MFA Financial Inc (MFA) 2010 Q2 法說會逐字稿

Ladies and gentlemen thank you for standing by and welcome to the MFA [Mortgage Investments] second quarter 2010 earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will be given at that time. (Operator Instructions). As a reminder, this conference is being recorded today, Tuesday, August 3, 2010.

And now I would like to turn the conference over to Alexandra Giladi. Please go ahead ma'am.

Good morning. The information discussed on this conference call today may contain or refer to forward-looking statements regarding MFA Financial Inc. and reflect management's beliefs, expectations and assumptions as to MFA's future performance and operations. When used, statements which are not historical in nature including those containing words such as believe, expect, anticipate, estimate, plan, continue, intend, should, may or similar expressions are intended to identify forward-looking statements.

All forward-looking statements speak only as of the date on which they are made. These types of statements are subject to various known and risks, uncertainties, assumptions and other factors including but not limited to those relating to changes in interest rates and the market value of MFA investment securities, changes in the prepayment rates on the mortgage loans securing MFA's investment securities, MFA's ability to borrow to finance assets, implementation of or changes in government regulations or programs affecting MFA's business, MFA's ability to retain maintain its qualification as a real estate investment trust for federal income tax purposes, MFA's ability to maintain its exemption from registration under the Investment Company Act of 1940, and risks associated with investing in real estate related assets including changes in business conditions and the general economy.

These and other risks, uncertainties and factors including those described in MFA's annual report on Form 10-K for the year ended December 31, 2009, quarterly reports on Form 10-Q for the quarters ended March 31, 2010 and June 30, 2010, and other reports that it may file from time to time with the Securities and Exchange Commission could cause MFA's actual results, performance and achievements to differ materially from those projected, expressed or implied in any forward-looking statement it makes. For additional information regarding MFA's use of forward-looking statements, please see the relevant disclosure in MFA's quarterly report on Form 10-Q for the quarter ended June 30, 2010 and/or the press release announcing MFA's second quarter 2010 financial results.

Thank you for your time. I would now like to turn this call over to Stewart Zimmerman, MFA's Chief Executive Officer.

Good morning and welcome to MFA Financial's second quarter 2010 earnings call. With me this morning are Bill Gorin, President and CFO; Ron Freydberg, Executive Vice President; Craig Knutson, Executive Vice President; Tim Korth, Senior Vice President and General Counsel; Theresa Covello, Senior Vice President and Chief Accounting Officer; and Kathleen Hanrahan, Senior Vice President.

For the second quarter ended June 30, 2010 we generated net income available to common stock of $46.3 million or $0.16 per share of common stock. For the second quarter core earnings were $51.3 million or $0.18 per share our common stock. Core earnings for the quarter represent a non-GAAP financial measure which reflects net income excluding impairment losses and changes in the unrealized net gains in MBS forwards.

On July 1, 2010 we announced our second quarter 2010 dividend of $0.19 per share of common stock which was paid on July 30, 2010 to stockholders of record as of July 12, 2010. We continue to provide stockholders with attractive returns to appropriate leveraged investments in residential mortgage-backed securities.

Second quarter 2010 results were negatively impacted by extremely high Agency MBS prepayment rates, due primarily to programs instituted by the GSEs to buyout 120-day plus delinquent loans from their Agency MBS pools. For the second quarter of 2010, our weighted average Agency MBS prepayment rate, as measured by CPR, was 42.7% compared to 25.6% for the first quarter of 2010.

Prepayments at mortgage-backed securities acquired at a premium reduced earnings as the premium is advertised based on prepayment. With the completion of the initial implementation of the buyout programs, we believe that our Agency MBS prepayment rates will decline in the third quarter.

Our goal remains to position MFA to generate double-digit returns on equity over time and we continue to take advantage of investment opportunities by identifying and acquiring nonagency mortgage-backed securities with superior loss adjusted yield at prices significantly below par.

We have substantially reduced our reliance on leverage through repurchase financing. As of June 30, 2010 our debt to equity multiple was 2.8 times versus 4.8 times as of June 30, 2009. By utilizing less leverage we believe that future earnings will be less sensitive to changes in interest rates and the yield curve.

I would like to go over some recent financial results and certain additional data highlights as they pertain to our second-quarter 2010 results, second quarter net income per share of $0.16 and core earnings per common share of $0.18. Book value was $7.61 per common share at the end of the second quarter.

In the second quarter nonagency residential mortgage-backed securities, including mortgage-backed securities underlying MBS forwards, held by our MFResidential Assets I LLC subsidiary generated on an unlevered basis a loss adjusted yield of 10.3%. Based on MFR LLC nonagency MBS asset performance exceeding prior expectations, $81 million of the purchase discount on these assets was reallocated in the second quarter from credit reserves into accretable discount.

