Cherry Hill Mortgage Funding Company (NYSE:CHMI) Q1 2023 Earnings Convention Name Could 8, 2023 5:00 PM ET
Garrett Edson – ICR
Jeffrey Lown – President, CEO & Director
Julian Evans – CIO
Michael Hutchby – CFO, Treasurer, Secretary & Head, IR
Convention Name Individuals
Mikhail Goberman – JMP Securities
Matthew Howlett – B. Riley Securities
Good day, and thanks all for standing by. Welcome to the Cherry Hill Mortgage Funding Company’s First Quarter 2023 Convention. [Operator Instructions]. Please be suggested that in the present day’s convention is being recorded. I might now like handy the convention over to our speaker in the present day, Garrett Edson. Please go forward.
We would prefer to thanks for becoming a member of us in the present day for Cherry Hill Mortgage Funding Company’s First Quarter 2023 Convention Name. Along with this name, we have now filed a press launch that was distributed earlier this afternoon and posted to the Investor Relations part of our web site at www.chmireit.com.
On in the present day’s name, administration’s ready remarks and solutions to your questions might comprise forward-looking statements which might be topic to dangers and uncertainties that might trigger precise outcomes to vary from these mentioned in the present day. Examples of forward-looking statements embrace these associated to curiosity revenue, monetary steering, IRRs, future anticipated money flows in addition to prepayment and recapture charges, delinquencies and non-GAAP monetary measures equivalent to earnings out there for distribution, or EAD, and complete revenue. Ahead-looking statements symbolize administration’s present estimates, and Cherry Hill assumes no obligation to replace any forward-looking statements sooner or later. We encourage listeners to assessment the extra detailed discussions associated to those forward-looking statements contained within the firm’s filings with the SEC and the definitions contained within the monetary shows out there on the corporate’s web site.
At this time’s convention name is hosted by Jay Lown, President and CEO; Julian Evans, the Chief Funding Officer; and Michael Hutchby, the Chief Monetary Officer.
Now I’ll flip the decision over to Jay.
Thanks, Garrett, and welcome to our first quarter 2023 earnings name. On our final name, we famous that we stay positioned for extra price hikes as we awaited phrase from the Fed as to when the tightening cycle would finish, and our efforts to navigate the atmosphere and defend e-book worth had been holding up properly within the first quarter. Simply a few days after our name, Silicon Valley Financial institution immediately collapsed, with Signature Financial institution proper behind it, sending the U.S. banking sector into a major disaster that we had not seen since 2008.
Practically in a single day after the SVB information, rates of interest fell sharply because the markets consider the speed hike cycle was poised to finish a lot prior to anticipated and priced in price cuts within the second half of 2023 in anticipation of financial circumstances deteriorating. Subsequently, the yield curve each steepened meaningfully as short-dated charges fell considerably greater than longer-dated charges. We weren’t positioned for dis fast violent response. And given we had been positioned for larger charges, this situation was the place we had been most uncovered. That, mixed with further unfold widening submit the financial institution failures mid-March, negatively impacted our efficiency for the quarter.
In gentle of the continued banking turmoil, we have now maintained a conservative posture in the direction of each our publicity to rates of interest and the mortgage foundation. We consider the Fed funds price is approaching the terminal price, and the banking disaster is essentially contained, regardless of the current failure of First Republic, and see alternatives within the RMBS sector throughout the second half 2023. For the primary quarter, whereas we generated a GAAP internet loss relevant to frequent shareholders of $0.87 per diluted share, we generated earnings out there for distribution, or EAD, a non-GAAP monetary measure, of $5.2 million or $0.21 per share. Whereas EAD is just one of a number of components thought of in setting our dividend coverage, once we contemplate the present unsure atmosphere, we anticipate that EAD will proceed to be pressured within the close to time period.
Provided that macro backdrop and topic to Board approval, we anticipate to realign our dividend in June to a degree nearer to a yield of 13% to fifteen% of our present e-book worth. We consider this transformation will make sure that the dividend is extra in step with our present earnings outlook. E-book worth per frequent share completed at $5.52 as of March 31, down 8.9% from year-end 2022. A portion of that decline, as all the time, is as a result of most well-liked inventory makes up a good portion of our general fairness profile.
