Greetings and welcome to the Cherry Hill Mortgage Investment Corporation Fourth Quarter and Full Year 2020 Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rory Rumore. Thank you, Rory. You may begin..

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's Fourth Quarter and Full Year 2020 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..

Thanks, Rory and welcome to today's call. 2020 was validation that we have the right team in place to handle the most challenging conditions and succeed longer term. I want to thank our team for all their hard work and dedication to navigate our company through this unprecedented environment.

We're very much looking forward to putting last year behind us. Almost exactly one year ago, the world completely changed as COVID-19 hit our shores, and caused massive sharp volatility in the worldwide economy.

Mortgage rates across the board were forced to act expediently to save their companies as liquidity greatly tightened and asset valuations dropped precipitously. We have always proactively managed our portfolio, which enabled us to generate solid core earnings and preserve our book value in multiple interest rate environments.

However, the events that began last March proved to be our greatest challenge yet, as we work to delever our portfolio and stabilize our company. By executing efficiently and effectively, we positioned ourselves to maintain a stable liquidity profile, which proved to be a significant catalyst in recovering from the crisis.

By the third quarter, we had largely stabilized book value, and our focus was squarely on rebuilding value, despite a record low interest rate environment, and significantly elevated prepayment speeds in our portfolio. For the full year, our book value performance compared to the broader hybrid REIT sector was very much in line with the group..

Thank you, Jay. The fourth quarter was marred by political uncertainty and continued bad accommodation as another wave of COVID cases and restrictive city lockdown policies hit the country. In the fourth quarter, we remain proactive in terms of adjusting our positioning to maintain our strong cash position.

But in recent weeks, the prospects for greater growth and renewed inflation have started to brew. To start 2021, the US economic and vaccine information has been solid. Vaccine distribution has picked up steam, COVID cases and hospitalizations globally, as well as domestically have dropped.

In the Georgia senate elections coupled with President Biden's early new stimulus plans have added fuel to the fire of an economy that was already heated up based on stimulus provided in the fourth quarter. The before mentioned factors have laid a solid foundation for upward growth in 2021.

We are observing the environment closely and expect to be opportunistic in making new investments this year. As Jay mentioned, the fourth quarter was impacted by weakness in both the MSR and the RMBS portfolios. Increased amortization affected both portfolios. The MSR portfolios weakness was partially offset by increased new MSR flow purchases.

In addition to amortization, the RMBS portfolio experienced softness as a portfolio was restructured. We experienced weakness in a specified pool collateral and liquidity in the market faded. Overall CPRs in the portfolio remained solid, but the fourth quarter liquidity was limited at best.

Servicing related investments comprise a full MSRS had a UPB approximately $22 billion in a market value of approximately $174 million at quarter end..

Thank you, Julian. Our GAAP net income applicable to common stockholders for the fourth quarter was $6.4 million or $0.38 per weighted average shares outstanding during the quarter. While comprehensive loss attributable to common stockholders, which includes the mark-to-market of our held for sale RMBS was $5.2 million, or $0.31 per share.

Our core earnings attributable to common stockholders were $6.3 million, or $0.37 per share. Our book value per common share as of December 31, 2020, was $11.16 compared to a book value of $11.74 as of September 30, 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 fourth quarter, we held interest rate swaps, swaptions, TBAs, and Treasury futures, all of which had a combined notional amount of $2 billion..

Our first question comes from Kevin Barker with Piper Sandler..

Hello, good afternoon. Can you guys give us just maybe a little bit update on how the first quarter is coming along, given where, we're through a good part of it, just give us an idea of like, where book value sits, and how you see the portfolio changing? I know you gave some color on, more aggressiveness on the MSR investment and so forth.

But just a little bit of update on what's going on in the first quarter..

Sure, Kevin. How are you doing? So we don't have all the information yet for February MSRS yet, so the only thing I can give you is through January. And through January, inclusive of accounting for the dividend, it was a little over 1% down..

