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Cherry Hill Mortgage Investment Corp (NYSE:CHMI)
Q1 2021 Earnings Call
May 10, 2021, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings and welcome to Cherry Hill Mortgage Investment Corporation First Quarter 2021 Earnings Call. [Operator Instructions]

I will now turn the conference over to Rory Rumore of ICR. Thank you. You may begin.

Rory Rumore -- Vice President, ICR

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's first quarter 2021 conference call. In addition to this call, we have filed a press release that was distributed earlier this afternoon, and posted to the Investor Relations section of our website, at www.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 core 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.

Jay Lown -- President and Chief Executive Officer

Thanks Rory and welcome to today's call. In the first quarter of 2021, we continued to reposition our portfolio, while maintaining a solid balance sheet, as rates continued to climb off historic lows. Despite the rising rate dynamic, elevated prepayment speeds persisted throughout the quarter, due in part to the delay between locks and closings on new loans. At the same time, mortgage rates did not keep pace with the broader rate sell off, as MBS spreads remain at historic tights. This divergence swing in rates continues and has had a near-term impact on the portfolio's performance. However, with two recent rounds of stimulus and an economic recovery seemingly fully under way, we believe rates are positioned to head higher in the coming quarters. As the shift evolves, we believe MBS spreads will normalize to higher levels, which better align with our hybrid strategy of pairing RMBS with MSRs.

In the first quarter, we generated core earnings of $0.21. We have emphasized in previous calls, that core earnings is one of several factors we consider in setting our dividend policy. During previous quarters, where core income far exceeded the distribution level, we were clear that we expected core to normalize over the coming quarters, as amortization expenses increased due to higher prepayment speeds. We remain confident in the near-term sustainability of our dividend, and assuming rates remain at these levels or move higher and prepayments further slow, we expect core earnings to realign with the distribution level.

For the first quarter, we maintained a strong liquidity position ending the quarter with $62 million in unrestricted cash on the balance sheet. We continued purchasing MSRs through our flow program and expect the market for MSRs to remain competitive in this higher interest rate environment, as new buyers enter the market. The MSR strategy has been a part of our DNA since inception. We believe our ability to manage this asset exceeds those, who opportunistically enter and leave this space, whether large or small.

Our RMBS portfolio underwent significant changes during the quarter, as we work to reposition its composition in a higher interest rate environment and to control our exposure to spread duration. We believe that a portfolio of lower coupon 15-year and 30-year TBA, married with higher coupon pools, is the appropriate positioning, as rates move higher. Throughout the quarter, we increased our TBA position at the expense of whole loan pools, as price premiums for many prepayment protection stories suffered in a higher interest rate environment, and performance for select assets underperformed expectations.

Company leverage was reduced to 3.4 times from 4 times at the end of the prior quarter. This was primarily due to the company not taking on additional leverage available to us on the MSR portfolio toward the end of the quarter. Subsequent to the first quarter, we elected to draw on those lines and expect leverage at the end of the second quarter to retrace somewhat, toward levels in prior quarters.

We believe our portfolio remains well-positioned relative to our view on the revitalization of the economy and an expectation of higher rates over time, allowing us to take advantage of future investment opportunities that offer attractive risk-adjusted rates of return.

As the economy has continued to rebound, forbearance statistics have also further improved. As of April 27th, borrowers and active forbearance were at 3.6%, a decline of approximately 2.3% from year-end. With our solid liquidity position, we are sufficiently capitalized to satisfy all of our servicing advance obligations for the foreseeable future.

Book value per common share finished at $10.83 as of March 31st. The primary reasons for the change in book value quarter-over-quarter related to volatility spiking in the second half of February, the change in the shape of the yield curve relative to our hedge position, and higher tax provision expenses, partially offsetting the related increase in MSR mark-to-market. We continue to adjust the composition of our portfolios and hedges, in order to drive performance and preserve book value.

Ongoing elevated prepayment speeds for our RMBS and MSR portfolios, also impacted our first quarter performance. We believe speeds in the MSR portfolio peaked in the fourth quarter, and will continue to tail off, amid a higher interest rate environment and the ongoing reduction in the weighted average note rate of the loans underlying our MSRs.

During the first quarter, we acquired approximately $2.5 billion in Fannie and Freddie MSR, utilizing our flow purchase program. We continue to make significant improvement in our recapture efforts, with a 24.5% recapture rate on our MSRs in the quarter. The portion of the MSR portfolio serviced by RoundPoint, experienced a recapture rate of approximately 30% for the first quarter, which was the primary driver for the meaningful increase quarter-over-quarter.

