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spk00: Good day and thank you for standing by. Welcome to the Cherry Hill Mortgage Investment Corporation second quarter 2023 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Garrett Edson. Please go ahead.
spk02: We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's second quarter 2023 conference call. In addition to this call, we have filed a press release that was distributed earlier this afternoon and posted 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 different 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 Hodgeby, the Chief Financial Officer. Now, I will turn the call over to Jay.
spk06: Thanks, Garrett. and welcome to our second quarter 2023 earnings call. Markets in the second quarter were again largely driven by the Fed and economic data as regional bank pressures eased and markets absorbed the MBS asset sales from the FDIC. At a macro level, while rates ended the quarter higher at 3.84 percent, the U.S. 10-year treasury fell as low as 3.3 percent early in the quarter when the banking crisis was still top of mind. Spreads tightened slightly toward the end of the quarter, creating some tailwinds for agency MBS investors, and the worst-case scenario of a significant recession seemed to wane. In light of the uncertainty around Fed policy and the direction of rates during the quarter, we continue to maintain a disciplined, neutral posture, avoiding significant rate bets in either direction, working to protect and enhance value. Inflation, while stabilized, has remained elevated above the Fed's 2% target, giving the Fed enough justification to raise rates 25 basis points in May and again last week. We believe we are near the end of the tightening cycle, and as others have noted, this should be a positive catalyst for agency MBS securities and potentially drive more attractive returns. Assuming that remains the case in quarters ahead, we are positioned well to deploy capital into new RMBS opportunities as we move through the back half of the year. For the second quarter, we generated a GAAP net loss applicable to common stockholders of $0.03 per diluted share, and we generated earnings available for distribution, or EAD, a non-GAAP financial measure, of $4.2 million, or $0.16 per share. As we've noted before, EAD is only one of several factors considered in setting our dividend policy. Additionally, factors such as the existing market environment and portfolio return potential, our level of taxable income, including hedge gain impacts, and the degree of certainty regarding forward investment return economics all contribute to determining what we believe is the appropriate dividend level. Book value per common share finished at $5.19 as of June 30th, down 6% from March 31st. On an NAV basis, which includes preferred stock in the calculation, and before taking into account any issuances of equity through our common stock ATM program, we were down 3% relative to March 31st. As noted in our prior quarter, Our existing mix of common to preferred equity amplifies the impacts of changes in our total equity or common book value. Creating a more stable equity profile is in our shareholders' best interest and remains a top priority for us. During the second quarter, we continued to stand firm on our MSR portfolio, as we believe agency RMBS presented a better return profile in the current environment. Prepayment speeds on our MSR portfolio remain low, and thus the pace of reinvestment required to maintain the allocation of capital to the asset class is low. Recapture rates on MSRs remain minimal, given the higher interest rate levels. Our portfolio of MSRs has a weighted average note rate slightly less than 3.5%, providing us with plenty of room to weather potential rate cuts down the road before impacting our prepay speeds in a meaningful manner. We continue to believe our strategy of pairing MSRs with agency MBS, along with proactive portfolio management and hedging, is the right long-term strategy to steer through the current challenging environment. At the end of the quarter, financial leverage stayed consistent at 4.4 times as we opportunistically deployed additional capital through the quarter. We remain prudently levered and assuming the economy slowly continues its march towards stabilization, we expect to remain opportunistic in the deployment of capital. We ended the quarter with $53 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile. Looking ahead, we are maintaining our conservative yet proactive approach to portfolio management for the near term. As the volatility around the Fed further diminishes, and we begin to return to an environment where mortgages typically perform better, we believe there is an opportunity to deploy capital into additional agency MBS, which currently presents a strong risk-adjusted return profile. Our priority remains to protect book value, and we remain mindful of our liquidity and leverage profile. With that, I'll turn the call over to Julian, who will cover more details regarding our investment portfolio and its performance over the second quarter.