On an NAV foundation, which incorporates most well-liked inventory within the calculation, and earlier than bearing in mind any issuances of fairness by means of our frequent inventory ATM program, we had been down 5.3% relative to year-end. We added a slide on this quarter’s investor presentation which describes this influence in additional element. We consider making a extra steady e-book worth profile is in our shareholders’ greatest curiosity and stays a high precedence for us. We’re centered on persevering with to navigate by means of this very difficult and dynamic macro atmosphere.
In the course of the first quarter, we basically stood pat on our MSR portfolio, selecting to not make further purchases right now. Prepayment speeds on our MSR portfolio stay low and thus, the tempo of reinvestment to keep up the allocation of capital to the asset class has decelerated. Recapture charges on MSRs had been minimal as anticipated, given the upper rate of interest ranges. Our portfolio of MSRs has a weighted common observe price lower than 3.5%, offering us with vital room to climate price cuts down the street earlier than impacting our prepay speeds in a significant manner. We proceed to consider our technique of pairing MSR with Company RMBS, together with proactive portfolio administration and hedging, is the fitting long-term technique to steer by means of this difficult atmosphere.
On the finish of the quarter, monetary leverage rose modestly to 4.4x as we opportunistically deployed further capital throughout the quarter. Given the continuing market volatility, we consider we stay prudently levered and anticipate to be additional opportunistic in deploying capital within the months forward. We ended the quarter with $55 million of unrestricted money on the stability sheet, sustaining a strong liquidity profile.
Trying forward, we’ll proceed to keep up our conservative and proactive method to portfolio administration for the foreseeable future as markets digest macroeconomic knowledge and forecast Central Financial institution financial coverage actions. The place there are risk-adjusted alternatives to selectively deploy capital, we’ll take benefit as we did within the prior quarter. Our precedence stays to guard e-book worth, and we proceed to be aware of our liquidity and leverage profile.
With that, I will flip the decision over to Julian, who will cowl extra particulars relating to our funding portfolio and its efficiency over the primary quarter.
Thanks, Jay. The primary quarter of 2023 can greatest be described as unstable. The yr started on a optimistic observe for mortgages, with rates of interest transferring decrease and mortgage spreads tightening. That lasted till the tip of January, and subsequently, mortgage spreads was wider because the funding markets realized inflation was extra persistent and that the Fed would wish to proceed its rate-hiking path. In early March, the U.S. skilled a banking disaster, marked by the dual failures of SVB and Signature Financial institution, and was marred by the continued struggles of First Republic Financial institution, amongst different regional banks.
Practically in a single day, investor sentiment shifted to consider that the Fed price mountain climbing cycle was over, and that the funding markets can be experiencing nice cuts earlier than the tip of the yr to attenuate doable recession. Not would the Fed proceed to lift charges by means of the summer time. The Fed is in a tricky state of affairs and can have tough choices to make this spring headed into the summer time. Inflation is decrease, however stays elevated and above its goal of two%. Whereas the banking disaster, considerably contained, has the potential of spreading and tightening credit score circumstances and thus, decreasing progress.
These points might lead the Fed to ending its price mountain climbing cycle prior to initially anticipated and will maintain charges regular longer than anticipated because the Fed seeks higher readability on the problems beforehand talked about. In consequence, we continued to make use of a considerate hedging technique within the first quarter. And whereas the volatility of charges in March impacted e-book worth, we consider we’re managing by means of the atmosphere as greatest as doable. Our funding technique has carried over into the second quarter.
At quarter finish, our MSR portfolio had a UPB of $21.3 billion and a market worth of roughly to $271 million. In the course of the quarter, we made solely minimal purchases of latest MSRs by means of our bulk and move applications. At quarter finish, the MSRs and associated belongings represented roughly 45% of our fairness capital and roughly 28% of our investable belongings, excluding money. In the meantime, our RMBS portfolio accounted for about 39% of our fairness capital. As a proportion of investable belongings, the RMBS portfolio represented roughly 72%, excluding money at quarter finish.