As we move forward, our team will continue to proactively manage our portfolio, to ensure that we are in a position to take advantage of attractive investment opportunities when presented. We would expect to invest further in MSRs, to take advantage of potential rate increases and generate value for the company and our shareholders.

With that, I'll turn the call over to Julian, who will cover more details regarding our investment portfolio and its performance over the first quarter.

Julian Evans -- Chief Investment Officer

Thank you, Jay. In the first quarter, the U.S. experienced higher interest and mortgage rates, as expectations increased, potentially higher growth in inflation, as a nationwide vaccine program was rolled out. The successful vaccine rollout, as well as two additional rounds of government stimulus, added further fuel to the economy. With many states reopening and relaxing most COVID related protocols, there appears to be a solid foundation for upward economic growth in 2021.

In the first quarter, we remained proactive in terms of adjusting our portfolio positioning, and maintaining our liquidity position. We continue to closely monitor the overall environment and we remain opportunistic in making new investments throughout the year.

At quarter end, our servicing-related investments comprised of full MSRs, at a UPB of approximately $22 billion and a market value of approximately $217 million. During the quarter, we purchased $2.5 billion of new MSRs through our flow program. At the end of the first quarter, MSR investments represented approximately 48% of our equity capital, and approximately 14% of our investable assets excluding cash, well above where we stood at December 31st. Meanwhile our RMBS portfolio accounted for approximately 35% of our equity.

As a percentage of investable assets, RMBS represented approximately 86% excluding cash at quarter end. Our conventional MSRs averaged approximately 35% net CPR for the first quarter, down from 45% net CPR in the previous quarter, driven by better prepayment speeds, as well as improved recapture, as Jay previously mentioned. We saw mortgage volumes begin to decline and mortgage fees begin to decelerate from the record fourth quarter levels, in large part due to the increase in interest and mortgage rates.

Meanwhile, the RMBS portfolio's weighted average three-month CPR rose for the first quarter to approximately 21% relative to 20% in the fourth quarter. With mortgage rates higher, but still at historically low levels, April CPRs remained similar, as homeowners continue to take advantage of the environment.

As of March 31, the RMBS portfolio, inclusive of TBAs stood at approximately $1.4 billion, down from $1.6 billion in the previous quarter. During the first quarter, we continue to reposition and delever our portfolio to maintain liquidity, as well as invest in MSRs. As Jay mentioned, we sold specified pools and moved into TBA positions in 30-year and 15-year collateral. Quarter-over-quarter, we reduced our 30-year securities position from nearly 100% the previous quarter to 79% of the portfolio. As an offset the 15-year securities position in other securities grew to 21% of the portfolio.

For the first quarter, we posted a one spot 5.7% RMBS net interest spread versus a one spot 7.7% net interest spread reported for the fourth quarter. The reduction in spread was primarily driven by increased RMBS amortization expense. In the recent quarter, our amortization expense has increased, as mortgage prepays have risen. Homeowners have taken advantage of historically low mortgage rates, and servicers have improved their refinancing capabilities. The increased amortization lowered yields, more than offsetting the decline in interest expense.

As interest and mortgage rates rise, we believe amortization has the potential to improve, as the year progresses for the RMBS and MSR portfolios. The current mortgage market is approximately 42% refinanceable, below where we started the year, given the movement in interest rates. Mortgage volumes declined, but remained elevated, and we expect that will remain the case in the near-term, as interest rates have firmed since quarter end.

Despite the recent rate move, we believe improvements in amortization may show up in the second half of the year. Repo costs should continue to remain low, as the Fed remains committed to holding the Fed's funds rate near zero and allowing growth and inflation to run hotter than historical norms to make up for periods when inflation was run too low previously. At quarter end, the aggregate portfolio operated with leverage of approximately 3.4 times.

I will now turn the call over to Mike for our first quarter financial discussion.

Michael Hutchby -- Chief Financial Officer

Thank you, Julian. Our GAAP net income applicable to common stockholders for the first quarter was approximately $18.3 million or $1.07 per weighted average share outstanding during the quarter, while comprehensive loss attributable to common stockholders, which includes the mark-to-market of our held for sale RMBS, was approximately $600,000 or $0.04 per share. Our core earnings attributable to common stockholders were approximately $3.5 million or $0.21 per share. Our book value per common share as of March 31st, was $10.83 compared to a book value of $11.16 as of December 31, 2020.

