Cherry Hill Mortgage: Internalization Unlocks Strategic Growth and Tech Edge (NYSE:CHMI) - CHMI Stock Research Report

## Executive Summary / Key Takeaways * Strategic Internalization Completed: Cherry Hill Mortgage Investment Corporation (CHMI) has transitioned to a fully integrated, internally managed structure, a move expected to reduce operating expenses by $1.1 million to $1.6 million, or $0.03 to $0.05 per common share, in 2025, enhancing shareholder alignment and operational efficiency. * Dual Asset Strategy Amid Volatility: CHMI maintains a balanced portfolio of Agency Residential Mortgage-Backed Securities (RMBS) and Mortgage Servicing Rights (MSRs), currently favoring RMBS for new investments due to superior levered return profiles, while positioning neutrally on rates to manage market volatility. * Q2 2025 Performance Reflects Headwinds: The company reported a GAAP net loss of $0.03 per diluted share and a book value of $3.34 per common share, impacted by mortgage basis underperformance, lower dollar roll income, and a maturing swap position, though servicing costs decreased. * Emerging Tech Differentiator: A strategic partnership and investment in Real Genius LLC, a digital mortgage technology company, represents a new growth avenue, with expectations for profitability and dividend contributions within the first year. * Cautious Outlook with Growth Potential: Management anticipates leverage to gradually increase as economic clarity improves, with potential Fed easing in September 2025 expected to influence prepayment speeds and MSR recapture rates, supporting a "twist" thesis for the yield curve. ## A New Chapter for Cherry Hill Mortgage: Internalization Fuels Strategic Evolution Cherry Hill Mortgage Investment Corporation (CHMI) operates as a residential real estate finance company, strategically investing in a diversified portfolio of residential mortgage assets, primarily Agency Residential Mortgage-Backed Securities (RMBS) and Mortgage Servicing Rights (MSRs). Incorporated in 2012 and commencing operations in 2013, CHMI established itself as a REIT, leveraging tax advantages to enhance shareholder returns. Its historical journey, initially under external management, laid the groundwork for a significant transformation. A pivotal moment arrived on November 14, 2024, with the completion of an Internalization Event. This strategic shift terminated the external management agreement, converting CHMI into a fully integrated, internally managed entity. This move is designed to foster stronger alignment between management and shareholder interests, eliminate potential conflicts, and streamline decision-making. Crucially, the internalization is projected to yield substantial operational efficiencies, reducing operating expenses by an estimated $1.1 million to $1.6 million, or $0.03 to $0.05 per common share, in 2025. This cost reduction is a tangible benefit that directly impacts the bottom line and improves the company's capital structure. ### Competitive Landscape and Strategic Positioning CHMI operates within the highly competitive mREIT sector, where it is positioned as a more specialized player compared to larger, diversified rivals such as Annaly Capital Management (TICKER:NLY), AGNC Investment Corp (TICKER:AGNC), Two Harbors Investment Corp (TICKER:TWO), and Redwood Trust (TICKER:RWT). While CHMI's REIT status offers tax benefits, its smaller scale presents certain competitive disadvantages. For instance, CHMI's TTM Net Profit Margin of -7.77% significantly lags its larger peers, with NLY at 84%, AGNC at 89%, TWO at 22%, and RWT at 5%. This disparity underscores the challenges CHMI faces in achieving comparable profitability and efficiency due to its more limited operational footprint.

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The company's strategy, however, emphasizes agility and a focused approach to residential mortgage assets. This allows CHMI to target specific market niches where it can achieve better risk-adjusted returns. Management has explicitly stated a preference for Agency RMBS over MSRs for new investments, citing superior levered return profiles in the current environment. This contrasts with some competitors who may lean more heavily into MSRs. CHMI's customer and supplier dynamics are largely tied to the broader mortgage market, with dependencies on mortgage originators and sub-servicers. The company strategically navigates these by maintaining a diversified set of counterparties and actively monitoring performance. ### Technological Differentiation: The Real Genius Partnership A direct and compelling benefit of CHMI's internalization is its newfound flexibility to explore unique, accretive investment opportunities beyond traditional mortgage assets. A prime example is the strategic partnership and investment in Real Genius LLC, a Florida-based digital mortgage technology company, announced in May 2025. This collaboration represents CHMI's explicit foray into technological differentiation within the mortgage ecosystem. Real Genius has developed a proprietary direct-to-consumer platform designed to offer an efficient, fully online mortgage experience. This platform includes instant prequalification, an automated document process, and real-time loan tracking, all powered by a custom-built point-of-sale system. The tangible benefits of this technology are clear: enhanced customer experience, reduced processing times, and potentially lower operational costs for mortgage origination. While specific quantifiable metrics for Real Genius's performance were not detailed, management expects the company to achieve profitability within the first 6 to 7 months, with CHMI anticipating receiving dividends from this investment within its first year. This technological play is a strategic initiative to diversify income streams, potentially creating a new competitive moat by integrating into the digital mortgage origination value chain, thereby contributing to CHMI's long-term growth strategy and financial performance. ## Portfolio Dynamics and Performance in a Volatile Market CHMI's investment objective centers on generating attractive current yields and risk-adjusted total returns, primarily through dividend distributions. The company's income is largely driven by the net spread between the income earned on its assets and the cost of its financing and hedging activities. The second quarter of 2025 presented a complex market environment. Initial tariff announcements in April triggered significant volatility and a flight to quality, though markets later discounted the worst-case scenarios. The 10-year Treasury yield ended the quarter marginally higher at 4.23%. However, the Agency MBS sector underperformed, primarily due to the mortgage basis widening relative to swap and treasury hedges. This led to heightened hedging costs and a significant tightening of swap spreads in April, impacts that subsequent months could not fully offset. For Q2 2025, CHMI reported a GAAP net loss applicable to common stockholders of $0.03 per diluted share. The book value per common share declined to $3.34 from $3.58 on March 31, 2025, with the Net Asset Value (NAV) decreasing by approximately $6.2 million, or 2.7%, quarter-over-quarter. Earnings Available for Distribution (EAD) attributable to common stockholders stood at $3.2 million, or $0.10 per share, a reduction from $0.17 per share in Q1 2025, primarily due to the maturity of a large swap position that had previously contributed income.

