you know that's a really good question um and it i think you know broadly speaking i think our performance during the quarter was better
spk07: than a lot of agency guys in part because we divested of a lot of the lower coupon MBS throughout the quarter early on in anticipation of a potential spread widening more heavily in the lower coupon stack. I think others may have held on and they got hit in the second quarter and got a bigger benefit in the third quarter. But we definitely repositioned ourselves more out of the lower coupon stack, part of the coupon stack because of a fear that if the Fed does start to sell, they are the primary holder of this stuff and could materially impact spreads on the lower coupon MBS. And while we don't have a strong view either way that they're going to sell or just let it run off, our view was that we weren't really interested in managing that risk. And hence, I think you see a slightly or a more stable profile relative to the book value in that side of the house because of that. Do you think that accurately describes it, Julian? Yeah, I think so.
spk03: No, that makes – it's definitely smart repositioning. The book held up a lot better than Pierce. I guess the last comment is on – like you said, you know, Carrie Hill would get this big – because you have a little bit more preferred, you're going to get this big snapback in book. I think you said 50 bips and basis tightening. The book could go to like eight or nine, back to eight or nine dollars. But at the same time, you probably really like the wide spreads. You don't really want to see the basis tighten. So to investors, just think about, we just think about getting, you know, high returns, high cash flows, using low leverage and just, you know, let, you know, what, you know, what, sort of just enjoy that part of it instead of just sort of, you know, waiting for the spreads to tighten? Do you feel like this is now a time to really begin growing again, given where spreads are and how well you're positioned for, you know, the rate environment?
spk07: So I would say that, you know, clearly we're at wides for a lot of coupons spread-wise. You know, I think that it's not as easy to just say that on a more broad level because... of who owns certain coupons and where we think a more historical norm is for the spreads on that part of the coupon stack. But I would say that we do expect to tick up leverage at some point, and we feel good about having taken it down thus far and are looking for good opportunities to grow the RMBS portfolio as we feel things sort of get to a point that's more normalized from a historical level. Julian, do you have anything you want to add to that?
spk06: Yeah, I think the main thing is I think you're looking for some stability in rates. I mean, every day we've moved probably a half a point to a full point, which equates to six basis points to 12 basis points a day. So I think what we're looking for is a little bit of stability. And I don't think that's truly played out in the markets. What we've seen, at least in the start of the third quarter, You've had lower coupon mortgages outperform given the flattening or kind of the continued invertedness of the curve that's taken place, and higher coupons have actually lagged in the spread tightening. So I think in general we can get some stability in rates. We take up the leverage. We put more money to work. But I think that we've got to get more stability out of the Fed. The Fed is obviously this week stated they've got very much committed to to raising interest rates or Fed fund rates to getting them to a level that's much more restricted in the economy. And I think this goes back to the last paragraph that I kind of talked about, which is at the end of the day, you know, there's going to be this fight over the next couple months, and it comes down to is there going to be a recession or are we going to have a soft landing and the Fed is going to be able to achieve what it wants to do on the Fed funds rate side?
spk03: Gotcha. Well, look, returns are just phenomenal for the leverage you're currently using. So to think that they could get better is something that's really eye-opening. But I appreciate the patience, and thanks for your comments. Thanks, Matt.
spk00: We have completed the allotted time for questions. I will now turn the call over to Jay Lone for closing remarks.
spk07: Thanks, everyone, for joining us on our second quarter 2022 call, and we look forward to updating you in a couple months for our third quarter results. Have a great evening.
spk00: This concludes today's conference call. Thank you for your participation. You may now disconnect.
Disclaimer