In the course of the quarter, we continued to expertise CPR enhancements in each our MSR and RMBS portfolios. Our MSR portfolio internet CPR averaged roughly 4.7% for the quarter, down from 5.4% internet CPR within the earlier quarter. The decline was primarily pushed by seasonality and the change in mortgage manufacturing coupons, which drove slower prepayment speeds for the quarter. The portfolio’s recapture was lowered roughly 1% versus roughly 2% within the fourth quarter. As anticipated, with present mortgage price ranges, the motivation to refinance is minimal. Transferring ahead, we proceed to anticipate low recapture charges and a steady internet CPR for the foreseeable future given the present ranges of curiosity in mortgage charges.
The RMBS portfolio’s prepayment speeds remained low, pushed by the mix of latest asset purchases in addition to the truth that present larger mortgage price atmosphere is compressing CPRs, the brand new system proposed. As of in the present day, the vast majority of the mortgage universe stay out of the mannequin when it comes to refinancing. We’d anticipate prepayments to stay low so long as rate of interest ranges keep at these ranges or larger. For the quarter, the RMBS portfolio’s weighted common 3-month CPR decreased to roughly 3% in comparison with roughly 3.8% within the fourth quarter. As of March 31, the RMBS portfolio, inclusive of TBAs, stood roughly $709 million in comparison with $646 million within the earlier quarter.
Quarter-over-quarter, the spec pool portion of the portfolio continued to develop as we opportunistically put new money to work in addition to changing a number of greenback rolls into swimming pools as greenback rolls weaken additional. We additionally proceed to proactively change the portfolio’s composition. On the finish of the primary quarter, 30-year securities place represented 100% of the RMBS portfolio. For the primary quarter, our RMBS internet curiosity unfold was 3.41%, pushed partly by having a bigger portfolio and by having extra securities on repo. At quarter finish, the portfolio’s monetary leverage stood at roughly 4.4x. Trying ahead, we stay aware of the persevering with unsure atmosphere and await additional readability from the Fed relating to the terminal price.
I’ll now flip the decision over to Mike for our first quarter monetary dialogue.
Thanks, Julian. Our GAAP internet loss relevant to frequent stockholders for the primary quarter was $21.4 million or $0.87 per weighted common diluted share excellent throughout the quarter. Whereas complete loss attributable to frequent stockholders, which incorporates the March market of our out there on the market RMBS, was $7.1 million or $0.29 per weighted common diluted share. Our earnings out there for distribution attributable to frequent stockholders had been $5.2 million or $0.21 per share.
Our e-book worth per frequent share as of March 31 was $5.52 in comparison with a e-book of $6.06 as of December 31, 2022. We use quite a lot of by-product devices to mitigate the results of will increase in rates of interest on a portion of our future repurchase borrowings. On the finish of the primary quarter, we held rate of interest swaps, TBAs and treasury futures, all of which had a mixed notional quantity of $1.1 billion. You possibly can see extra particulars with respect to our hedging technique in our 10-Q in addition to in our first quarter presentation.
For GAAP functions, we have now not elected to use hedge accounting for our rate of interest derivatives, and consequently, we report the change in estimated honest worth as a part of the web acquire or loss on rate of interest derivatives. Working bills had been $3.2 million for the quarter. On March 16, the Board of Administrators declared a dividend of $0.27 per frequent share for the primary quarter of 2023, which was paid in money on April 25, 2022. We additionally declared a dividend of $0.5125 per share on our 8.2% Collection A cumulative redeemable most well-liked inventory and a dividend of $0.515625 on our 8.25% Collection B fastened to floating price cumulative redeemable most well-liked inventory, each of which had been paid on April 17, 2023.
Right now, we’ll open up the decision for questions. Operator?
[Operator Instructions]. Our first query comes from the road of Mikhail Goberman of JMP Securities.
I respect the colour on the dividend going ahead. A fast query for you. Simply wished to get your ideas on hypothetic situation. A number of reviews popping out that the banking trade goes to need to strongly lower its period in your portfolios, and that might find yourself having a reasonably extreme impact on MBS purchases as a marginal purchaser. Simply wished to get your ideas on the way you see that probably enjoying out going ahead with spreads? And likewise form of piggyback on that, if that had been to develop, how do you guys take into consideration the connection between MSRs and MBS in that atmosphere?
