Cherry Hill seeks better returns as volatility dents earnings

Cherry Hill Mortgage Investment Corp. recorded a loss under generally-accepted accounting principles during the third quarter as it contended with the same market volatility that impacted some of its peers.

The real estate investment trust reported a GAAP net loss of $14.8 million or 49 cents per share to common shareholders in the third quarter as interest rates swings during the period affected the values of some of its mortgage servicing rights and bonds.

Its results missed the Standard & Poor's Capital IQ consensus estimate of a positive 30 cents in earnings per share. Cherry Hill had recorded a lower GAAP loss of 6 cents per share the previous quarter. Its EPS result was a positive 49 cents a year earlier.

The company's performance contributed to a thin earnings distribution to its shareholders for the quarter. REITs must distribute a portion of their taxable income as dividends.

The company also recorded a positive $2.5 million in earnings available for distribution or 8 cents per share for the third quarter. This EAD per share was the same in the second quarter, but down from 16 cents a year prior.

Cherry Hill will be emphasizing agency residential mortgage-backed securities to maximize returns as it moves forward so long as current market conditions persist, CEO Jay Lown said in the company's press release and earnings call.

"Looking ahead, we will continue to monitor the macro environment and are positioning our portfolio for further rate cuts. In the near term, that means continuing to deploy capital into agency RMBS, which still presents a strong risk-adjusted return profile," he said.

Meanwhile, the company's decision to pass on a possible sale and pursue another option has resulted in some tension with its external manager, an affiliate of Freedom Mortgage, Cherry Hill decided to internalize its management after its review of strategic alternatives.

In July, the external manager sent a letter to the company's counsel calling for an $18.4 million contractual termination fee that the REIT is disputing, according to earnings reports.

"At this time, it is not known whether this matter will result in litigation. Should this matter result in litigation, the company intends to vigorously contest this matter," the company said in an earnings-related filing.

The development has some parallels with tensions that surfaced a few years ago when another mortgage REIT, the recently rebranded Two Harbors, also faced a manager dispute as a result of an internalization decision.

Noting Two Harbors' more recent decision to rebrand as "Two" and focus on MSRs, one analyst asked during Cherry Hill's call why that company was leaning into agency mortgage bonds instead.

"While we expect that short-dated rates are expected to move lower, which should improve the return prospects of the MSR portfolio on a levered basis, broadly speaking, MBS still presents a better return profile," Lown said during the call. "For us, at least, it's primarily due to the fact where we think the MSR is currently priced and the associated yield with it, and so maybe there is a difference of opinion on the yield around the asset and how that impacts a levered return," he added.

Given the current outlook, Cherry Hill will continue to invest selectively in servicing in addition to MBS, Lown said. The company also is addressing uncertainties related to the direction of interest rates by hedging.

"MBS still presents a better risk-adjusted return profile. That doesn't mean by any stretch that we don't like the MSR asset or that we're not interested in continuing to invest in it or that we think it should remain static," he said. "It just means that as a small company and someone who's constantly looking to maximize returns today, as things sit today relative to the return profiles of the two asset classes, we prefer MBS."

Some other MSR buyers in the market also have become more selective in the back half of the year, with Mr. Cooper reporting that it sidelined some of its activity at one point amid reports of aggressive buying in the market.

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