Okay. And then given your expectations for MSRS, I would assume that you're anticipating the prepay speeds to come down pretty hard as we go through the second quarter into the third quarter, just given the movement and rates.

What do you anticipate, as far as just a drop in CPR given the level that we're at today?.

Are you saying you expect CPRs again?.

What would your expectations just given the move in rate that we've seen in the last few weeks for decline in CPR?.

I'll tell you dogs, I said hi, and -.

Sorry about that..

COVID, I'm going to hand it over to Ray, he has a better grip on the portfolio for that..

Hey, yes, I think, coming in Q1, a lot of those locks would have already taken place, in December, January.

So Q1, probably not a whole lot of change coming into Q2, I think with what we saw in February, and the pop up in rates, the thought would be that you could see a decline and CPRs into the call the mid-30s, high-30s from where we're currently printing around the 45 mark that we had in Q4..

And then servicing costs came down a touch quarter-over-quarter, but we are relatively elevated for most of 2020 just given the forbearance programs, and then decline in forbearance rates, and the changes that are occurring, with the exploration of some of these foreclosure moratoriums, maybe sometime in the next few months, what are your expectations for servicing costs as we go into the back end of the year?.

I mean, I think a lot of that's going to depend on how much we have work out of the forbearance into either deferrals or reinstatements. For the next few months, I think the moratoriums ending sometime towards the end of Q2, so in the next couple months; I would suspect that for the most part things will be similar to Q4.

Not a whole lot of uptick in forbearance. But then again, we're not seeing a lot of, exiting from forbearance, either since they've pushed back the forbearance timeframes. Going into, later in the year, I think the expectation would be that forbearances will start to clear up; you'll start to see the exits and the turnovers from loss in mitigation.

And that's where we might see some pickup in servicing costs dropping..

So would you expect like a spike in servicing costs, just due to an increasing amount of foreclosures in the back half the year, maybe early 2022, before dropping back closer to like a normalized level? Like, how should we think about that --?.

No, because I think when you think about if you had, even if you had 20% of your forbearance loans continue through the path of foreclosure, which I think is, by many estimates would be a very high number, you're still looking at a substantial amount of forbearance loans, which are currently delinquent and are being charged, higher delinquent cost.

And those would all be wiped out as they go through either deferral or reinstatement. So I think net-net, the impact would be, an upside to sub servicing costs decreasing as it relates to the amount of forbearance loans dropping off even with some continuing on the path through foreclosure..

Yes, I would add that we've seen stabilization in the absolute level of forbearances. And so I wouldn't quite - correct me if I'm wrong - I wouldn't anticipate significant increases in cost of service and given most of the loans that are in forbearance are already past that 90-day delinquency charge.

So I would expect that we wouldn't see a huge increase in forbearance costs related to servicing expenses until we get to a point where we're allowed to kind of move more aggressively towards deferral or to get them out.

Is that fair?.

Yes, that's right..

Our next question comes from Henry Coffey with Wedbush..

Yes, hi, how are you all? And congratulations on a solid quarter. And just listening both to the remarks you made to Kevin and the comments on the call.

Obviously, we're off to a good start but it seems like there's a lot of good things to look forward to in the second half, if servicing costs start to come down, if the rise in rates actually does create some slump in speeds in the second half.

Are there other sorts of inputs that we should think about as rates rise, and we start looking at the second half of this year?.

I think speeds are really the thing that we think about the most, I mean, you can see in the presentation, that speeds have been elevated for the third party to be quoted now.

And as we all know, there's a lag between origination and when you actually see the speeds come through and closes so it's been a good quarter so far, relative to the primary rate rising in tandem with rates. And so you've seen that in the primary secondary spread. But, there's still some fruit left on the tree for these guys to take.

And we would expect, I think we noted in the presentation, over the coming quarters, that we would expect to see that but really speeds, the thing that we think about the most relative to interest income versus amortization, and how that impacts earnings go forward, as well, as just broadly speaking, on the ARM-based side, just absolute yields, and the leverage, associated with the asset to get to an income level that we think is commensurate with the risk return..