spk04: Thank you, Jay. The second quarter of 2023 began with the overhang of the banking crisis, as the market seemed to believe that the Fed would need to stop raising rates. As concerns related to the banking crisis ebbed and began to fade during the quarter, rates began to rebound higher as the Fed used the resilient economy as a backdrop to continuous war on inflation, raising rates 25 basis points in May and once again last week. Notably, with the headline CPI posting 3% in June, it seems that the Fed is getting close to a terminal rate for Fed funds, with the possibility of one or two more rate hikes left as the Fed attempts to get inflation back to the target rate of 2%. Optimistically, this appears to be giving the market signs of stabilization amid a growing belief that the Fed may be able to achieve a soft landing while holding rates higher for longer. We continue to employ a thoughtful hedging strategy in the second quarter, remaining long duration, which impacted our book value. However, we believe we are properly positioned from a hedging perspective given the current macro environment and managing through the environment as best as possible. Our investment strategy has carried over thus far into the third quarter. At quarter end, our MSR portfolio had a UPV of $20.8 billion and a market value of approximately $265 million. At quarter end, EMSR and net related assets represented approximately 43% of our equity capital and approximately 31% of our investable assets, excluding cash. Meanwhile, our RMBS portfolio accounted for approximately 40% of our equity capital. As a percentage of investable assets, the RMBS portfolio represented approximately 69%, excluding cash at quarter end. During the quarter, prepayment speeds for our MSR and RMBS portfolios rose modestly as rates fluctuated for much of the quarter. Our MSR portfolio's net CPR averaged approximately 6.2% for the second quarter, up from 4.7% net CPR in the previous quarter. The rise was mainly driven by seasonality. The portfolio's recapture rate remained consistent but low at approximately 1%. As the incentive to refinance continues to be minimal, Moving forward, we continue to expect low recapture rates and a stable net CPR for the foreseeable future given the current levels of interest and mortgage rates. The RMBS portfolio's prepayment speeds remain low, driven by the combination of new asset purchases as well as the fact that the current higher mortgage rate environment is compressing CPRs for the existing portfolio. As of today, the majority of the mortgage universe remains out of the money in terms of refinancing. We would expect prepayments to remain at low levels as long as interest rates stay at these levels or move higher. For the quarter, the RMBS portfolio's weighted average three-month CPR moved a bit higher to approximately 4.2% compared to approximately 3% in the first quarter. As of June 30th, the RMBS portfolio, inclusive of TBA, stood at approximately 602 million compared to 709 million at the previous quarter end. Quarter over quarter, the spec pool portion of the portfolio remained constant, but the composition of the portfolio changed during the quarter as we opportunistically moved into higher coupon mortgages and put new cash to work. At the same time, we materially increased our TVA hedges as an offset. For the second quarter, our RMBS net interest spread was 3.84%. The increase was driven by higher asset yields resulting from new purchases as well as a change in the portfolio's composition, both of which helped to offset higher repo costs. At quarter end, the portfolio's financial leverage remained at approximately 4.4 times, and the 30-year securities position represented 100% of our RMBS portfolio. Looking forward, We remain mindful of the ongoing challenging environment, but are optimistic that we may be getting close to a terminal rate given encouraging inflation data. I will now turn the call over to Mike for our second quarter financial discussion.
spk03: Thank you, Julian. Our gap net loss applicable to common stockholders for the second quarter was $0.9 million or 3 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 available for sale RMBS, was $3.9 million or 15 cents per weighted average diluted share. Our earnings available for distribution attributable to common stockholders was $4.2 million or 16 cents per share. Our book value per common share as of June 30th was $5.19 compared to a book value of $5.52 as of March 31st, 2023. 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 approximately $700 million. You can see more details with respect to our hedging strategy in our 10-Q as well as in our second quarter presentation. For gap purposes, we have not elected to apply hedge accounting for interest rate derivatives. As a result, we record the change in estimated fair value as a component of the net gain or loss on interest rate derivatives. Our operating expenses were $3.7 million for the quarter. On June 15, 2023, our Board of Directors declared a dividend of 15 cents per common share for the second quarter of 2023, which was paid in cash on July 31, 2023. 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 17th, 2023. At this time, we will open up the call for questions. Operator?
spk00: Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile a Q&A roster. Our first question comes from Mikhail Goberman with JMP Securities. Your line is open.
spk01: Hey, good afternoon, guys. Hope everybody's doing well. With the recent kind of bond sell-off firmly in mind, just kind of thinking about how are you guys thinking about the mix of agency MBS and MSRs should rates continue to sell off and we get a continuation of the rising rate environment? How are you?