Mikhail, it is Julian. As for gross sales of MBS, clearly, we have now began to expertise some gross sales by means of the FDIC. In the mean time, these have gone fairly properly when it comes to promoting a number of the securities that had been in SVB’s portfolio. On a going-forward foundation, it will not shock me that banks themselves form of pull again a little bit bit on purchases of RMBS securities. I am not anticipating them to be a giant purchaser as we transfer ahead. And as such, sure, mortgage spreads have tightened in over the previous couple of days, however we might see them form of being unstable for the remainder of the yr, whether or not that be tightening in a number of days per week after which widening out a number of days per week.
And consequently, we’re additionally conserving our powder dry and in addition attempting to maintain our leverage on the decrease hand facet of issues. This market, we anticipate, as I discussed, from a technical standpoint, the consumers of mortgages are simply not going to be the consumers that we have had up to now. The Fed is just not shopping for. The GSEs aren’t shopping for. And as talked about, I believe the banks will probably be restricted when it comes to the purchases that they’re doing.
And I will flip it over to Jay if he desires to make some feedback on MSR in addition to RMBS.
So I believe the vital factor to notice on the MSR portfolio is from a diffusion perspective, we have identified through the years that it positively does a greater job of defending with present coupon. And as I famous within the speech, our coupon — or our observe price on the mortgages is within the mid-3s. And so by definition, it should defend much less relative to a diffusion widening on the MBS. However clearly, to some extent, simply much less. And I believe that is true for anyone who holds a big portfolio of MSRs that had been originated pre-2023.
Bought it. Recognize that coloration. And will you guys give an replace on e-book worth so far this quarter.
Mikhail, it is Mike. Sure. At April 30, we estimate that our e-book worth per share is down about 3%, and that is earlier than any dividend accrual because the Board has not but met to approve a dividend for the quarter.
Our subsequent query comes from Matthew Howlett of B. Riley.
First, on the upper coupons. I imply, you talked about, clearly, I imply, March stunned kind of everyone. Is the bias nonetheless in the direction of the upper coupons right here in the present day? I seen the yield got here down a little bit bit on the MBS facet. Was that due to kind of larger prepayment charges assumptions? Simply stroll me by means of the place within the stack you need to be, and what was the influence of the primary quarter on an NII foundation?
Matt, it is Julian once more. Let’s simply begin with like portfolio when it comes to coupon choice. The first coupon that we like within the portfolio is 30-year 5s within the portfolio. So barely beneath par form of on a reduced foundation you may get that exact coupon. And form of the coupons that form of encompass that a little bit bit, 5.5s in addition to 4.5s, we have been shopping for these for the portfolio over the time-frame.
Now clearly, if the Fed is altering its posture and thinks that it must decrease charges inside the coming yr, I believe that there’ll immediately be a shift — slowly be a shift into maybe some decrease coupons. We’re conserving powder dry. They had been low cost. They’ve — partially pushed by the actual fact that there have been going to be safety gross sales that all of us knew that had been going to be popping out by the FDIC when it comes to a number of the financial institution portfolios. These gross sales have truly gone fairly properly, and we have seen decrease coupons commerce fairly properly.
We nonetheless assume the Fed has acquired a aim right here to perform when it comes to inflation. We predict it is going to be extra persistent than what a number of traders are form of considering. We predict that the Fed is just not going to chop charges this specific yr. If that had been to alter, or previous to that altering, we have now seemed into the valuations of lower-coupon securities. We nonetheless personal some 3s in addition to 3.5s in our portfolio. However we’d start to take that up in measurement if — in the direction of the tip of the yr, I consider, because the Fed could also be altering its posture at that cut-off date.
As for the NIM, a part of the NIM was pushed by the truth that some further securities went on repo. And quarter-over-quarter, there have been a few securities that had but to be placed on repo and that form of decreased our general NIM within the quarter.
Bought you. Makes a number of sense. I assume only a comply with on. I assume the second query is simply — I imply, we take a look at the debt ceiling. How do you — I assume a fast query is, how are you positioning for an occasion — for some unlikely occasion of default or that? I imply is there any kind of coloration you can provide us on how you may place going into June?