Together with coupon interest, accretable discount is recognized as interest income over the life of the asset. Therefore we expect that this $81 million will be reflected in income over the life of these nonagency mortgage-backed securities.

Agency MBS prepayment rates are expected to decline in the third quarter, and it is currently anticipated that core earnings per common share will increase in the third quarter due to both the expected decline in Agency MBS prepayment rates leading to lower premium amortization expense and continued reinvestment of cash received from MBS principal repayments.

There's been quite a lot of discussion over the last few days regarding government-sponsored refinancing of agency mortgage-backed securities. Overall, we're of the belief that the risks and costs of trying to implement such a refi program most likely outweigh the potential benefits, not to mention that there are limited resources to affect such a refi program and such a program would likely hurt the housing recovery rather than help it.

In particular we believe that, one, the potential impact of such a refi program would have a negative effect on banks, insurance companies and all other investors in agency mortgage-backed securities. Two, the GSEs would likely be negatively impacted with a resultant continued negative earnings. Three, a potential significant increase in mortgage rates is also likely, and lastly, additionally, there's a limited origination and servicing capacity available for such a potential refinancing.

As previously mentioned our MFA/MFR portfolio consists of both agency and nonagency mortgage-backed securities, and as a result, even if such a refi program were instituted we strongly believe that MFA's strategy of blending agency and nonagency mortgage-backed securities would work to mitigate the negative impact of any such program. The end result is that it is unlikely that a government-sponsored refinancing will occur. However, if such a refi program were to occur, we believe our investment strategy will be much less impacted than other companies in our space.

I thank you for your continued interest in MFA Financial and at this time I would like to open the call to questions.

(Operator Instructions) Bose George, KBW.

Good morning guys. This is actually [Ryan Osteen] on for Bose George. So was good to see the $81 million reallocated to the accretable discount. Can you kind of talk about what goes into the decision to do that? Also, is it likely we're going to see that again in the future?

Craig, do you want to handle that?

Sure. As far as what goes into that decision it is really -- it's a process that we go through all the time of reevaluating all of those assets and the actual performance versus the assumptions that we book those assets on. So as we get more and more historical data it becomes a little easier to say well, gee, we think our assumptions were little bit harsh here, or we think our assumptions were little bit lenient.

At the end of the day it is really loss severity, default and prepayment that govern the performance of these securities. So it is a combination of those things and it varies by security. Again, the fact that in many of these cases and in most of these bonds where we did this reallocation, they're purchases from 2008 and 2009 where we do have some more substantial pay histories.

As far as do we anticipate this in the future, it remains to be seen. Most of the bonds that we adjusted were 2009 and prior. Bonds that we purchased in 2010, at most we have six months of data which is not really all that conclusive. So we'll continue to monitor it. We do that at least quarterly. And to the extent that the evidence is compelling that we do need to change those, we will.

Just add to that, our surveillance process is all encompassing. And when Craig and his team, they look at each of these securities certainly on a monthly basis after the remittance reports come in on or about the 25th of the month. So again that is continually revisited.

Great. Thank you. And then just a couple of quick ones. One, what kind of unlevered returns are you getting right now on your nonagency portfolio? And two, do you have the duration gap at the end of the quarter?

The nonagency assets that we continue to purchase, it was a little over $300 million that we purchased in the second quarter, they vary by asset types and class. But I would say generally those yields, loss adjusted, unlevered, range from about 7.5% to 9%.

Great. And did you have the duration gap?

For the overall portfolio?

Yes, at the end of the quarter.

Do you want duration or -- the effective duration for the whole portfolio it is 0.49 at the end of the quarter. That includes a negative (inaudible) 0.75.

Jason Arnold, RBC Capital Markets.

Good morning guys. Thanks for the color on the refi thoughts there. That was helpful.

I was just curious if you could talk a little but about the purchases made in the quarter on the agency book. You mentioned some purchases of 15-year MBS, but perhaps you could offer a little bit more color there on what you found attractive in the quarter.

I'm going to turn it over to Ron in a moment to answer that. Again, as you know, we've been basically an ARM buyer. But we saw some real value in 15-year, so we kind of dipped our toe in that pool and it turned out to be I think a very, very good decision. Ron, why don't you give some detail?

Sure. For the most part we bought about $1.5 billion of agency mortgages in the quarter and that includes $200 million odd of 15-year. Those were 4%, those are 4% coupons. And we bought those at the beginning or to the middle of May when we saw much better yields than what we're seeing in the hybrid, especially when you compared it with the effective duration we were getting. So we viewed it as a much better risk/reward than we were seeing on the hybrids.

The rest of the portfolio we purchased were essentially [5.1] hybrids, 3.5 coupon on average. So those are the two main categories that we did purchase, but you know (inaudible) 15-year we've been looking at the 4s and the 4.5s.

