MFA Financial Inc (MFA) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the MFA Financial Inc.'s second-quarter 2011 earnings call.

At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions being given at that time. (Operator Instructions). As a reminder, today's conference is being recorded.

I would now like to turn the conference over to Alexandra Giladi for opening remarks. Please go ahead.

Good morning.

The information discussed on this conference call today may contain or refer to forward-looking statements regarding MFA Financial Inc. that 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 unknown risks, uncertainties, assumptions and other factors, including but not limited to those relating to changes in interest rates and the market value of MFA's investment securities; changes in the prepayment rates on the mortgage loans securing MFA's investment securities and the feasibility to borrow to finance its assets; implementation of or changes in government regulations, or programs affecting MFA's business; MFA's ability to 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 and (inaudible) factors, including those described in MFA's annual report on Form 10-K for the year ended December 31, 2010, and other reports that MFA 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 statements 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, 2011, and/or the press release announcing MFA's second-quarter 2011 financial results.

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

Mr. Zimmerman, if you are speaking, we cannot hear you.

Good morning and welcome to MFA's second-quarter 2011 earnings call. With me this morning are Bill Gorin, President; Stephen Yarad, Chief Financial Officer; Ron Freydberg, Executive Vice President; Craig Knutson, Executive Vice President; Al Schwartz Senior vice President and General Counsel; Teresa Covello, Senior Vice President and Chief Accounting Officer; Kathleen Hanrahan, Senior Vice President; Shira Finkel, Senior Vice President; and [Zumunda Christiansen], Vice President.

Today, we announced financial results for the second quarter ended June 30, 2011. Recent financial results and other significant highlights for MFA include the following -- second-quarter net income per common share of $0.22 and core earnings per common share of $0.26. On July 29, 2011, we paid our second-quarter 2011 dividend of $0.25 per share of common stock to stockholders of record as of July 14, 2011. In June, we sold $1.283 billion in principal value of non-on agency mortgage-backed securities as part of a resecuritization. In connection with this transaction, $474.9 million of senior bonds rated AAA by DBRS were issued to third-party investors via a trust at a rate of LIBOR plus 125 basis points. As required under GAAP, we will consolidate the resecuritization or account for this fine transaction as a financing.

Book value per common share was $7.48 at the end of the second quarter versus $7.86 at March 31, 2011, due primarily to price weakness within the Non-Agency mortgage-backed securities sector. In the quarter, we grew our Non-Agency MBS portfolio at an accelerated pace through the purchase of approximately $945 million of Non-Agency mortgage-backed securities.

For the second quarter ended June 30, 2011, we generated net income allocable to common stockholders of $77.2 million, or $0.22 per share of common stock. Core earnings for the second quarter were $91.6 million, or $0.26 per share of common stock.

Core earnings is a non-GAAP financial measure which reflects net income excluding $2.4 million of other than temporary impairment charges, $11.7 million of unrealized net losses on linked transactions and includes an adjustment of $0.7 million to increased interest income following the de-linking of certain non-agency mortgage-backed securities previously reported as linked transactions for GAAP.

We continue to provide stockholders with attractive returns through appropriate leverage investments in both agency and non-agency residential mortgage-backed securities. We are well positioned with an Agency MBS portfolio with an average amortized cost of 102.4% of par.

In the second quarter, we continued to implement our strategy of identifying and acquiring non-agency mortgage-backed securities with what we consider to be superior loss adjusted yield at prices well below par. We currently project that approximately 2/3 of our third-quarter 2011 core earnings will be generated by non-agency mortgage-backed securities.

In the second quarter, non-agency mortgage-backed securities generally experienced widespread price weakness, which created a buying opportunity. Due to underlying borrower characteristics and certain structural features, our portfolio was less impacted by the overall price movement, declining an average of 3.4 points. We believe that the factors that impacted Non-Agency MBS prices were continued negative housing market views, concern over the continuing sale of Maiden Lane II assets and overall weak economic data.

While housing fundamentals remain weak, we believe that we have appropriately factored this into our cash flow projections and credit reserve estimates. We continue to favor high-yielding non-agency mortgage-backed securities at discount prices as we believe the value of these assets will be positively impacted over time as the existing private label MBS universe continues to decline in size due to prepayments, default, and limited issuance.

