Michael Hutchby - Controller Jay Lown - President & CIO Julian Evans - Senior Portfolio Manager Martin Levine - CFO.

Paul Miller - FBR Capital Markets Henry Coffee - Sterne Agee Jeremy Campbell - Barclays Michael Kaye - Citigroup.

Greetings, and welcome to the Cherry Hill Mortgage Third Quarter 2014 Conference Call. At this time, all participants are in a listen-only mode. (Operator Instructions) I would now like to turn the conference over to your host, Michael Hutchby. Thank you. You may now begin..

Good afternoon. We’d like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's third quarter 2014 conference call. In addition to this call, we have filed a press release that was distributed today 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 competitive 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 Chief Investment Officer.

Also present on the call today are Marty Levine, our Chief Financial Officer and Julian Evans, our Senior Portfolio Manager. And now, I will turn the call over to Jay..

Thanks, Mike, and thank you, everyone, for joining us today on our third quarter second 2014 earnings conference call. As part of our call, we've posted on our website a presentation that we'll touch upon throughout this call, and we'll reference specific slides when appropriate. After our prepared remarks, we will open up the call for your questions.

I think it’s safe to say that a year ago when we launched Cherry Hill there was a stronger view that interest rates were headed higher and arguably considerably higher. Despite a year of significant volatility, rates were substantially unchanged year-over-year. In fact, the U.S.

10-year treasury closed 12 basis points lower on September 30th this year versus a year ago. The domestic economic recovery is on firmer footing. The U.S. growth has been moderate, but clearly improving. Global macroeconomic challenges, however, persist.

Global interest rates remain range bound and choppy as skittish markets await more data in the near-term. Long-term, our investment thesis remains prejudice towards rising rates and our portfolio is well-positioned for this. Specific Cherry Hill, the third quarter produced results substantially in line with second quarter.

To this end, our mission remains unchanged to generate consistent attractive returns for our shareholders. We believe our current portfolio is constructed does just that and we are committed to broadening the scope of investment opportunities as we look the ways to grow our business.

Notable market takeaways for the quarter include a continued downward trend in rates, increased market volatility and increased gross prepayment speeds. As shown on slide five, MBS prepayment speeds have consistently increased quarter-over-quarter throughout the year as interest rates has fallen.

Accordingly, a primary focus for our team is the run-off of our portfolio and we are working with Freedom to protect and defend our investment. We remained focus on the MRS asset class to execute our investment strategy, and believe it offers attractive returns over the long term, especially in a higher interest rate environment.

During recent months, however, excess MSRs were deemed to be less attractive given current market pricing. As such, we deployed excess capital into Agency RMBS over the quarter.

As we have previously stated having the ability to purchase full MSRs should broaden our investment option, and we believe that there will be healthy supply of full MSRs in the near-term. Turning to our quarterly results as shown on slide six. The third quarter produced divided, eligible income consistent with the second quarter.

We declared and subsequently distributed a $0.51 dividend to our shareholders. Net interest spread for the RMBS portfolio for the quarter was 1.55% marginally lower than the 1.59% in the first half of the year and prepaid fees for the RMBS portfolio averaged slightly over 5% DPR, in line with management expectations.

Throughout the year, our RMBS portfolio has exhibited favorable prepayment characteristics versus generic and TBA cohorts. Book value per share this quarter dropped slightly to $21.22 primarily as a result of a reduction in value of our investment in excess MSRs, driven by an increase, the prepayment expectation.

In addition, RMBS has had a difficult time keeping pace with interest rates as rates rally. Our aggregate debt to equity ratio at quarter-end was approximately 2.1 times, up slightly from the second quarter, but not unexpected given our reinvestments of principal and Agency RMBS.

During the third quarter, we made significant progress in our efforts to license our taxable REIT subsidiary to be able purchase full MSRs and whole loans. Currently, we are licensed in 15 of the 17 states required for us to own MSRs and to purchase closed residential whole loans on a nationwide basis.

Approvals from the GSEs and Ginnie, service mortgages are more time-consuming to acquire and we hope to have them in place by the end of the first quarter 2015.

