Greetings. Welcome to the Cherry Hill Mortgage Investment Corporation First Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host Garrett Edson, you may begin.

We'd like to thank you for joining us today for Cherry Hill Mortgage Investment Corporation's First Quarter 2022 Conference Call. In addition to this call, we have filed a press release that was distributed earlier this noon 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 earnings available for distribution or EID, 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.

Thanks, Garrett, and welcome to today's call. First quarter was certainly eventful for both Cherry Hill and other agency-focused REITs, as markets endure the considerable widening of mortgage spreads, inflation hitting 40-year highs, a war in Eastern Europe and continued market concerns about supply chains not at full capacity. As the Fed began to telegraph, its strategy to fight inflation, rates spiked meaningfully during the quarter and that has further progressed into May. The US 10-year treasury finished the quarter at 2.34%, 83 basis points above year-end. At the same time, economic data held the line for most part with unemployment remaining near historic lows, and close to we're at full employment levels. The Fed has telegraphed significant rate hikes in the months ahead to combat high inflation, and started with a 50 basis point move last week. Markets globally are digesting the velocity of future hikes, and the Fed's intentions around reducing its balance sheet. We are actively adjusting our investment portfolio as we evaluate the impact these actions will ultimately have on the broader economy, as well as mortgage-related assets. For the quarter, improving prepayment speeds continue to aid our earnings available for distribution or EAD a non-GAAP financial measure. In the first quarter, we generated GAAP net income applicable to common stockholders of $25.6 million, or $1.40 per share, and EAD of $6.2 million, or $0.34 per share exceeding our quarterly dividend level of $0.27 per share. On an annualized basis, our dividend yield is 16% based on the recent average of our closing price of our common stock. As a reminder, EAD is just one of several factors we consider in setting our dividend policy. Book value per common share, finished at $7.27 as of March 31. During the quarter, we reduced the size of our…

Thank you, Jay. The first quarter was characterized by a rising rate environment that had long been anticipated. As inflation took center stage and the Fed signaled a clear shift in its policy in order to fight inflation and reduced its balance sheet. The assumption of pending rate hikes was known to the market. However, the pace and the size of future hikes is still very much uncertain, which is evidenced by the broad range of forecasts produced by market fundings, as the Fed works to return inflation to neutral and to engineer a soft landing for the US economy. In March, the Fed took its first step by hiking rates 25 basis points. But with the Fed Chair noting that taming inflation is absolutely essential, we were not surprised to see the Fed hike rates an additional 50 basis points the last week and we expect there will be many more to come in the coming months. In the meantime, the market has attempted to get ahead of the Fed and is priced in multiple rate hikes for this year. At quarter end MSR had a UPB of $20.4 billion and a market value of approximately $246 million. During the quarter, we purchased approximately $500 million UPB of new MSRs to our flow programs, as Jay mentioned. At the end of the first quarter, the MSR portfolio represented approximately 45% of our equity capital and approximately 21% of our investable assets, excluding cash. Meanwhile, our RMBS portfolio accounted for approximately 40% of our equity. As a percentage of investable assets, the RMBS portfolio represented approximately 79% excluding cash at quarter end. During the quarter, we continued to experience CPR improvements in both our MSR and RMBS portfolios. Our MSR portfolio, net CPR averaged approximately 15% for the first quarter,…

Thank you, Julian. Our GAAP net income applicable to common stockholders for the first quarter was $25.6 million or $1.40 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 $17.9 million or $0.98 per share. Our earnings available for distribution attributable to common stockholders, was $6.2 million or $0.34 per share. Our book value per common share as of March 31st was $7.27, compared to a book value of $8.56 as of December 31st. 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, treasury futures and options on treasury futures all of which had a combined notional amount of $1.4 billion. You can see more detail with respect to our hedging strategy and 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 record the change in estimated fair value as a component of the net gain or loss on interest rate derivatives. Operating expenses were $3.5 million for the quarter. On March 10th, our Board of Directors declared a dividend of $0.27 per common share for the first quarter of 2022 which was paid in cash on April 26th 2022. 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 18th, 2022. At this time, we will open up the call for questions. Operator?

And at this time, we will be conducting a question-and-answer session. Our first question comes from the line of Mikhail Goberman with JMP Securities. Please proceed with your question.

Hi, good afternoon gentlemen. You guys said book value was up slightly in April. I'm wondering what would you describe that a relatively good performance to?

