Cherry Hill Mortgage Investment Corp
NYSE:CHMI
Earnings Call Analysis
Summary
Q4-2023
The company entered Q4 2023 prepped for a 'higher for longer' rate environment, proven prudent by previous Fed indications and inflation data. However, the Fed's later dovish pivot led to unexpected market shifts—lower rates and tighter spreads—impacting the company's book value. Despite this, early 2024 showed alignment with their initial strategy as rates began climbing. The company posted a GAAP net loss applicable to common shareholders of $35.5 million, with book value per share decreasing 9.2% to $4.53. Earnings available for distribution were $4.5 million, covering the quarterly distribution. Strategic priorities include enhancing the equity profile, managing a GAAP net interest spread at 3.2% (up from previous quarter), maintaining a 4.2x leverage, and aligning the capital structure to bolster shareholder value. The company remains vigilant, ready to adapt in the persistently volatile market.
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Good day, and thank you for standing by. Welcome to the Cherry Hill Mortgage Investment Corporation Fourth Quarter 2023 Earnings Call. [Operator Instructions] 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 with Investor Relations. Please go ahead.
We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's Fourth Quarter 2023 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.chmireit.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.
Thanks, Garrett, and welcome to our fourth quarter 2023 earnings call. On our prior call, we talked about how we were laser-focused on risk management as the 10-year crossed 5% and agency mortgage spreads significantly widened. To that end, we proactively positioned our portfolio for flat to higher rates and to mitigate the spread widening we were seeing in the summer and early fall, by hedging out a portion of our basis risk in our RMBS portfolio with the TBAs.
By doing this, we had a strong third quarter and successfully preserved the vast majority of our shareholders' equity while others such as agency REITs were considerably impacted by the spread widening. Through our positioning, we were aware that should mortgage spreads compress, we would also not participate as much in any upside.
Shortly after our third quarter call, the Fed unexpectedly pivoted towards a much more accommodative tone, all but signaling that it would consider cutting rates beginning in early to mid-2024. The Fed further reinforced their tone in December despite the data continuing to support a higher for longer strategy. As a result, rates plummeted in the final 2 months of 2023. Lower coupon MBS outperformed higher coupon MBS and spreads tightened. As a result, our book value was impacted by this near-term movement. That said, we've seen a reversal thus far in 2024 as the data continues to track and align with how we initially positioned our portfolio. Inflation remains hot with the PCE still elevated, which has compelled the Fed to telegraph a more patient posture around future rate cuts.
The market has gradually followed and rates have risen in the first 2 months of this year. We are watching the Fed and economic indicators closely as we position our portfolio moving forward and believe our overall strategy of pairing MSRs with Agency RMBS remains the proper strategy for the current environment.
For the fourth quarter, we generated GAAP net loss applicable to common stockholders of $1.29 per diluted share, and we generated earnings available for distribution or EAD, a non-GAAP financial measure of $4.5 million or $0.17 per share, which once again covered our quarterly distribution. As we've noted before, EAD is only 1 of several factors considered in setting our dividend policy. Additional factors such as the existing market environment and portfolio return potentially.
Our level of taxable income, including hedge gain impacts and a 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 the year at $4.53, down 9.2% from September 30, primarily driven by portfolio positioning, combined with lower MSR marks as well as having a negative duration positioning, all of which was marginally offset by spread tightening. On an NAV basis, which includes preferred stock in the calculation, NAV would have been down approximately 4.3% relative to September 30. If we were to exclude the capital raised through the ATM.
We've consistently noted that our existing mix of common preferred equity amplified the total changes in our total equity or common book value compared to our NAV. We shared in the past that creating a more stable equity profile is a top priority in terms of our overall strategy. In the fourth quarter, we began to put that strategy to work. We raised $11.8 million through our at-the-market common share program, and we utilized over $6 million of the funds raised earlier this year to repurchase some of our Series B preferred shares. We believe it is the right step for the company to put us on a much firmer footing with respect to our capital structure. This approach should benefit common shareholders as the repurchase of Series B preferred shares ultimately reduces the amount we pay for preferred dividends once the Series B transitions to a floating rate.