During previous calls we have also stated that we are taking a two-pronged approach here and are actively searching for acquisition targets that fit our needs in addition to our organic efforts. We have been looking at originator servicers that could provide with the necessary approval and servicing assets that fit our needs.

As you can imagine, the mortgage origination community is consolidating and we expect this trend to persist in the near-term. We are committed to executing our whole loan strategy and believe our relationship with Freedom will provide us with significant access to loans once the platform is in place.

Our diversified business model is integral to our growth and we are focused on investment opportunities in the whole loan space that we think generate good risk adjusted return. Prime jumbo loans, non-QM loans and second loans remain a focus for us. A healthy securitization market is essential for the growth and success of these initiatives.

Let's move on to discuss our investment portfolio. Slide seven highlights our aggregate portfolio composition. At quarter-end, our excess MSR investment represented approximately 62% of our equity capital and approximately 20% of our assets excluding cash.

Our RMBS portfolio comprised approximately 33% of equity and approximately 80% of assets again excluding cash. The RMBS portfolio remains concentrated in shorter-duration assets. We did, however, increase our exposure to longer duration assets in light of the current interest rate environment.

Julian will discuss the performance of this portfolio in more detail shortly. At the aggregate portfolio level, we maintained a neutral duration gap throughout the quarter, and at quarter-end, our duration gap stood at negative 0.09 years.

Our excess MSR portfolio for the third quarter, which is referenced on slides eight and nine, performed in line with management expectations, generating solid returns during the quarter. The current carrying value of this portfolio stood at approximately $96 million at quarter-end.

Our recapture agreement resulted in over $670 million in loans being recaptured during the quarter. The vast majority in Pool 2, which posted a 53% recapture rate. Life to date, Freedom has recaptured over $1.8 billion in loans for our portfolio.

Freedom has done an outstanding job protecting and defending our portfolio and we actively work together to seek ways to improve these results. Weighted-average CPRs net of recapture all of our excess MRS portfolio remain within current management expectations.

In light of declining interest rates year-to-date, we did experience a decline in the value of Pool 1 primarily driven by an expectation of higher prepayment speeds. I'll turn the presentation over to Julian, who will provide some detailed information on Agency RMBS portfolio and its performance over the quarter.

Julian?.

Thank you, Jay. As of September 30th, the RMBS portfolio stood at $376 million, up from $343 million at the end of the second quarter, as shown on slide 10. As the portfolio remains concentrated in shorter-duration assets and was run on modest leverage at 6.29 times.

At quarter-end, approximately 54% of assets were comprised of 20-year and 15-year fixed rate hold pools, and the remainder in 30-year fixed rate hold pools, TBAs, and hybrid ARMs. During the quarter, additional RMBS purchases were made in the 30-year and 20-year collateral at the expense of 15-year collateral.

As shown on slide 11, loan balance stories remain a majority of the overall collateral composition at quarter-end. The portfolio's composition continue to exhibit favorable prepayment speeds, due to its composition posting a weighted average of 5.03% CPR for the quarter and 5% CPR for the last six months.

Going forward, we would expect prepayments speeds to increase given the portfolio of composition, and the persistent drop in mortgage rates that occurred during the third and the beginning of the fourth quarter. The aggregate portfolio continues to be managed conservatively.

The portfolio operated with modest leverage and a fairly neutral duration gap given our long-term interest rate views and current fundamental mortgage valuation. As shown on slide 12, we ended the quarter with an aggregate portfolio duration gap of a negative 0.09 years.

Portfolio's duration gap remains stable under various interest rate stress scenarios. Our duration gap would move from a negative 0.09 years to a positive 0.04 years following a 200 basis points instantaneous shock according to our model.

The portfolio's gap is driven by the composition of RMBS portfolio, the associated hedges and the fact that over 60% of the portfolio's equity was comprised of excess MSRs during the third quarter. I will now turn the call over to Marty Levine, who will review our third quarter financial results in more detail.

Marty?.

Thank you, Julian. As Jay stated in his opening remarks, we had another solid quarter. Net interest income was approximately $5.1 million in the third quarter. However, our excess MSRs, RMBS, swaps, and swaptions reduced the combined net decrease in asset value of approximately $3 million.