So, Julian do you want to talk about that?

Sure. I mean look I think some of it happens to deal with coupon positioning. As we moved into the second quarter, we have a little bit more focus being up in coupon. We also -- in terms of the lower coupons, have some short positioning there. I'd also say we had pretty good swap hedges on especially in the front part of the curve as things were moving higher. We also had some additional futures hedges on in the portfolio and they were mainly in the back part. And our MSR also rose in value during that time. So, I think it was just a good combination of being properly hedged for what we thought was going to happen in April and tactically doing it.

Well done and best of luck in continuing that performance. I'm wondering how much spread widening do you guys think is still possible in MBS and also kind of parallel to that maybe how much sensitivity MSR values have to further spread widening or moves up in rates?

You want to talk about the I'll take the MSR, but I'll have Ray talk about the MSR Julian will start off on the MBS side.

Yes. I mean I think we -- I guess in terms of investors are trying to find out with the Fed what is neutral in terms of interest rates. I think the market is looking for some type of stability. We do view mortgages as being quite attractive at this point in the market, but we also have elevated volatility. The continuous sell-off I think has made them attractive from a yield and a dollar price perspective and even on a LIBOR OAS perspective, but they still have more room to go. I think if the market deems that the Fed has a lot more rate hikes to do in terms of moving past neutral. They're assessing that neutral is probably 2.5%, 2.75% in terms of interest rates. But they also have also described that they're going to have some hikes in fiscal year 2023. So, if we have to go meaningfully above neutral, I would say, there's probably at least another 15 to 20 widening that has to occur in mortgages. But if we can find some stability in rates in terms of a round here or let's say near 350 MAX, I think, we can have some support and mortgages can begin the process of firming up.

Ray, do you want to talk about the MSRs? Please?

Sure. I mean on the MSR front I think given the speed at which we saw rates rise it's really dampened the impact from prepayment slowdown due to spread widening on coupons that are -- or note rates that are now 100 basis points out of the money. I suspect as the year goes on and new acquisitions occur that are more towards where par sits today which is low-5s. That will start to grow again. But right now with the speed of how quick everything happened I think even production that's coming in the door right now is like 4.5% note rate which sits 75 bps below par.

All right. That's helpful. Thank you. And one more if I could just a housekeeping question. I know your queue is probably coming out soon but is there any change to the DTA level from $20.6 million at the end of the year?

Yes. The DTA's down to approximately 16 -- hang on let me pull it up.

It was 16 and change million at the end of Q1. .

All right. Thank you very much, guys.

No problem.

Our next question comes from the line of Henry Coffey with Wedbush. Please proceed with your question.

Good afternoon, everyone and thanks for taking my call. So I'm looking at slide 15 in your deck which is very instructive. But the thing that sticks out is that when you talk about book value change and interest rate sensitivity that the big problem is basis risk in other words spreads widening. And if I'm reading this correctly you're saying that if basis stays the same book value stays the same at 727, a 25 basis point widening would take book value down to 647 And then on interest -- yes and is that a real possibility and it does -- I mean listening to you it does sound like something that hasn't occurred because your book value is up a little bit but could occur. And then the offset from rates just isn't that large.

100% at the rate sensitivity is significantly less than the basis risk. And I think that it's been that way. It's always been that way. And nobody really focused on it when the Fed was tightening narrow easing over the last two years. But clearly, lot of book value gains for agency REITs during that time was attributable to spread tightening. And for better or for worse however everybody kind of portrayed that message the reality is a lot of risk resides and basis risk exposure because it's not something that traditionally agency REITs hedged for in a significant way. So if the question is how much do we think there is to go? Julian tried to I guess give you some feel for what might happen. Look a lot of this is Fed dependent, in terms of the market's comfort level about how this landing is and terminal rates going into the tightening. And while they are clearly doing a better job today of conveying their intentions, a lot of things could impact what they do going forward relative to growth recession, macroeconomic events, the war in Ukraine. So I think we're just trying to really manage through that from the perspective of trying to understand what the right hedge ratio is for the assets in terms of where they could fully extend to as well as managing what we think the contribution is from the MSR to offset some of that, which I think I said in the script as we approach 3% on the 10-year, the ability for the MSR to assist in terms of limiting the effect of spread widening decreases just based on the pure fact that the current coupon as Ray mentioned, somewhere in the four versus the current coupon on our portfolio which is in the mid-3s. Does that help? There's no real...