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 first quarter, we held interest rate swaps, swaptions, TBAs and treasury futures, all of which had a combined notional amount of approximately $2 billion. You can see more details with respect to our hedging strategy in our 10-Q, as well as in our first quarter presentation. For GAAP purposes, we have not elected to apply hedge accounting for our interest rate derivatives, and as a result we've recorded the change in estimated fair value as a component of the net gain or loss on interest rate derivatives.

Operating expenses were $3.4 million for the quarter. On March 4, 2021, our Board of Directors declared a dividend of $0.27 per common share for the first quarter of 2021, which was paid in cash on April 27, 2021. 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 April 15th, 2021.

At this time, we will open up the call for questions. Operator?

Questions and Answers:

Operator

Thank you. [Operator Instructions]. Our first question is from Mikhail Goberman with JMP Securities. Please proceed.

Jay Lown -- President and Chief Executive Officer

Hi Mikhail.

Operator

Please check and see if you have your line muted.

Mikhail Goberman -- JMP Securities -- Analyst

I'm sorry, I had my line muted. Thank you. Sorry about that. Good afternoon. I'm wondering how much you expect prepay speeds to slow in the second quarter thus far, or how you're also thinking about leverage, given how tight MBS spreads are currently? Thank you.

Jay Lown -- President and Chief Executive Officer

Are you talking about speeds on MBS or on MSRs or both?

Mikhail Goberman -- JMP Securities -- Analyst

Both.

Jay Lown -- President and Chief Executive Officer

So, I'll take the MSR part and I'll let Julian talk about the MBS and the leverage. We have seen speed slowdowns. April was a pretty good print for us relatively speaking, given the past three or four quarters, and we expect that to persist, as I think I noted in the script that due to the turnover of the collateral, the weighted average note rate has come down decent amount over the last couple of quarters, and as such we have seen speeds net of recapture fall. The key is net of recapture, because the reality with recapture is your -- those outbound calls are going to increase your gross CPRs and you're really focused on the net CPR after the recapture, but we have seen continued through April, print somewhere around 30, low 30 CPR net.

Julian Evans -- Chief Investment Officer

On the RMBS side, look our April speeds came in line to where the March speeds were. There was slightly -- a little bit of differential that we saw there. One of the things is, we've been -- and that's just on the specified pool portfolio. We have obviously increased the TBA portfolio, as Jay has kind of mentioned, as we've gone into TBAs and 30-year as well as a 15-year collateral. So -- for some diversification. So, the overall speeds we're expecting a slow down, if you include the combination of TBA, as well as spec pools. But the spec pools, they were similar to where they were the previous month.

In terms of the overall -- what we think of mortgages; mortgages are on the tight side. I think from a fundamental valuation perspective, most people note that either on a nominal spread basis or on a LIBOR-OIS basis they are tight [Phonetic]. The technicals are expected to remain strong, and be with us throughout, probably the second and third quarter. There is an expectation potentially, if the U.S. data remains on good footing, that the Fed might announce something later at Jackson Hole, but that will depend on the data and -- well, then they will decide, whether they will taper at that point in time. So mortgages, we view them as on the richer side, but from a fundamental standpoint, with the technicals, they can still remain well bid here for a while.

Mikhail Goberman -- JMP Securities -- Analyst

Got you. And if I could just follow-up on just the corresponding question on leverage. I believe Jay, you mentioned that leverage would maybe drift back to historical levels, but is there sort of a range that you guys are targeting going forward?

Jay Lown -- President and Chief Executive Officer

As for range, I wouldn't exactly pinpoint it to a range. I think it's a function -- it will be more a function of asset allocation, with respect to equity and how much equity we decide to deploy outside of RMBS, and potentially into MSRs on a go-forward basis. So, like I mentioned in the script, in April, we did take advantage of money available to us on the MSRs, and that brings us more in line with what I would say historical, over the last couple of quarters, somewhere around 4%.

Mikhail Goberman -- JMP Securities -- Analyst

Got it. Thank you very much gentlemen.

Operator

[Operator Instructions] There are no further questions at this time. I would like to turn it back over to management for closing remarks.

Jay Lown -- President and Chief Executive Officer

Thanks everybody for joining us on our first quarter call. We look forward to updating you in August on our second quarter results. Have a great afternoon.

Operator

[Operator Closing Remarks].

Duration: 21 minutes

Call participants:

Rory Rumore -- Vice President, ICR

Jay Lown -- President and Chief Executive Officer

Julian Evans -- Chief Investment Officer

Michael Hutchby -- Chief Financial Officer

Mikhail Goberman -- JMP Securities -- Analyst

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