But I mean is it fair to say that it's not the first half of the story when we see any of these positive developments, but more like, the second half, or towards the back end of this year, given the factors that you just kind of pointed to?.

So the one thing I would say is the following. This is not the opinion of the company, but mine, I'm not really sure you're going to see the seasonal impact that you did over the last number of years, because people have the ability to move at any point in time given, work from home and an education from home.

So I have a view that the seasonal may not be as heavily impacted this summer, as you might think, because the speeds have remained elevated, throughout the year, just given the absolute low level of rates and the ability of people to refinance and to be mobile.

So I think, from our perspective, we would say, maybe second quarter is when we would start to see that decrease in speeds and, and I have a lot of confidence in our recapture capabilities to further mitigate that, and I'm hopeful that our speeds, net of recapture, come down meaningfully..

Are there places in the portfolio where you're willing to really be aggressive, or are there spots in the portfolio where, you really want to put on the brakes and slow things down?.

Across the two asset classes?.

Yes..

It's a balancing act when it comes to these two asset classes, as I think we've all talked about over the last number of years. So I don't think we want to get to in over the skis relative to the percentage of equity in MSRS. But I think broadly speaking, today; we see the MSR space as a compelling opportunity.

And we have been actively using our income from amortization to invest more into the MSR space than we have into the MB space..

Is there any question about capital levels or anything that would cause a restraint to you executing where you want to execute?.

Yes, I mean, capital is always a constraint, right? We want to maintain a fairly healthy balance sheet still. And so within the context of that, you can only do so much broadly speaking relative to the reinvestment that occurs every month.

If we had additional capital, yes, I would say the same holds true that we would probably allocate more of that capital into servicing than the assets..

Would it be appropriate for you to raise more preferred or traditional straight term debt capital to do that? Or we just not there yet..

Yes, well, we're not there yet. But I think, given the movement in the company over the last year, I'd say we're pretty heavily-- we're pretty heavy on preferred say..

Our next question comes from Steve Delaney from JMP Securities..

Hi, Jay and everyone. Nice to be on with you this evening. Well, first look, congrats on the strong core EPS and the dividend coverage. I mean, you're showing a 10% yield on our comp table and fourth quarter, you had 130% dividend coverage. So it seems to me the issue with Cherry Hill, it's certainly not earnings at this point.

It's certainly not attractive dividend. You cut it like most everybody cut it. But it's, that's life and COVID in 2020 for sure. I guess my concern is more structural. This is not like a one-on-one quarter thing, as you mentioned, like in COVID last year, and I'm sure your numbers are right, Jay, about the book value decline in 2020 being in line.

So obviously, most of the pains in the first quarter and anyone who had credit got destroyed in the first quarter. What looking at your numbers, what surprises me a bit? One, you didn't have any credit? Okay, for sure. But your book value by my math is down 19% over the last three quarters of the year. And we know what you own good fundamental assets.

And obviously, there's tons of liquidity in the agency space and repo is great. I guess what I'm saying is the market this year was very strange between primary and secondary rates gain on sale margins for the originators. And Henry and Kevin, I and Trevor have been all over these IPOs. And that's been the story in the market.

And they're obviously were extreme. And they have plenty of room to be very slow. And it seems like there's this big lag. There's a big lag between as the tenure moved up. As the FNCL moved up, the primary rates have not moved up. And I guess Ray can you tell us but it seems to me that I assumed the MSR models pay a lot of attention to primary rates.

And I guess what I guess I'm saying is 2020 has been a strange year because of refi volumes, a lot of other stuff. Is there an anomaly here? That is made the last 12 months more complex for those who choose to pair agency MBS with MSRS? Then you would expect over say a five-year average. I'm just - I'm looking at it and say this trade should work.

But what's going on between the results? And what's going on in the primary mortgage market. Sorry for the ramble, but I hope you get to essence..

I understand the question. Yes. So the first thing I'll say is a decent portion of the book value issues over the past three quarters was around the deferred tax asset. That's number one. So you'd have to, from my perspective, separate that out from the rest of the performance over the last couple quarters.