Our GAAP net income for the quarter was $2.8 million or $0.37 per share. Our comprehensive income, which includes the mark-to-market on our held-for-sale RMBS, was $844,000 or $0.11 per share.

As detailed in slide 25, we use interest rate swaps and interest rate swaptions to mitigate the effects of increases in interest rates on a portion of our future repurchase borrowings.

At the end of the third quarter, we held swaps and swaptions, which allow us to enter into rate swaps at a later date, with notional values of approximately $210 million and approximately $115 million respectively.

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. Also, as Jay mentioned earlier, 62% of our equity capital is deployed in excess MSRs at quarter end.

Our investment in excess MSRs are currently unlevered and our implied debt to equity ratio on the RMBS portfolio was leveraged 6.29 times at quarter end. Our overall debt to equity ratio was 2.06 times at quarter end.

Operating expenses were $1.3 million for the quarter, which included approximately $115,000, which was related to the licensing efforts and other infrastructure cost, relating to CHMI Solutions, our taxable REIT subsidiary. For the quarter, our total operating expense as a percentage of average equity was 3.1%.

For the third quarter, we had REIT income eligible for dividend purposes of approximately $3.9 million, which represents $0.52 per share for the quarter. On September 11, we declared our third quarter 2014 dividend of $0.51 per share, which was paid on October 28.

It is our goal to distribute regular quarterly dividends of all, or substantially all, of our taxable income to holders of our common stock and to the extent authorized by our Board of Directors. Lastly, this afternoon, we filed two registration statements on Form S-3. The first covers the possible resale of shares held by Stan Middleman.

This shelf was filed pursuant to the requirements of the registration rights agreement we entered with Stan at the time of our IPO and concurrent private placement. We also filed a shelf registration statement for primary issuances by Cherry Hill.

Although we have no current plans for an offering, we're being prudent in preparing for the future, should conditions warrant. Now, I'd like to turn the call back to Jay for closing remarks..

Thanks, Marty. Our primary goal has been and continues to be aimed at delivering consistent attractive returns for shareholders.

We're excited about the initiatives underway at Cherry Hill and are looking forward to expanding our strategies and diversifying our business to exploit additional opportunities in the residential mortgage space as the industry evolves. We'll now open up the call for questions.

Operator?.

Thank you. At this time, we'll be conducting a question-and-answer session. (Operator Instructions) Our first question comes from Paul Miller from FBR..

Yeah, on the prepayment speed, we saw the volatility in rates really move around over the last couple of weeks.

Has that impacted at all your IRR on some of the MSR pulls that you reflected?.

Hey, Paul how are you? It hasn't affected the IRR as much, no. It has not, no. Our IRRs are essentially similar to what they were in prior quarters..

So, the volatility hasn't had any meaningful impact on those things?.

No, we see the increase in speeds on the origination side here in terms of the true excess MSR valuation related to the discount rate. We haven't had significant changes to that..

And then the other thing is your primary seller of assets is Freedom Mortgage.

Are you actively seeking out other relationships?.

Yes, we are. On a regular basis, we seek other relationships around anything related to both whole loans and MSRs. I will tell you that this year has been an interesting year in the origination space just based on margins compressing and consolidation among originators, small and mid-size.

So, I think their primary goal has been to show profits and so far throughout this year, we've seen a more of a trend in selling the full MSR versus being interested selling in excess MSR and treating that as is some kind of financing.

So, what I will tell you that we've seen an increase in margins in the origination space over the last quarter or so. So that could change but you know as you know things are fluid and for the first nine months that's been the trend..

And then you guys, correct me if I'm wrong, you guys don't have a flow agreement with Freedom, right? Or do you and are you seeking out flow agreements with other entities?.

We do have the ability to enter into flow agreements with Freedom. Again that's obviously dependent upon things like price. This quarter we did not have a flow agreement with Freedom, unlike other previous quarters.

We do look to other counterparties as well as freedom to do something flow related, but again, it goes back to the excess MSR conversation on a broader more macro basis..

Okay. I guess, thank you very much..

Sure..

