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Cherry Hill Mortgage Investment Corporation (NYSE:CHMI)
Q2 2021 Earnings Call
Aug 9, 2021, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings ladies and gentlemen, and welcome to Cherry Hill's Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]

It is now my pleasure to introduce your host, Mr. Garrett Edson. Thank you, sir. You may begin.

Garrett Edson -- Managing Director

I'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's second 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 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, Chief Investment Officer; and Michael Hutchby, Chief Financial Officer.

Now, I will turn the call over to Jay.

Jay Lown -- President and Chief Executive Officer

Thanks, Garrett and welcome to today's call. In the second quarter of 2021, we continue to actively manage our portfolio while maintaining a strong balance sheet. With the two rounds of stimulus and the ongoing economic recovery, as well as recent spike in inflation, our view was that rates would hold and we managed our portfolio accordingly. However, despite strong economic data, the Fed has continued to play a dominant role in treasury asset purchases and interest rates much lower through the quarter, finishing down about 30 basis points from the end of Q1.

Second quarter performance was driven largely by the significant full flattening of the yield curve and the widening of spreads, particularly on higher coupon MBS, which led to a decrease in the values of MSRs as well as MBS prices. We believe that the recent rally in rates is not sustainable and that rates will turn as the fundamentals of the economy remain strong. In addition, the Fed is closer to paring back its asset purchases and additional fiscal stimulus appears close. Accordingly, we will remain positioned for a bounce higher in rates, which aligns with our hybrid strategy of pairing RMBS with MSRs.

In the second quarter, we generated core earnings of $0.28 per share, covering our quarterly dividend. Prepayment speeds improved quarter-over-quarter across the portfolio, positively contributing to earnings performance. Importantly, core earnings is just one of several factors we consider in setting our dividend policy. While we are watching closely the recent fluctuations in rates and the potential impact on prepayments and asset yields, we remain confident in the near-term sustainability of our dividend.

For the second quarter, we continued purchasing MSRs through our flow program. Pricing for MSRs has been aggressive, particularly in the bulk space where potential recapture origination economics often appear as a component to the pricing of in-the-money collateral. We expect the market for MSRs to remain competitive. That said, we believe our ability to manage this asset class effectively exceeds those who speculatively enter and leave this space, whether large or small.

In our last call, we noted our intention to access funds available to us on the MSR financing facilities. And as a result, company leverage ticked up slightly to 3.6 times from 3.4 times at the end of the prior quarter. Book value for common share finished at $9.63 as of June 30. The change in book value on a quarter-over-quarter basis was primarily due to the impact of spread widening, which is not something for which we've historically hedged. We continue to proactively manage the composition of our portfolios and hedges in order to drive performance, preserve book value and increase our shareholders' equity.

In terms of prepayment speeds for our RMBS and MSR portfolios, we benefited in the quarter from lower speeds, RMBS positioning and the ongoing reduction in the weighted average note rate of the loans underlying our MSRs. We continue to make significant progress in our recapture efforts with a 27.6% recapture rate on our MSRs in the quarter. During the second quarter, we acquired approximately $1.6 billion in Fannie and Freddie MSRs, utilizing our flow purchases program. We believe this approach provides benefits as it mitigates the impact of current coupon spread widening on our portfolio.

As the economy has strengthened, forbearance statistics also continue to improve. As of July 13, borrowers in active forbearance were 2.9%, a 70 basis point improvement from our update on last quarter's call. With our liquidity, we are sufficiently capitalized to satisfy all of our servicing advanced obligations for the foreseeable future.

We ended the quarter with $54 million of unrestricted cash on the balance sheet. 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. We remain constructive on the US economy and its recovery from the pandemic, the current bout of the Delta variant, notwithstanding. We expect to further invest in MSRs to take advantage of an anticipated bounce in interest rates that we believe should 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 second quarter.

Julian Evans -- Chief Investment Officer

Thank you, Jay. In the second quarter, the US economy continued to improve, as many Americans were eager to spend and travel with COVID protocols mostly relaxed. Pent-up demand has driven the US economy out of recession and into an expansionary mode. Despite the economic improvements and the fact that inflation has been outpacing expectation, US interest rates rallied under the weight of continuous Fed-regimented purchases and an assumption that we've experienced the best the US economy has to offer. We are yet to see any real signs of an economic slowdown and continue to believe interest rates will progress higher over-time.