And I believe that was somewhere around 7%, or something of the 70% of the book value loss in the third quarter. Relative to that, I would say, within the servicing space, I think that the servicing behavioral models were have been slow to change over the course of the last nine months relative to just actually seeing the speeds come in.

And so that's one thing that's difficult to hedge for, because can't anticipate changes and behavioral models, relative to how the third-party evaluators think about the asset. In the fourth quarter as both I and Julian noted, the mix became, just a little bit more difficult relative to things around pay up stories and just speeds.

And if I were to answer your question, just very short, I would say given the absolute low level of rates and given a degree of refinance ability within the servicing portfolio, and the fact that originators have enjoyed incredibly high margins over the last, let's just call it nine months or so that has been a dynamic that broadly speaking over the last seven years we have not seen or dealt with because in a normal environment, when rates move, because the originators should have fully included all of that into their margins at the time, they would move their rates in tandem with real rates moving treasury rate, right.

And so what we've found and you can see it just in terms of looking at the primary secondary spread is that it's been, it widened and then tightened. And, broadly speaking, the originators had a lot of wiggle room before they needed to change rates just based on the amount of low hanging fruit.

And I think that once you get to a certain point in the 10 year, whether that's 151, 175 that number, is coming up quickly, whereas we've seen and you've seen originators feel the need to adjust their origination rates and their primary rate to compensate for the loss and margin.

And, Ray, correct me if I'm wrong, but we're definitely starting to see that. And I believe that once you hit a number, somewhere between once 150 and 175 in 10 year, you'll start to see a more normalized environment where originators will start to move the primary rate in a manner that's more consistent with historical norms.

But you're absolutely right, last year was just based on the absolute level that rates hit on the low side, and the absolute historic margins that you've seen, covering the originators, it created a dynamic that we had not seen..

I think that's important to note, that's why I brought it up. And it seems to me that in normalization and in 2021, there is this lag effect that the originators eventually will, there'll be rationalization in pricing. And the MSR asset should perform better relative to rates in 2021 rather than 2020.

And I'm not asking you to make a declarative statement on that. But I would point to the fact that last Friday, the 30-year fixed MBA 30-year rate was 167, over the 10 year, and on March 31 of last year, it was 277. Now obviously, the 10-year crash, but it was 207 at the end of 2019.

So wish you all the best for this year, we'll be watching closely and good luck with everything you're trying to accomplish..

Our last question comes from Eric Hagen with BTIG..

Hey, thank you very much. Thanks for taking my question.

Can you guys share some color around how lower coupon specified pools have performed since the end of December? And do you feel like durations have fully extended on the portfolio of 2.5 at this point? Or do you think there's some more? And then maybe you could share some color around just the gross yield? Do you think you're getting on new purchases of MSR?.

Hello. This is Julian Low coupons, I would say from an excess return standpoint versus treasuries or even swaps have underperformed, specifically 1.5 and 2 and 2.5. I think there's a breakage when you kind of get above 3. There has been some outperformance in terms of those coupons on an excess return standpoint.

Obviously, everything is down on a total return standpoint and lower coupons getting - being hurt more from all in total return standpoint. So just from dollar prices falling as rates have moved higher. I think and that has continued. There has been some firming up over the last couple days as rates are trying to find some footing.

But we still see - we have seen weakness there from a year-to-date perspective mainly in February is when we saw that the weakness. It started in January rolled into February. And I would say early March there's been still some weakness but a little bit of firming, firming up from that particular standpoint.

Great, good color.

And how about the MSR component?.

Yes, I would say somewhat, for us and we haven't really been active in the bulk market because we've seen some pretty steep pricing there over the past month or so, but in the flow space, we're still seeing unlevered returns in 8% to 9% which for us is continues to be attractive..

There are no further questions at this time. I would like to turn the floor back over to Jay Lown for any closing comments..

Thank you, operator. At this time, the call is ended and we appreciate your continued interest in Cherry Hill and we look forward to updating you next quarter. Have a great evening..