Yes. No, how aggressive are you willing to be in terms of leaning in one direction or the other put differently, how aggressive would you be on the MSR book given that rates are moving higher.

In terms of mortgage...

Mortgage rates are moving higher and I know it gets more complex after that.

I don't understand the word aggressive. Aggressive in what sense?

Buying more MSRs with more leverage and selling down RMBS. In other words, increasing the mix of MSR, selling RMBS, buying more MSRs either with additional leverage or through liquidating the other side of the business. So I would describe getting more aggressive on MSR is it simply buying more? Okay. And I'll let you out the details.

Sure. So look given that approximately 40% of the equities in the asset, there is no real desire to take it to say 60 today. But we do have an interest in acquiring servicing assets that we think can be harvest return hurdles in terms of characteristics that we like. We don't have any intention to sell a significant portion of that portfolio today. I think one of the hardest things we will tell you about MSRs is managing prepayment risk. And given that the portfolio has a weighted average note rate that's low today that's great for cash flows. And so that's critical. But what we have done, which I think probably hasn't gone to notice is we've reduced the size of the MBS portfolio a fair amount. And so what we've done to try to limit our exposure to the basis risk is to delever that MBS portfolio. And I believe we've taken it down a couple of hundred million over the last four months in an effort to kind of reduce our exposure to the basis. And should we feel that we have more to go, it wouldn't surprise me if we made a decision to continue to do that more aggressively.

And where would the cash go? There's some cash that comes out of that I'm looking at your numbers.

Yeah. It's not -- look the leverage on that is obviously higher. That cash -- maybe it's held in cash. Maybe we buy some MSRs. But honestly, we think that at some point during the year, these mortgage spreads will normalize. And as again, we said in the script, I think at that point we would return to that space fairly aggressively and look to invest capital in that area.

Great. Thank you.

Our next question comes from the line of Matthew Howlett with B. Riley. Please proceed with your question.

Hi, Jay, hi, everybody. Thanks for taking my question.

Hi, Matt.

The first on the net CPR for the MSRs was 12.7%. I know the recapture came down, but the overall CPR came down. My question to you where could that go? First, where could gross CPRs going to MSRs could it be 5%, 6%, 6 CPR. And kind of what do you think how far low the net CPR could go on that portfolio?

Well, I'll try to get Ray to limit the amount of time he'll spend on this because he could spend half an hour on the phone with us talking about that. But Ray, tell Matt, what you think based on our portfolio and what you think let time speeds and short-term speeds could go relative to the current portfolio?

Yeah. I mean I think that I look back to prior to the pandemic 2017 I want to say 2018 when rates were rising and we actually had out of the money MSRs and where were print back then and they were definitely in the mid- to high single-digits. And those were not nearly as out of the money as the portfolio sits today. I'm always hesitant to kind of think six as possible, but it does seem like it's in the realm of possibilities given that everything is 150 basis points out of the money or more.

Okay. So you said five or six recapture possible.

Yeah. I suspect recapture will become quite negligible and CPR on a gross basis will just sit more or less around the mid-singles and it will be on gross and net.

So from a P&L perspective, if I look at that servicing fee income and the servicing income line was up a little, servicing cost line was up a little bit. It improved sequentially, holding everything constant like the portfolio, should we expect that line item that net service income to continue to improve it speeds -- it's amortization continues to go lower and lower?

Well, I mean from an improvement standpoint that line item is largely driven by the size of the portfolio. So it's a 25 basis point strip essentially on the UPB. So as far as the UPB increasing that drives it higher. But slowdown in speeds just means that your rate of decline diminishes. It doesn't necessarily mean that it's going to grow.

Okay. You just -- because you're modeling it, you're running at a speed.

Correct.

Okay. So I'm just trying to get -- I guess where I'm going with is I want to go to the RMBS portfolio, you did a 300 basis point plus spread and it's one of the highest, I've seen in the space. So congrats to you and the team. I guess where I'm going with, do you think will that come in as the Fed as repo cost, or do you have that hedged out?