In addition to the interest rate rally, the portfolio was impacted by the mortgage basis spread widening and higher levels of realized volatility in the second quarter, as Jay mentioned earlier. The mortgage basis was a key driver of under-performance for the portfolio. In general, mortgages widened on both a nominal and an option-adjusted spread basis. More specifically, our higher coupon mortgage positions were impacted by the basis widening. Thus far, for the first third quarter, mortgage spreads have been softer, but the impact has not been as great as they were in the second quarter. Looking forward, we will remain opportunistic as we pursue investments in the second half of the year and we will continue to monitor closely the Delta variant and the potential impact it may have on global markets and economy.

At quarter-end, MSRs had a UPB of approximately $22 billion and a market value of approximately $212 million. During the quarter, we purchased $1.6 billion of new MSRs through our flow programs. At the end of the second quarter, the MSR portfolio represented approximately 43% of our equity capital and approximately 13% of our investible assets excluding cash. Meanwhile, our RMBS portfolio accounted for approximately 42% of our equity. As a percentage of investible assets, RMBS represented approximately 87%, excluding cash at quarter-end. Our MSR portfolio averaged approximately 27% net CPR for the second quarter, down from approximately 35% net CPR in the previous quarter, driven by slower prepayment speeds, as well as an improved recapture rate. We saw mortgage speeds continue to decline from elevated fourth quarter levels, in large part due to higher interest in mortgage rates. Meanwhile, the RMBS portfolios weighted average three months CPR also improved in the second quarter to approximately 18% compared to approximately 21% in the first quarter, as we turn the specified pool portfolio over to improve prepayment speeds.

During the quarter, we repositioned our portfolio, moving [Phonetic] spec pools that we felt will continue to prepay quickly and purchasing pools we expect to exhibit slower prepay characteristics. The improvements were mainly implemented in the latter half of the quarter and we expect these changes to benefit the portfolio for some time. As of June 30, the RMBS portfolio inclusive of TBAs stood at approximately $1.4 billion, which was comparable to the previous quarter. The repositioning of the RMBS portfolio also helps liquidity, improves RMBS prepays, increases carry as well as allow for further investments in MSRs.

Quarter-over-quarter, we increased our 30-year security position from 79% in the previous quarter to 83% of the portfolio this quarter. 15-year securities and other collateral positions were reduced to 17% of the portfolio to finance the increase in 30-year securities. For the second quarter, we posted a 2.32% RMBS net interest spread versus a 1.57% net interest spread for the first quarter. The improved spread was driven by lower mortgage amortization, which benefited from better prepayment speeds. The repositioning of the portfolio also improved the RMBS net interest spread.

Mortgage volumes remained elevated toward the end of the second quarter and we expect that trend will remain as interest rates have pushed lower in recent weeks. Currently, 45% of the mortgage market has a 50 basis point incentive to refinance. We experienced amortization improvements in both the RMBS and MSR portfolios and we are hopeful that those improvements will continue in the second half of the year as mortgage and interest rates potentially move higher.

We do expect repo costs to remain low as the Fed stays committed to holding the funds rate near zero and allowing growth and inflation to run hotter than historical norms to compensate for periods when inflation has run too low previously. At quarter-end, the portfolio leverage stood at approximately 3.6 times at the aggregate level.

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

Michael Hutchby -- Chief Financial Officer

Thank you, Julian. Our GAAP net loss applicable to common stockholders for the second quarter was $13.8 million or $0.81 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 $15.8 million or $0.92 per share. Our core earnings attributable to common stockholders were $4.7 million or $0.28 per share.

Our book value per common share as of June 30, 2021 was $9.63 compared to a book value of $10.83 as of March 31, 2021. 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, swaptions, TBAs, treasury futures and options on treasury futures, all of which had a combined notional amount of $1.9 billion. You can see more details with respect to our hedging strategy in our 10-Q as well as in our second 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 $3.7 million for the quarter.

On June 17, 2021, our Board of Directors declared a dividend of $0.27 per common share for the second quarter of 2021, which was paid in cash on July 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 July 15, 2021.

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

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Henry Coffey with Wedbush. Please proceed with your question.