spk04: Good, thank you. This is Julian. You know, look, it's been a very interesting week, very volatile. I think we're constantly updating and changing the portfolio on a given day. From a longer-term, I should say, perspective, the combination of, you know, MSR and as well as agency mortgages is a very sound strategy that we truly believe in. I think in the short term what we found is that RMBS at the current moment yields a little bit better than what the MSR is yielding from a valuation standpoint. And so we'd probably be holding more agency RMBS. As for rates continuing to go up, we continue to move around the portfolio, manage the asset side as well as the liability side, and, you know, we're trying to effectively minimize the risk in the portfolio.
spk06: And one other thing to note, Michael, is that, you know, a decent portion of our RMBS portfolio is hedged. with TBAs, which mitigates some of the spread widening that you've seen this week. So in a widening environment, we feel great about what we're doing. Obviously, in a spread widening, you have more protection. And when spread's tightened, we definitely don't get the same benefit that others do. But we definitely have tried to mitigate some of the spread widening risk. in an environment where we think the Fed may not be done, and if we are in higher rates, there's the potential for further spread of money.
spk01: Got it. Thank you for that. Just kind of thinking about the mix of possibly issuing more stock through the ATM versus buybacks with the stock at about 90% of book. How are you guys thinking about the trade-offs there going forward?
spk06: So we haven't really thought, you know, so we haven't thought about the ATM in a little bit with respect to, you know, where we are relative to, I think, what you're referencing as tangible book. You know, it's definitely something that we think about with respect to the board, but, you know, it's a decision that we make with the board. Currently, you know, we are not tapping the ATM today, but... We do have some parameters internally to think about relative to how we think about raising capital through that program. And similarly, I think if the stock gets to a level that would support buybacks, then we would definitely consider that as well. Same thing with the preferred.
spk01: Got it. So when you're thinking about buybacks, do you look at the stock on a tangible basis or on a straight-up book value basis?
spk06: To be perfectly candid, tangible.
spk01: Okay. And with that in mind, just one more, if I may. Just any update on book value thus far in the third quarter. Thank you, guys.
spk06: Yeah, sure. So we just don't have that yet. Honestly, it's been all hands on deck to be able to report at this point. And we're three days into the month. And as you know, with the MSRs and that, we just don't have that for you. I wish I did, but We were racing to get, you know, done to be able to do the call on time, and I just don't have it yet.
spk01: No problem. Best of luck going forward. Thanks, guys.
spk00: Thanks. One moment for our next question. Our next question comes from Matthew Howlett with B Reilly. Your line is open.
spk05: Oh, hey, good afternoon. Hey, Jay. Hey, everybody. Hey, Matt. Good. Thanks. Thanks for taking my question. Just on the comments around MBS and value and spreads, and I think I heard you correctly where you said sort of you don't see a lot of catalysts for things to tighten here, at least in the short term. I want to hear how you look at value. Do you look at – how do you look at spreads to treasuries? Do you look at other – how do you address value in the MBS space? And what are the signs you need to see where sort of spread widening is done and it's time to kind of go in? Is it just the Fed needs a signal they're going to cut rates or the Fed needs to stop running off their book? I'd just love to hear it because everything we read is that MBS is just cheap to corporates and it's just huge value. There's not a lot of supply. Fannie's book came down and that supply is going to tighten spreads here in the back half of the year.