I mean our swap position is going to offset that once some of the payer swaps reset. Do I know if it will be a perfect 1:1?There's always a lag of let's say two to three months each time the swaps are kind of resetting to where the Fed is moving the Fed's funds. Right now it looks like it's moving in tandem. Our interest expense is kind of declining a little bit so -- or at least holding flat. So for the moment it looks pretty good. But I would say, as we get to a point of where we believe there is a high in rates, we will do some movements or change and make some changes to the portfolio. So, as we said, as time goes on we will make changes to the portfolio in terms of the environment and things like that. But for right now, I think it looks pretty good.

I guess, where I'm going on this Jay is just you got a great earnings available for distribution number and you're covering the dividend, you're putting out a very high ROE to common shareholders. I mean, what was --is that looks pretty fairly stable? I mean, what could go wrong? I mean, sort of what do you expect -- what can you tell me in terms of, I know, the environment is changing, but where you get the book position today? Do you feel like you can still do a pretty strong earnings EAD number for at least the near term?

Yes. So with respect to -- is it in -- the question probably sounds like is the dividend secure in the near term? And to Julian's point, a lot of things relative to how fast the Fed tightens and how that impacts our funding costs, et cetera, really determines a lot of things that you're talking about. And so clearly so far things have worked out well for us. It seems the Fed isn't planning on doing 75 basis points or 100 basis points in tightening. So if things are stable with respect to how the Fed approaches this tightening cycle, the Board will certainly think about that when it decides and determines what the appropriate dividend level is for the company.

Right. Got you. I mean, when you just look at the trade-off, where you're not getting really paid for a high teens yield and just -- we'd rather just more focused on growing equity value. And I just -- do you have some preferred, I guess, or they're callable up here. I know the market's wide. But just when you look at the company going forward, I mean, would you like to really grow book value and retain more income? I know you're some restrictions on that, but just curious of.

Yes. Look, so I'm not going to speak for the Board on the call. But what I can tell you is everything that you just mentioned is discussed and has been discussed at the Board meetings and we meet again in June. And I imagine it will be another pretty healthy conversation.

Great. And then Jay just one broader question on the mortgage industry with excess capacity and where we are. Any just sort of thoughts on how high mortgage rates could go and just general health of the more U.S. mortgage industry given your enrollment in it?

Yes. So good question. I don't spend a ton of time on the origination side. Obviously, originators volumes are down meaningfully and they're very focused on cutting costs and margins. And I think it will be interesting to see how all these guys do post-March relative to the most recent uptick in rates, and what they're planning on doing relative to cutting their margins to maintain volume or whether they start to get religion. We've seen some decent layoff announcements. We've seen some companies come out and say publicly that they're not planning on laying off. But we're definitely seeing through the daily origination volumes coming through decent drops in volume on a regular basis. And from the people that we talk to in the space while volumes had maintained themselves fairly well through April to a lot of people that indicated that just a delay in the timing of pipelines that were started towards the beginning of the year. And our expectation is that volumes will continue to drop on the origination side and originators will be forced to make some pretty hard decisions around profitability. But, I say that mostly in the conventional space, because we just don't really follow the Ginnie space.

Could it possibly see some -- the bulk market and just if you addressed that at all? And could you ever see packages that come out? I know pricing sounds pretty rich right now but just curious on that -- that side of...

Yeah, right. We follow the bulk market, and we've been active in the bulk market recently. But Ray, do you want to spend a second on talking about the bulk market?

Sure. Definitely, I've seen a lot of volume come out thus far this year. It has been a little bit difficult from the standpoint of -- we talked earlier about utilizing MSR for spread widening and the protection benefits there. Everything that's been coming to market has been basically originated in the last 12 months. So, there's nothing that is not fully priced or darn close to fully priced. And that's not been our strong interest to double down there. But I think from the flow space or as we see originations coming out right now that will probably go into the bulk market over the next few months. I think that's where our interest lie more in terms of the risk return profiles of MSRs. But definitely, there's a lot of bulk volume out there. And if you're confident with the CPRs at seven for Life, it's there for the taking.

That's a good point. So what you're saying is what the current coupon now on the MSRs that could be interesting down the road on the newer production in terms of looking at those, and running those speeds maybe a little differently than what's already been originated.

Yes exactly.

Great. Well, thanks everybody.

And we have reached the end of the question-and-answer session. I'll now turn the call back over to Jay Lown for closing remarks.

Thank you, operator. Thank you everybody for joining the call today. We look forward to talking to you in a few months to report on our second quarter results. Have a great evening.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.