Henry Coffey -- Wedbush Securities -- Analyst

Good afternoon, everyone, and thanks for taking my call. When we look at the things you can control, the business is doing well and that's your operating earnings. When we look at the things you can position for, it's simply a question of taking a stance, I guess, in waiting. If nothing changes interest rate wise, what does the business' earnings potential look like going forward? And if, nothing were to change, could we assume that the volatility in GAAP earnings would diminish? And obviously, if rates went up, I have to assume that things would get better.

Jay Lown -- President and Chief Executive Officer

Yeah. I think a lot of it -- hey Henry, it's Jay. How are you? I think a lot of that depends on speeds. I think that MSR portfolio has turned over nicely over the last year and the current gross weighted average note rate on that is down meaningfully year-over-year. So we would expect that the MSR portfolio would be more stable than it has been in the past. In addition to that, as you can see from what we said on the call and in this presentation that recapture has been a very good component for us relative to, again, trying to keep that volatility lower. So I would say, on the MSR side, those components, and also just the way it's accounted for in terms of GAAP would lead me to believe that, that position is a lot more stable today than it was a year ago.

On the MBS front, I think that we're barbells to some degree. We're short -- we're long TBAs on a shorter or the lower end of the coupon stack and we're long spec poles in the higher end of this coupon stack. And so if rates stay here, I think what you've seen recently around what's in the money is probably more focused on like the 2.5%s versus the 3%, 3.5%s and 4%s, relative to those borrowers already having an opportunity to prepay and some burn-out effect around that. So the volatility that I see from the MBS portfolio is more around the 2.5% coupon than anything else today, just given where we sit in rates. So to your question, if rates stood here, you could see some volatility in that part of the portfolio. But outside of that, I think that where we sit relative to this quarter's earnings and at least in the near term, should persist.

Julian Evans -- Chief Investment Officer

Yeah. I'll add on to that. Henry, it's Julian. What we've seen so far from our prepayment size on the mortgage for at least on the July front, it's been pretty consistent with what we've seen kind of in the latter half of the second quarter. I do think, Jay is right, the custody coupons have just been created, something that's kind of in the [Indecipherable] and 2.5% and 3% coupons are refinanceable. The only thing, I think what we've been waiting for, like a majority of these investors, I would say, in some of the higher coupons is, we've been waiting for to have burnout in some of the higher coupons. I don't think the burnout has been what most investors thought it would be, given the efficiencies that we've seen from some of the originators and the technological advances, obviously. But the recent speeds that I've seen in that part of the portfolio have trended down. And so we are hopeful that we will remain consistent going forward.

Henry Coffey -- Wedbush Securities -- Analyst

[Speech Overlap] I think some slowing. I mean it's there. It's just time is what's weighing heavily on the equation?

Julian Evans -- Chief Investment Officer

Yeah. I mean look, I think that's right. I think most investors are getting or homeowners, I should say, are getting another bite at the apple. What we've tried to do in the second quarter is turn the portfolio over, especially on the RMBS side, spec pools. We ended up selling a pretty significant portion of that portfolio and reinvesting it into other pools, eliminating some of the stories that we -- as we mentioned, that we thought were going to exhibit continued faster prepays and hopefully putting the money back to work and stuff that we thought would be slower during that time. But it has been surprising that we are at this level of rate and we're -- like many investors waiting for rates to pull back.

Henry Coffey -- Wedbush Securities -- Analyst

All right. Thank you.

Operator

Thank you. [Operator Instructions] Our next question comes from the line of Matthew Howlett with Nomura. Please proceed with your question.

Matthew Howlett -- Nomura -- Analyst

Hey guys. Just on the origination market, where gain on sale spreads have come in for all the originators, are they looking to sell more MSRs to make up for that? Can you just give us an update on, are you guys positioning for what looks like it is going to be a much different environment in the back half of the year for the originators?

Jay Lown -- President and Chief Executive Officer

I'm not sure I totally understand that. Are you asking if we expect to change the ratio of MSRs relative to historically [Speech Overlap]

Matthew Howlett -- Nomura -- Analyst

More like bulk or flow deals out there or pricing [Speech Overlap]

Jay Lown -- President and Chief Executive Officer

Right. Okay. Sure. Look, I would tell you, hands down that flow has worked much better for this company than bulk historically. And I would tell you that, as I think I noted in the speech that just concerning to us to some degree is the fact that both deals are now starting to reprice, recapture economics in them and that's great if you have a very strong call center. But if you're relying on a third-party to do that, that's pretty challenging to price that in relative to in the past, historically, where you have not had to price that in. So for us, we love the asset class. It's about the value and the pricing relative to our expectations on yield to determine how involved we are in the asset class. But broadly speaking, we would expect to see more acquisition through the flow versus bulk for us at least.