As we move through 2024, we will continue focusing on similar measures to further enhance our equity profile while remaining mindful of our balance sheet strength and our investment portfolio. At the end of the year, financial leverage reduced slightly to 4.2x as we continue to stay prudently levered as the volatile market dynamics persist and selectively deploy capital. We ended the quarter with $53 million of unrestricted cash on the balance sheet, maintaining a solid liquidity profile. Looking ahead, we continue to manage our portfolio closely and focus on risk management in these volatile times. We will continue to selectively deploy capital into additional Agency RMBS, which still presents a strong risk-adjusted return profile compared to MSRs. And we'll remain hard at work improving our equity profile for the ultimate benefit of common shareholders while not sacrificing our strong liquidity and leverage. With that, I will turn the call over to Julian, who will cover more details regarding our investment portfolio and its performance over the fourth quarter.
Thank you, Jay. As Jay noted, we had appropriately positioned our portfolio for the higher for longer rate environment. That economic and inflation data continue to support and we benefited in the third quarter as well as in October from that positioning. In November, despite the data still supporting our position, we were surprised by the Fed's sudden shift in policy away from higher for longer. And clearly intimating that they would be looking to cut interest rates multiple times in 2024.
Interest rates rallied, the yield curve flattened and mortgage spreads tightened over the next 2 months. Ultimately, lower coupon RMBS outperformed the higher coupon RMBS, where we were primarily invested. Our MSRs were impacted and our portfolio's negative duration was not positioned for the rate rally, leading to our book value performance. Thus far, in 2024, we've seen another pivot in the Fed's policy partially stepping back from the aggressive language as the economic and inflation data further booster our thesis that our portfolio was appropriately positioned. We are prevailing thus far in the first quarter. We continue to closely watch the Fed and will further proactively adjust our portfolio as necessary given the ongoing volatility. At year-end, our MSR portfolio had a UPB of $20 billion and market value of approximately $254 million. The MSR and related net assets represented approximately 44% of our equity capital and approximately 28% of our investable assets, excluding cash at the end of the quarter. Meanwhile, our RMBS portfolio accounted for approximately 39% of our equity capital. As a percentage of investable assets, the RMBS portfolio represented approximately 72%, excluding cash at year-end. Prepayment speeds for our MSR and RMBS portfolios continue to remain relatively steady compared to the prior quarter given the elevated mortgage rate environment. Our MSR portfolio's net CPR averaged approximately 4.2% for the fourth quarter, modestly down from 5.6% net CPR in the previous quarter. The portfolios 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 at a stable net CPR for at least the near term, which should the Fed pursue rate cuts would expect both matrix to rise over time. The RMBS portfolio's prepayment speeds remained low as expected, driven by a combination of new asset purchases as well as the fact that the current higher mortgage rate environment continues to compress CPRs for the existing portfolio. As of today, the majority of mortgage universe remains out of the money in terms of refinancing. We would expect prepayments to remain at low levels as long as the interest rates remain at these levels, but should there be a rate cut later this year, prepayments will begin to rise. For the quarter, the RMBS portfolio's weighted average 3-month CPR was slightly higher at approximately 4.9% compared to approximately 4.4% in the third quarter. As of December 31, the RMBS portfolio inclusive of TBAs stood at approximately $655 million compared to $583 million at the previous quarter end. Quarter-over-quarter, we reduced some of our TBA hedges in the portfolio as we shifted towards a more neutral posture given the Fed's pivot on their policy stance towards potential rate cuts.
For the fourth quarter, our RMBS net interest spread was 3.2%. The increase from the prior quarter was driven by lower repo costs due to lower repo balances and improved amortization expenses. At year-end, the portfolio's financial leverage remained at approximately 4.2x, and the 30-year securities position continued to represent 100% of the RMBS portfolio. Looking forward, we expect volatility to remain elevated for at least the near term. Our macro growth and particularly inflation to have a significant impact on the upcoming Fed decisions. We will continue to manage our portfolio thoughtfully while looking to shift our overall capital structure to further add value for shareholders through improved performance and earnings.