Properly, as an example, submit March 8, we have now began to place the portfolio rather more conservatively. Previous to that, the expectation was the Fed was going to proceed at a price path of probably 2 to three extra hikes within the yr and probably getting a terminal Fed funds price of 6%. We’re not beneath the idea that they cannot get not less than 1 extra hike this yr, however let’s simply say that is not doable and so they maintain out for the tip of the yr. The debt ceiling clearly, is considerably of a priority and form of sarcastically, as you are saying, the truth that the U.S. cannot pay its debt, folks have a tendency to purchase the debt. So we’re not attempting to take any actual positioning. We’re attempting to easy out our positioning on the curve in addition to our period.
Look, that makes a number of sense. And I am anticipating clearly — you are not anticipating any disruption within the repo market or that imply that you simply form of put — your haircuts look flat and then you definitely’re nonetheless good within the repo market?
Now we have discovered liquidity to be superb within the repo market. I believe all it’s important to do is take a look at the Fed’s repo facility, and you have got $2.5 trillion sitting there. Individuals had money that they want to put to work. Now we have entry to repo, that has not modified.
Nice. After which final query, I take a look at you guys, and you’ve got accomplished a very commendable job getting by means of these price hikes with the MSRs and I like that slide when it comes to the popular now displaying the influence, the leverage of the frequent, the higher the influence that it is had on you guys, and also you guys have actually defended it rather well, and hopefully, it begins engaged on the opposite finish.
With the rightsizing of the dividend, whenever you take a look at the corporate within the subsequent stage of progress, as an example the Fed does cease right here or sooner or later, start slicing and also you get all these MBS popping out spreads. For those who take a look at the corporate, I do know you need to develop it. Would you take a look at transferring in the direction of a a lot greater RMBS portfolio over time in MSRs that was kind of an incredible hedge to have on throughout this rising price atmosphere. And that you may actually — you may have a number of dry powder. However in the event you even let the MSRs run off extra, even promote them, we might actually have a greater stability sheet going into subsequent and the leg of the cycle. Simply discuss to me about the place — with this dividend reset, I imply, the place do you see the corporate going, Jay, the subsequent a part of the cycle, assuming that we’re near the tip of this one.
Sure, I am pleased to do this, Matt. So I believe there is a worth dialog relative to simply charges. Wells Fargo and others have put out a reasonably vital quantity of servicing this yr to this point. And the expectation is that ought to proceed for a while. And so we have now seen some reduction, if you’ll, in pricing round servicing. In order a lot as you consider charges, you consider pricing and yield. And in order we take a look at the MSR area and the quantity of capital that we need to allocate to it, particularly in a situation that you simply identified, which is a progress situation. I believe we’ll be taking a look at a number of issues, which is one what is the optimum combine between the two methods that we expect is sensible from an fairness capital perspective, after which additionally from a yield perspective as properly.
I believe there is a view on our facet that any reduction in charges will primarily come from the entrance finish of the curve and the again finish of the curve could be much less unstable over the close to time period, if you’ll. And so from that perspective, we expect that the MSR continues to current and symbolize a reasonably good funding various for us. It turns into a dialog about returns and the quantity of absolute capital that you simply’d prefer to deploy into the sector. So we expect that when the Fed begins slicing, that’s predominantly a entrance finish of the curve phenomenon, which ought to present some reduction to the MBS returns, however we can’t take away from the MSR returns.
And by the best way, one of many causes I discussed the observe price on the within the script was as a result of I simply need to level out that we’re — we have now a lot runway left with this portfolio relative to what actually issues, and that speeds. And so to the extent that speeds are managed, we will handle by means of the pricing side of it from a charges perspective, however we really feel actually assured in regards to the potential for the portfolio to carry out from a prepayment perspective. Does that assist?
It helps tremendously. I imply you’d need to see mortgage charges, I imply, go I imply beneath 3 and I imply do you may have the CEO met some pre-COVID degree, proper, to even put any of these within the cash to refinance.
Proper. Whereas my youngsters are very hopeful that may occur, I am much less optimistic for them.
Thanks. I would like to show it now again to Jay for closing remarks.
Thanks, operator. Thanks very a lot for becoming a member of us on in the present day’s name. We stay up for updating you quickly on our second quarter outcomes. Have a very good night.
Thanks in your participation in in the present day’s convention. This does conclude this system, and you could now disconnect. Thanks, everybody. Sorry in regards to the hiccup with the recording. We did get better, however I respect your grace and endurance in that and need you an incredible night. I’ll now finish on the convention.