Matthew Howlett -- Nomura -- Analyst

Got you. And Jay, remind me how many counterparties are you dealing with -- how many arrangements do you have on the flow side?

Jay Lown -- President and Chief Executive Officer

Well, we deal with two different counterparties, but their relationships are in well over, I would say, over 30, at least, probably more. But we deal with two specific counterparties that run their own programs and have their own sellers, but we only face those two counterparties.

Matthew Howlett -- Nomura -- Analyst

Got you. And then is there anything with mortgage rates and what they limited to the adverse fee, Fannie, Freddie delivery and some originators are saying that's going to give them -- open the refi window a little bit more. But I mean just generally speaking, I mean originators, given the margin pressure they're seeing, are they going to have to lift rates at some point to just improve profitability? I mean just walk through the dynamics of mortgage rates. Could they lift?

Jay Lown -- President and Chief Executive Officer

So the reason -- that's one of the primary reasons I mentioned 2.5%s, because the adverse GP coming off definitely puts that coupon more into play than it had been and that is specifically related to the 2.5%s and potentially the 3%s. But look, I can't sit here today and tell you what originators need for margins. I would tell you that as volumes have come down, broadly speaking, since the winter, margins have taken it on the chin and we've seen more competition relative to the origination business in sectors like the wholesale and the correspondent channels. But I think that originators are going to want to keep people in their seats as long as they can and they'll probably sacrifice margin to do that.

Matthew Howlett -- Nomura -- Analyst

Right. Exactly. Deal with the excess capacity. And then from -- just from the last question from Cherry Hills perspective, when I think of long term, I mean let's just say maybe it's Europe, what are like normalized CPRs? Are they like 10 or 11? And what are normal multiples on MSRs? Are they [Indecipherable]? Just give me a sense on like what is normal in an environment where the refi wave go?

Jay Lown -- President and Chief Executive Officer

Are you talking about unlevered returns on servicing?

Matthew Howlett -- Nomura -- Analyst

Unlevered multi-valuation multiples you know [Speech Overlap]

Jay Lown -- President and Chief Executive Officer

Oh multiples. So look, I think historically, originators, who have been in this space for a long time would say to you that they're a buyer at 4 times and they're a seller at 5 times.

Matthew Howlett -- Nomura -- Analyst

Right.

Jay Lown -- President and Chief Executive Officer

That's a very broad statement, I know. But within the context of the interest rate environment, just origination margins, the view on rates, etc, I would say that we are getting toward the high-end of that range today versus a year ago, we were in the 2s for multiples. And so again, the way we think about that asset class is not necessarily those numbers that I said, but given the assumptions required to bid the collateral even in an anticipation of a higher rate environment, if the yields just look too tight, then obviously, we're probably not a meaningful net buyer of that asset.

Matthew Howlett -- Nomura -- Analyst

Right. Got you. And then the CPRs, I mean, could we -- on the MSR book, see 10, 12 CPR at some point?

Jay Lown -- President and Chief Executive Officer

I think at some point, you could, sure. That really depends on rates being 1.75% or higher, especially with the adverse fee. I think the adverse fee, if I'm not mistaken is about an [Indecipherable] to borrowers. So they just got that benefit versus three months ago. So we think that once you hit 1.75%, things start to slope down and then higher.

Matthew Howlett -- Nomura -- Analyst

Got you. Great. Thanks for answering the questions, Jay. I appreciate it.

Operator

Thank you. Ladies and gentlemen, at this time, I would like to turn the floor back to Jay Lown for closing comments.

Jay Lown -- President and Chief Executive Officer

Thank you, operator. Thank you, everyone, for joining us on our second quarter 2021 earnings call. We look forward to updating you in the third quarter for our -- results for the third quarter of 2021. Thank you. Have a good night.

Operator

[Operator Closing Remarks]

Duration: 27 minutes

Call participants:

Garrett Edson -- Managing Director

Jay Lown -- President and Chief Executive Officer

Julian Evans -- Chief Investment Officer

Michael Hutchby -- Chief Financial Officer

Henry Coffey -- Wedbush Securities -- Analyst

Matthew Howlett -- Nomura -- Analyst

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