spk04: Yeah, so, hi, Matt. It's Julian. You know, look, I think when we look at agency RMVs, you know, in the past, we've looked at them versus swaps. Now that the swap curve has kind of gone away, the question is, do you want to look at them versus SOFR or treasuries? I'd say on a nominal basis, we're looking at them versus treasuries. We still run OAS to kind of see where mortgages are. I think those two are effective tools in terms of trying to figure out the valuation. In terms of spreads, I think, look, I think we've all looked at spreads from a historical standpoint on a nominal basis. And if you take a look at them over the five-year timeframe, they are very attractive from a historical standpoint. I think if you look at the average over the five-year timeframe, it's like to an 83 spread And, you know, right now we're probably about 175, given the widening that we've had continuing over the last couple of days. It's been as high as 200. In our mind, I think that chops around. You know, I think it's going to chop around a little bit, given that volatility is you know, comes and goes all the time, it seems, as of late. And it can come from anywhere in terms of statements, either by our own Fed or from other central banks globally at this point in time. And I think what you're asking for is when will you finally see some type of, you know, tightening that's more continuous than what we have experienced so far. I think you need stability in rates. I think you need volatility to kind of stabilize, if not truly be able to maintain the lower levels and continue forward. I do think that you need the banks to feel comfortable coming back into the market to buy mortgages. I think a lot of people have bought mortgages at the wider levels of $175, $200 in that particular range. I think you'll find a lot of the indexers or investors who had been on the sideline are kind of neutral to kind of overweight at this point in terms of mortgages. There is no doubt that they are attractive from a long term, but over this short-term time frame, if volatility continues to move the way it is, I think it's going to be hard for them to tighten and stay there continuously. And I think it's the reason why we continue to hold TBA shorts in the portfolio.
spk05: Look, it makes a lot of sense. Did you say spreads did widen here this past week with the soft and long bond?
spk04: Yes, they have widened.
spk05: Okay, good. Look, it makes sense what you're saying and keeping the short TBA position. My next question is this. I mean, we all try to kind of figure out how much excess capital each REIT has and where they could take leverage up to. And it's hard to do it holistically across the space. I want to ask you, when you look at your leverage just over four turns and your asset mix with 40% RMBS and 43% service, when you talk about full deployment or where you could take the portfolio to or where you could take leverage to, how should we think about it? Some reads say 9, 10 times, but I know you have some MSRs. How do we look at your balance sheet and how much excess capital there could be when you finally decide to say, let's add some RMBS?
spk06: You know what? It's a great question, dude. I think that we've been holding more cash than I think I would like to in a normal, stable environment. But I think this week is a perfect example as to why we do that still, just given the the margin calls around spread widening this week in the S side of the house. I do think that, you know, as you get closer to the end of the year and you get closer, you know, to the end of the Fed cycle, that there's going to be an opportunity to take up leverage, whether that's, you know, one, two turns or whatever. We don't have that dialed in yet, but I think that, you know, as Julian pointed out, as other REITs have as well, when the spreads start to widen at specific points in time, we do try to nibble in when we think there's value. And I think you'll see slowly us take up leverage of it as we feel, again, to Julian's point, the ball's coming down, things are starting to stabilize, and market reactions to economic data, geopolitical news, et cetera, It doesn't create the volatility in the markets that it still currently does today. So our intention, I can tell you, is over time we would like to take up the leverage somewhat. I can't tell you exactly how, but I think that's really, you know, the Fed says data dependent, and I would say that it's really dependent upon the ability for the market to get to a point where it's able to absorb economic data and information and news and, and stabilize. And so do I think that's in the next six to 12 months? Absolutely.
spk05: Yeah. Look, it's clear. I mean, the earnings power is significant. I mean, if you take up, you know, you're just a turn or, you know, uh, and, and I think that's, uh, I think something we've all been waiting for. I don't clearly, you know, it's been incredibly volatile and you're doing, you know, a great job managing through it. But I think, uh, To hear you say you have a lot of dry powder and that you have the ability to gives me comfort that obviously there's significant earnings power in the company when the time is right.
spk06: Yeah, remember that's all going to come in on the RMBS too. We're pretty comfortable with where we're levered on the MSR front. You know, broadly speaking, we run about a 60% LTV. When we think about leverage on the MSRs and given some of the things that have happened over time, et cetera, et cetera, we're comfortable with that level for the MSRs. So if you think about where that additional leverage would come from, most likely it would come from the RMBS side of the house.
spk05: Gotcha. Well, great quarter, and we look forward to the next story of growth with the company. Thanks, Jay. Thanks, everybody. Sure. Take care, Mark.
spk00: Showing no further questions at this time, I would now like to turn the conference back to Jay for closing remarks.
spk06: Thank you, operator. Thank you, everybody, for joining us on our second quarter 2023 earnings call. We look forward to updating you soon on our third quarter's performance. Have a good evening.
spk00: This concludes today's conference call. Thank you for participating. You may now disconnect.
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