Thank you. Our next question comes from Henry Coffee from Sterne Agee..

Good afternoon, everyone..

Hi, Henry..

I'm looking at page six; can you kind of walk us through the details preferably on a per share basis of how we get from 37 to 52? It kind of shows up on our -- I know our modeling gets us right there, but I kind of wanted to see what the components were of that figure..

Okay. Well, you take out all the gains and losses as far as the capital transactions.

So, you have the $5 million worth of interest income and you have about a $1.264 in expenses and out of those expenses about $200,000 of it is not tax deductible and then there's the about $100,000 and change that is related to the TRS, which is also not tax deductible and divided by the number of--.

I'm looking at your P&L of the million dollars of -- hang on a second I'm sorry..

Sorry I was--.

Yeah the 1 million loss on derivative position is not part of the equation because of the taxable equation because--.

It's a tax hedge and there for we don't take any of that gain or loss..

Okay. And then--.

And we don't take a loss on the excess MSR either..

Right, right.

But because it's a hedge position, it's not included in the taxable equation?.

Correct..

The importance of getting a servicer license, this is the first time you've actually been fairly concrete about saying how -- well reasonably concrete about when you might get something and we talk about what steps remain, how much time remains between now and when you're likely to get a license and what it means to the company..

Absolutely, sure Henry. So yes, we were a little bit more descriptive this time. We were required to go after 17 states to be able to purchase whole loans and service on an issuing basis. As we noted on the call, we have 15 of those, we expect the other shortly. The agency approvals, they are a little bit more time consuming.

We were looking to get the approvals from both, Fannie, Freddie, and Jenny and we will be working over the next several months to do that. As we also mentioned, we're looking at inorganic opportunities that will allow us to take a short cut there.

But it is our desire and goal to have the licenses and approvals in place to be able to start buying full MSRs in the second quarter.

Why that's important to us is because it's our belief that there are a lot more opportunities around being able to purchase full MSR versus the ability to purchase the SSMSR and we continue to see a healthy market in the full MSR phase versus the SSMSR phase. So we believe we will have more opportunities to transact with servicing licenses in place..

And what's the difference kind of the in the bid and ask whether it's between you and Freedom or you and other parties in terms of actually putting more assets on now?.

That’s a tough question to answer on the call. I think it's -- that’s a very difficult question for us to answer that.

But it's not a small differences, I think there is a -- from our perspective there is a disconnect between what's happened in interest rates and where MSRs being bid with respect to life time CPRs and as such that disconnect has resulted in our not being as competitive as Freedom might look for us to be transacting with them today..

Two of the companies we -- mortgage REITs we work with talked recent about debts they have taken or that they can take to sort of the ease the whole loan burden, is -- the fact that you have to hold a certain amount of agencies to pass the REIT test, do you have any thoughts on that? And when you think of you -- of allocating capital and balances between agencies and servicing as more opportunities open up with the agency portfolio, potential source of funds and capital providing servicing or does it have to stay at its current level?.

No, I would say that we spend a lot of time thinking about what each asset class represents related to passing all of the tests around our company. And we have done a fair amount of work on our side about trying to decide how much capital to allocate to each strategy as we look to move forward some of the things in the whole loan space.

So, on our side we have a good grip with respect to what we think we could allocate capital wise towards loans versus, I think continue to allocate our portion of our capital, equity capital to the agency RMBS strategy.

Because of leverage, obviously, you can imagine given that their assets have the agency RMBS, portfolio is important to passing test.

But we do feel we have the ability to add a healthy percentage of our equity capital to whole loans in some way shape of form either through straight whole loans, or through holding the bottom part of the capital structure and securitization..

Great, thank you..

Thank you. Our next question comes from Jeremy Campbell from Barclays..

Hey, thanks guys.

Just want to clarify, if you guys look to buy an originator, would that purely be just the status for the GSE licensing or would you potentially look to have the originator actually start producing mortgages for you?.

Well, that’s a great question. In a perfect world you obviously just get licenses. But in the real world that comes with originator as origination capacities and you have to make decision as to whether or not that company is operating profitably or not.