Okay, perfect. I was curious also if you could offer a little bit of color on what you're saying in the nonagency repo availability end of things, you know, haircuts, rates, etc.

Sure. The nonagency repo was a little bit up from what it was in March. But I think March was $902 million; it was $929 million at June 30, so up a little bit, but relatively unchanged. We continue to see repo availability in that market.

Haircuts on the better quality assets typically as low as 10%. Haircuts on the lower rated assets are generally 30%, maybe in some cases 35% or 40%. In terms of rates I would say the tight end of rates is probably LIBOR plus 100, and LIBOR plus 175 is probably sort of the wide end of where rates are.

Terrific. Do you guys anticipate taking advantage of utilizing a little bit more repo leverage in the portfolio here going forward, or are you kind of comfortable with where you are at at this point?

On the agency or nonagency?

Nonagency please.

Certainly to the extent it is available, we look at that. I think we've also look at the resecuritization market as well. So I think we said at the beginning of the year that on the nonagency side that a lot of the task this year was to optimize the capital structure.

So at this point I think repo has obviously served us very well. It's more available than it was three months ago than it was six months ago and at very cheap levels. But at the same time the resecuritization market has improved, at least the execution, on a super senior bond that would represent permanent financing.

Okay, terrific. Thank you very much for the color.

Michael Taiano, Sandler O'Neill.

Just wanted to see if you could dig down a little bit further into the $81 million reallocation. Is there -- can you be a little bit more specific in terms of what you're seeing on those securities? Is it more severity is coming in better than you expected? Are there certain geographies that are performing better than you thought? Can you maybe give us a little more color there?

Sure. The analysis we do is really by security not by geographical reach them. So every security sort of stands on its own, it gets its own analysis. I would say of the three things I mentioned -- loss severity, prepayment speed and default -- that loss severity and prepayment speeds are probably the two most significant, right, because higher prepayments which come back at par obviously decrease our amortized cost and lower severities are typically more meaningful than lower default rates.

But it really is security by security. There were some securities where we may have had some very significant paydowns and the loss assumptions were more or less accurate. But remember that those loss assumptions, that default rate, we use a percentage number. So it's a percentage default rate. So if we get a very large prepayment, that percentage is now applied to a much smaller base number which means the dollar amount of defaults will be lower. Does that help?

Yes, no, that's helpful. And in terms of that flowing through the earnings do you have a rough estimate as to what sort of period we're looking at in terms of how long that would take the flow through at current prepayment speeds?

I would say that, again, on average -- but remember there are 200 odd securities here -- on average that the average life of the nonagency MFR portfolio is probably somewhere around seven years. Again, these numbers are not linear, but as an estimate, there are a lot of estimates involved here, I would say the annual impact of this change is probably about $7 million.

I think one of the most important things that comes out of this is the fact that the prices we've been able to buy, the quality maturities that Craig and his team have been able to purchase, and the type of surveillance they do, at the end result is there will be a better result than we had anticipated with some very realistic or even maybe some severe assumptions. So it is all -- it's good news. And again, the portfolio is adapting even better than we had anticipated.

Right. And then just finally in terms of the mix that you have, obviously you had a lot of runoff on the agency side last quarter that you had to replace. Where do you stand in terms of relative attractiveness of the two strategies, agency versus nonagency, given the run-up especially in the agency MBS prices?

I think we continue to prefer to the nonagency. We think that's real value added. The loss-adjusted, unlevered yield on the whole nonagency portfolio (inaudible) still in excess of 10%. There are assets available in this market place with yields of 7.5% to 9%. We much prefer that to an agency yield of 3%, albeit with a higher levered basis.

So we continue -- we think we create more value for the shareholders and for ourselves and for you by incrementally growing the nonagency and probably keeping the agency portfolio about where it is, which is originally we had a portfolio of excess of $10 billion and now we're mid-$6 billion. I think for now that is probably replacing runoff. Unless the opportunities increase, staying where we are on the agency.

But having said that, the agency product is still a product that we enjoy, that we look at and we continue to see where there is value. And again, Ron had looked at the opportunities in the 15-year as an example and we dipped our toe in that pool. So again I would agree with what Bill said. The nonagencies are very effective but we still enjoy the agency product.

Great, thank you very much.

Jasper Birch, Macquarie.

Good morning gentlemen, thank you for taking my question. I found your comments on potential refinancings pretty interesting. Just historically you guys have been pretty defensive of putting on high dollar price MBS.

I was wondering, I guess first of all, does your outlook on there not being a refinancing wave change that? What dollar pricing you are putting on and where you were comparable comfortable taking both your equity allocation and leverage on the agency book?