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Operationally, interest income for Q2 2025 was $14.813 million, with interest expense at $12.172 million, resulting in net interest income of $2.641 million. Servicing fee income was $10.933 million, while servicing costs decreased to $1.952 million, yielding net servicing income of $8.981 million. The reduction in servicing costs was attributed to the resolution of prior deboarding fees and a continued decline in the total loan count within the MSR portfolio. The RMBS portfolio, inclusive of TBAs, increased modestly to $756 million from $733 million in Q1 2025, reflecting a strategic shift towards higher coupon mortgages. The MSR portfolio's Unpaid Principal Balance (UPB) was $16.6 billion, with a market value of approximately $225 million. The RMBS net interest spread was 2.61%, lower than the previous quarter due to the maturing swap and reduced dollar roll income. Prepayment speeds for both MSRs and RMBS remained relatively low, with MSR net CPR averaging 6% and RMBS CPR at 6.1%.

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CHMI's hedging strategy employs interest rate swaps, U.S. Treasury futures, and TBAs to mitigate interest rate and financing pricing risks. A notable adjustment in Q2 2025 involved reducing longer-maturity SOFR swap hedges and replacing them with treasury futures, a response to fluctuating and tightening SOFR spreads. This dynamic approach aims to maintain a neutral duration stance and protect the portfolio from unexpected rate movements. ## Outlook, Risks, and the Path Forward Looking ahead, CHMI's management maintains a cautious yet adaptive outlook, positioning the company for potential shifts in the economic landscape. The overarching strategy involves evaluating a "more risk-on approach" as the economic environment stabilizes, while steadfastly preserving strong liquidity and prudent leverage. Financial leverage, which stood at 5.3x at the end of Q2 2025, is expected to "creep up" for the remainder of the year, contingent on greater clarity from the Federal Reserve and the impact of administrative policies on inflation.

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Management anticipates that the Federal Reserve may initiate rate easing, potentially in September 2025. Such a shift could lead to increased MSR recapture rates and higher RMBS prepayment speeds in the latter half of Q3 and Q4, particularly if long-end treasury and mortgage rates decline. The MSR portfolio, characterized by a weighted average note rate in the mid-threes and mid-single-digit prepayment speeds, is considered resilient to potential rate changes. The company's July 31 book value per share was estimated to be "about flat" compared to June 30, signaling a period of stabilization. Despite the strategic advantages and forward-looking initiatives, CHMI faces several inherent risks. Interest rate risk remains paramount, as fluctuations can significantly impact asset values and borrowing costs. Prepayment and extension risks affect the expected cash flows and yields of both MSRs and RMBS. Counterparty risk, particularly with repurchase agreements and sub-servicers, could lead to losses if obligations are not met. Funding risk is also a concern, as weaknesses in financial markets could affect the availability or cost of financing. Furthermore, the illiquidity of certain Servicing Related Assets poses a challenge if rapid sales are required. The company must also continuously comply with REIT qualification requirements to avoid adverse tax implications. CHMI's competitive standing, while bolstered by its internalization and the Real Genius partnership, continues to be influenced by its smaller scale relative to industry giants. This necessitates a focus on specialized asset selection and efficient management to generate competitive returns. The company's ability to capitalize on its technological investment and adapt its hedging strategies will be critical in navigating the dynamic market conditions and delivering on its long-term objectives. ## Conclusion Cherry Hill Mortgage Investment Corporation stands at a pivotal juncture, having completed a transformative internalization that promises enhanced operational efficiency and strategic flexibility. This new chapter is marked by a dual asset strategy, a cautious yet adaptive approach to market volatility, and a nascent but promising foray into digital mortgage technology through its Real Genius partnership. While recent financial performance reflects the headwinds of a volatile market, the underlying strategic shifts and cost-saving measures are designed to strengthen its foundation. The core investment thesis for CHMI hinges on its ability to leverage its internalized structure to optimize its RMBS and MSR portfolios, capitalize on the expected benefits of its technology investment, and prudently manage risk in an uncertain interest rate environment. Investors should closely monitor the impact of Fed policy on interest rates, the realization of cost savings from internalization, and the growth trajectory of its strategic partnerships. CHMI's disciplined approach to capital allocation and its commitment to a long-term "twist" thesis for the yield curve position it for potential value creation, despite the ongoing competitive pressures and market complexities.