So in an ideal scenario, we looking are looking for a company that has origination light with respect to having all of the licenses that -- and approvals that we would want to have on our end. So we would look to somebody that is not originating a significant amount of money on a monthly -- or significant amount of mortgages on a monthly basis.

We think we could potentially discuss some of that with Freedom around the originations piece of it. But in a perfect world I will tell you that it would be our desire to have something that was more holistically around licenses..

Okay.

And then we've seen other companies be able to lever whole MSR at least a half a turn, is there anything out there right now for excess MSRs or is this all kind of predicated on you guys getting fully licensed and actually owning the whole MSRs?.

So, I don’t think we are ready to have that conversation. But we do talk to people about the ability to leverage the excess MSR portfolio in some fashion. Clearly, it's not a wide market, but we definitely are having conversations with people about how to do something in that format..

And could you just remind us what kind of the addressable market is of assets that you guys may look to target that’s on Freedom's balance sheet right now? And maybe update us on what their quarterly production is looking too?.

I'm sorry. I didn’t totally get the first part of that question..

So how many MSRs we have on the balance sheet right now that would kind of fit your criteria?.

So, their overall portfolio is hovering around 50 billion. The vast majority of that is originated over the last three years. Of what portion of that would be of interest to us, so we owned 20 of it already.

So a portion -- so the answer is, I would say somewhere in the neighborhood of 10 billion to 15 billion could be of interest to us on a holistic basis the full MSR. Freedom has recently made a decision to service in-house and has been putting new originations MSRs on their internal services.

So we look forward to working with them as they grow that portfolio. Around Freedom's current origination production, I believe Freedom did $2.4 billion last month and in the last three months prior to that it was somewhere in the neighborhood of $2.2 million to $2.3 million. So we are consistently running in the low twos.

They recently closed on acquisition of a retail originator that was made public a week or so ago. That adds about 100 million to 150 million of retail production that will -- the company will start to see the fruits of I think this month..

Great. Thanks a lot guys..

Thank you. Our next question comes from Michael Kaye form Citigroup..

Could you comment a little bit more on the present environment for the whole MSR purposes.

Just wondering what kind of IRRs do you think you can get and do you think these returns will allow you to hit 10% ROE hurdle?.

So I think that points back at Jeremy's question in terms of leverage -- on an unlevered basis. I would tell you that we think that MSRs backed by Fannie and Freddie are still in the high-single digits. Not much has traded recently along Fannie. There was a large transaction by us recently that never happened.

But those portfolios seem to still be trading in the low teens. With leverage available to us on the GSE MSRs, we feel pretty good that the return will be substantially similar to where we quoted you guys last time in the low teens. .

Great.

One quick numbers question for Marty, just wondering why the management fee went down quarter-over-quarter?.

Well, embarrassingly we had a misinterpretation of a contract term and it was noted and corrected this quarter. About 150,000 pertained to previous quarters and we speak to it in the -- further in the MD&A. On an adjusted basis, comparatively, we would be at 670 for third quarter and 629 for the second quarter. .

So shall I think about 670 is like the run rate going forward?.

Yes..

Okay, thanks..

Okay..

Thank you. We do have a follow-up coming from the line of Henry Coffey from Sterne, Agee..

Yeah, on -- on the -- with the two filings that are out there, is your second filing the shelf of equity only or does it look at equity debt, the full range of the capital spectrum?.

Everything, the whole range..

So it’s a conventional filing in case you need it, but no specific plans to rush out and issue equity below book value?.

That’s correct. If you look at the filing it refers to common preferred warrants right units. So it is holistic, Henry..

And then obviously nobody can speak for Stan, but has he indicated, as part of this filing and registration of his shares that there might be a future sale of the shares or is he continue to hold where he is?.

To my knowledge he has not mentioned anything to that extent..

Okay, thank you. .

Thank you. I will now turn the call back over to Jay Lown for closing comments..

Great. Thank you everybody. We look to having another successful quarter in the fourth quarter. Thank you for joining us on our call today. We look forward to updating you guys next quarter on progress on subsequent calls. Have a great evening..

Thank you. This does conclude today's teleconference you may disconnect your lines at this time. Thank you for your participation..