Well, our agency exposure in terms of dollar price to premium is about 1.5%. So I would, again, maybe I misunderstood part of what you said. But we have never really been a large player in buying securities at very, very significant premiums.

Having said that, the agency market again is still attractive to us, although as we said a moment ago the nonagency is a little more attractive. But having said that, we've seen some opportunities and we have paid a little bit higher or higher premium for certain assets. But again, we've gone from -- I think it was 101.3 in the quarter previous to about 101.5.

Okay. And we should probably -- and you said that you're pretty much just replacing runoff on that book.

It's going to stay close to $6.5 billion.

In terms of your outlook on there not really being many more refinancings, I thought it was really interesting that you said you expected the yield curve to steepen with agency MBS. Is that really what is driving your outlook on that front? Or is it more lack of credit availability for borrowers?

I don't think I said that.

Oh, you didn't? I'm sorry; I thought I heard it in your opening remarks that you expected mortgage rates to go up.

(multiple speakers) No, we talked about the potential of the government kind of waving a magic wand and doing a refi across the board. And basically they're looking at some of the data and looking to see what the relative availability of the -- of what is available to the mortgage banking industry. There is less opportunity rather than more.

We feel the chances of them doing that across the board just aren't as readily available.

Okay, that makes a lot of sense. Thank you for the clarity on that.

One last question, if I remember correctly you run your agency premium amortization on the lifetime CPR. Could you -- (multiple speakers)

No, we do it based on -- we correct each quarter based on actual.

Based on actual, okay, great. Thank you very much. That's all I have.

(Operator Instructions) [Jim Ballan, Lazard Capital Markets].

I wanted to ask about the drop in the average yield on your assets just sequentially in the quarter. Can you talk about how much of that was maybe due to the greater amount of premium amortization because of the buyouts? Maybe the premium amortization exceeding the accretion of the discount, how much of it was related to that as opposed to just reinvestment at lower rates?

Look, there are three things that impacted us. One, obviously the higher prepays led to more premium amortization. Two, you're right; the Fannie and Freddie buyouts of the 120-plus day delinquencies were tiered by coupon. So, they went after the higher coupon first, as you know. And the third point would be we're still running with above average cash balances because of these heavy prepays.

So, to the extent the higher coupon -- to the extent that assets that yielded us 5 went away and was replaced by a 3, that is a permanent change on our yield. To the extent that prepays have spiked and are going to go back down, that will increase the yield.

I can't quantify exactly -- let's see. If the yield in the first quarter on our agency, and this is mainly the agencies. So if the agencies were yielding 4.64% in the first quarter and now it is down to 3.6% in the second quarter, let me see how much I would expect to back. I would say I would capture back -- it's hard to say exactly. It's about half and half.

Okay.

So basically we're saying the yield on the agencies will go back up to some extent as the premium amortization slows down, but it is not going to go back to where it was because higher coupon assets were called away and replaced with lower coupon assets.

So maybe something a little bit above 4s, just for modeling [purposes].

I don't want to say an exact number.

All right, great; that's helpful. Just one other thing if I can, the book value was -- didn't really change much but I'm sure there's a lot of moving parts in that. Could you talk a little bit about the components of the changes in book value, just agency, nonagency, the swap book, maybe the (multiple speakers) [repurchases]?

It's actually a very simple explanation. We got it very right in terms of our hedges. So basically we had an increase in value in both our agencies and nonagencies equal to the diminution value in swaps. The reason for the difference in book value from quarter end or the first quarter to the second was solely based on the difference in earnings.

So, to the extent that the earnings were less and basically we pay out -- we declared the dividend after the quarter. It was just that differential in earnings per share, explains the whole difference in book value.

[Steven Zakillick], a private investor.

Thank you. With increases in strategic defaults when doing your due diligence on nonagency securities, how do you relatively weigh FICO scores versus collateral values? And are you modeling in further declines in housing values?

We do model in further declines in housing value. As far as FICO scores and LTVs, I would say the predominant consideration is the mark to market LTVs on the loans underlying these pools.

While we do have the ability to get some updated credit, FICO or other borrower type credit information, it's -- generally the information available on FICO scores and credit is as of origination. So it's not as helpful obviously three, four, five years after the fact. So it is really primarily based upon what we believe the true mark-to-market loan to value ratios are now.

Thank you. If you were to issue preferred stock today what rate would it sell for and how have important do you view preferred in your capital structure?

Well, since we already have an existing preferred stock which has an 8.5% coupon and is trading near part, I would say near 8.5%.

Okay, thank you.

Thank you. There are no further questions. I will turn it back to management for any closing statements.

Just want to thank everybody for your continued interest in MFA Financial. We look forward to speaking with you next quarter.

Thank you. Ladies and gentlemen this does conclude our conference call for today. Thank you for your participation and you may now disconnect.