Cherry Hill Mortgage Investment Corp (CHMI-PA)
Cherry Hill Mortgage Investment Corporation is a Real Estate Investment Trust (REIT) focused on investing in mortgage-backed securities, particularly those issued or guaranteed by government agencies such as Fannie Mae and Freddie Mac. CHMI-PA is a class of preferred shares issued by Cherry Hill to raise capital for its investment portfolio. Like other preferred stock, CHMI-PA offers investors a fixed quarterly dividend and a senior claim relative to the company’s common equity, though junior to its debt.
The mortgage REIT model and Cherry Hill’s position
Mortgage REITs like Cherry Hill occupy a specific niche in financial markets. They do not originate mortgages or service them; instead, they buy pools of residential mortgages that have been packaged into securities — usually government-backed mortgage-backed securities (MBS). These securities are bonds backed by the cash flows from thousands of mortgages: as homeowners make monthly payments, those cash flows pass through to the MBS holder. Cherry Hill’s job is to purchase MBS at prices that offer an attractive spread (the difference between the yield on the MBS and Cherry Hill’s cost of funding) and manage the interest-rate risk that comes with owning mortgage assets.
The business is capital-intensive but not complex. Cherry Hill borrows money (usually through repurchase agreements, a form of short-term financing) at one rate, uses that money to buy MBS at a higher yield, and profits from the spread. The spread compensates for the risk of interest-rate changes, extension risk (if rates rise, mortgages are paid off more slowly, locking in lower yields for longer), and prepayment risk (if rates fall, mortgages are paid off faster, forcing reinvestment at lower rates). CHMI-PA is not a claim on those operations — that belongs to common shareholders and bondholders. Rather, CHMI-PA is a senior fixed-income claim on Cherry Hill’s earnings, paying a fixed coupon as long as the company generates sufficient earnings to cover it.
The capital structure of a mortgage REIT
Mortgage REITs finance through debt, preferred shares, and common equity in a tiered structure. At the bottom, senior debt (typically unsecured) has the first claim on cash flows. Preferred shares like CHMI-PA come next, with a contractual right to their fixed dividend. Common equity is last, receiving whatever is left after debt interest and preferred dividends are paid. This layering allows mortgage REITs to raise capital efficiently: investors willing to accept lower returns in exchange for priority get preferred shares; those willing to take more risk for more reward buy common shares.
The mortgage REIT model depends on leverage — borrowing to magnify returns. A typical mortgage REIT might have $10 of assets financed by $1 of equity and $9 of debt plus preferred shares. If the MBS portfolio yields 4% and the cost of debt and preferred financing averages 2%, the spread of 2% gets passed to common shareholders, amplifying their returns. But leverage cuts both ways: if the cost of funding rises faster than MBS yields, spreads narrow and common earnings suffer. Preferred shareholders, by contrast, receive a fixed dividend regardless of the leverage outcome; the risk is that deteriorating spreads compress the company’s earnings to the point where coverage of the preferred dividend falls and the dividend is threatened.
Interest-rate environment and MBS valuation
Cherry Hill’s earnings are highly sensitive to interest rates and the shape of the yield curve. When the Federal Reserve raises rates, MBS prices fall (because existing mortgages paying lower coupons become less valuable). When rates fall, MBS prices rise but prepayment risk accelerates (homeowners refinance, cutting off the stream of high-coupon payments). When rates are stable, mortgage REITs can earn steady spreads with less disruption. During periods of rising rates, the values in the MBS portfolio mark down, potentially reducing the equity cushion beneath CHMI-PA preferred shares. During periods of falling rates, prepayment speeds accelerate and reinvestment risk increases, squeezing forward earnings.
This volatility in earnings and asset values is the primary risk for CHMI-PA holders. If a severe rate shock (up or down) hits the mortgage market and Cherry Hill’s equity capital is depleted by portfolio losses, the preferred dividend could be threatened. This is why CHMI-PA trades at spreads significantly above Treasury bonds: the fixed income is valuable, but the underlying business is inherently volatile.
Competition in the mortgage REIT space
Mortgage REITs compete on the basis of portfolio positioning, leverage, interest-rate hedging, and operational efficiency. Some focus heavily on government-backed MBS (lower yield, lower default risk); others add agency-backed commercial mortgage securities or non-agency residential MBS for higher yields at higher risk. Cherry Hill has historically focused on government-backed residential MBS, a choice that reduces idiosyncratic risk but offers lower yields. Some competitors take more portfolio risk in pursuit of higher returns, which increases common shareholder potential gains but also increases the downside risk to preferred shareholders if losses mount.
The preferred dividend and coverage
CHMI-PA pays a fixed quarterly coupon determined at issuance. The company’s ability to pay that coupon depends on its portfolio yield, funding costs, and operating expenses exceeding the preferred dividend. In stable rate environments, coverage is typically comfortable; in volatile periods, coverage can tighten. Because mortgage REITs are required to pass 90% of taxable earnings to shareholders as dividends (a REIT tax rule), the company has limited ability to retain earnings as a buffer. This means the preferred dividend is paid from earnings in real time, not from accumulated reserves. If earnings fall sharply, the preferred dividend is at risk before common dividends are cut.
How to evaluate CHMI-PA as a fixed-income investment
An investor evaluates CHMI-PA by comparing its yield to alternatives, assessing the book value of the company (the equity capital cushion beneath the preferred shares), and monitoring interest-rate forecasts and MBS spreads. A mortgage REIT with substantial book value relative to the preferred claim is safer; one with declining book value and tightening spreads is riskier. Investors should also understand the composition of the portfolio: portfolios weighted toward agency MBS are more stable but offer lower yields; portfolios with more non-agency or commercial exposure offer higher yields but carry more earnings volatility and default risk.
The optimal environment for CHMI-PA is stable or gently rising interest rates (which maintain or widen MBS spreads), a well-funded cost of capital, and no portfolio credit losses. The challenging environment is rapid rate changes, funding stress (when repo rates spike), or unexpected mortgage prepayments that force reinvestment at lower rates.