I will now turn the call over to Mike for our fourth quarter financial discussion.
Thank you, Julian. Our GAAP net loss applicable to common stockholders for the fourth quarter was $35.5 million or $1.29 per weighted average diluted share outstanding during the quarter. While comprehensive loss applicable to common stockholders, which includes the mark-to-market of our available for sale RMBS, was $6.5 million or $0.24 per weighted average diluted share. Our earnings available for distribution attributable to common stockholders were $4.5 million or $0.17 per share. Our book value for common share as of December 31 was $4.53 compared to a book value of $4.99 as of September 30. 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, TBAs and treasury futures, all of which had a combined notional amount of approximately $955 million. You can see more details with respect to our hedging strategy in our 10-K as well as in the 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 8, 2023, our Board of Directors declared a dividend of $0.15 per common share for the fourth quarter of 2023. The which was paid in cash on January 31, 2024. We also declared a dividend of $0.5125 per share on our 8.2% Series A Cumulative Redeemable Preferred Stock and a dividend of $0.515625 on our 8.25% Series B Fixed-to-Floating Rate Cumulative Redeemable Preferred Stock, both of which were paid on January 16, 2024. At this time, we will open up the call for questions. Operator?
[Operator Instructions] And our first question comes from Mikhail Goberman with Citizens JMP.
I guess the first one I have is what are your guys' thoughts on appetite for leverage going forward, given it's kind of in the lowest level of recent memory, I guess, I could say? And I guess the second question would be perhaps an update on book value thus far in the first quarter.
In terms of leverage, I think we will adjust that over time. Right now, we feel as if the market is still very volatile, spreads in terms of RMBS are still attractive, but they're on the lower side of where they've been over the last year. I think the average has been about 150 basis points. And right now, we're trading a little bit through that, probably have some further downside to go. But could easily see, given the headlines and what the Fed actually decides to do it the next couple of meetings to still see the markets be very volatile. Longer term, we do think that the Fed will ease later this year. They've moved obviously from a tightening bias to more of a neutral bias. And at some point, they will get to an easing bias once they feel that inflation has gotten to the level that they feel comfortable with.
Mikhail, to touch on book value for you. We see our February 29 book value per share at about flat versus year-end -- quarter end. And that's prior to any first quarter dividend accrual as the board has not yet met to approve it.
Great. And -- as far as the preferred stock repurchases of $6.1 million in the last quarter. Can we expect sort of a similar pace going forward quarterly? Or maybe something else?
Mikhail, I think that I can't give you a definitive answer there, but it's clear that we're trying to rightsize the leverage calculation here. And that Series B becomes floating in April. So it is our strong desire to do that. I think the hard part about answering your question about the pace of that is around trying to be mindful about the diluted impact and we're trying to do it with this minimal impact as we can. So the pace, I think, depends on a few things, but it's definitely our desire to keep going.
Got you. And if I can squeeze in one more. Any sort of thoughts on this potential MSR sales from NYCB?
So I don't have any color on that. We've been -- our conversations with Flagstar have been pretty high level and macro relative to our relationship on the servicing front. But I can't imagine that if they do that, it would be in a small block. So I imagine that others who have the ability to purchase something $10 billion or higher are probably going to get a better look at that than us. But today, we have no color relative to whether or not that's just a rumor or what. I think the -- I think the capital they got was a huge step towards stabilizing things. And I have -- just have no insight into what they're thinking relative to future moves to either appease the regulators or prop up the balance sheet.
[Operator Instructions] And I'm showing no further questions at this time. I would now like to turn the conference back to Jay for closing remarks.
Thank you, operator. Thank you for joining us on our fourth quarter 2023 call. We look forward to updating you in a few months on our first quarter 2024 call. Have a good evening, everyone.
And this concludes today's conference call. Thank you for participating. You may now disconnect.