I would like to go over certain additional data highlights as they pertain to our second-quarter 2011 results. Overall leverage debt-to-equity, 3.3 times; portfolio spread, which is interest earning assets minus cost of funds, 305 basis points; the portfolio spread, which is interest earning assets minus cost (technical difficulty) including mortgage-backed securities, underlying linked transactions of 318 basis points; and our agency CPR was 16.6%.

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

(Operator Instructions). Jason Weaver, Sterne Agee.

Good morning. Thanks for taking my question. I was hoping you could detail a little bit about the $1 billion in non-agency purchases you made this quarter, both on timing and how that compares with the existing portfolio you had at the end of March.

Sure. I'm going to turn it over to Craig Knutson, who runs that area. Craig, if you would please answer.

Sure. So the purchases were pretty much spread out through the quarter, although June was the heaviest. As you can see, we did a resecuritization in early June which generated cash, so -- and it was actually lucky timing because the June month was really when we saw the most price weakness. So it was, like I say, it was spread through the quarter, but it was more in June than any other month.

As far as the assets and how they compare to the overall assets, I would say they're very comparable to the assets and you'll see in the Q in our table in the back where we list vintages by FICO buckets, the bonds are very similar to the bonds that we already owned.

Thank you. Also, I was just interested in your thoughts on a yield curve going forward. I know we've seen some flattening in the long end with the flight to quality, but I was just curious on your thoughts there.

I continue to see great opportunities for our Company in terms of the mortgage market. Yes, we had some flattening. The ten-year I guess is, what, about 260 plus or minus a basis point or two, but there are continued opportunities. So in fact you could continue to see a little bit of flattening on the longer side. I still think that if you look at the short end, not much is going to happen (inaudible) provides continuing opportunities for us.

Okay, thank you guys. Solid quarter.

Steve DeLaney, JMP Securities.

Thank you. Good morning everyone. A couple more thoughts or questions I guess on the Non-Agency portfolio, since that's sort of the current focus of the quarter. You reported in your press release that the portfolio, the Non-Agency book experienced an average price drop of 3.4%. Barclays puts out a data series on just indicative prices every week. And they, for the second quarter, at June 30, they were showing sort of Alt-A-ish type of paper, down more like 6 points. Obviously, every bond is a story, I know. But could you comment a little bit? I know you alluded to it in your press release, but is some of your -- you've never really described your portfolio I guess as Alt-A or prime, but it looks like some of the paper has more prime characteristics than Alt-A, if Barclays -- if we were to look at Barclays' data being realistic. Could you comment on that?

Sure Steve. Again, we don't characterize it as Alt-A and prime. Primarily the reason we don't do that is there is not one universal measure of what constitutes Alt-A and what constitutes prime. So what we've done is a surrogate in our FICO table is we show bonds that had average FICO scores at origination of 715 and below and 715 and above. So while we don't refer to 715 and below as Alt-A, that's sort of the distinction we make. I think if you look at the FICO table in the Q, it's probably 85%, give or take, FICO 715 and higher and about 15% 715 and below. So, I would certainly say that most people would characterize the majority of our portfolio as prime or near prime.

As far as price declines in the market, you are right. It's really bond by bond. But I would say, in general, an Alt-A portfolio probably was down 5 points. That's probably right. So the reason that we're down a little less than 3.5 points is it's skewed towards probably the higher and of that credit quality.

Just to follow up on that, again, Craig and his group are very, very selective, very careful in terms of what securities they do buy. Generally it's at the higher end rather than the lower end.

Yes, I think your $0.74 on the dollar average price does suggest that there are some better -- there are definitely some better quality collateral in there.

Exactly.

My second question is about your credit reserve. You're a little over $1.2 billion, and that's about 83% of your discount and it's 22% of the par value of the Non-Agency portfolio. I was just curious if you could comment on how your actual losses, since you use the reserves, you're really not breaking out losses for us as some competitors do. We know they are just being taken against that reserve. Can you talk about how your actual losses are tracking against your model and if you've made any adjustments, any transfers into or out of that reserve so far this year?

So yes, Steve. The $1.2 billion on about $5 billion, so you're right. It's about 22%. Also bear in mind that we still have about 6% structural credit enhancement that stands before that loss reserve.

As far as what we're seeing, we really don't have, quite frankly we really don't have a lot of bonds that are in first loss position. So when we do have a bond that's in a first loss position, the loss will obviously hit that credit reserve, but for the most part it's really too soon to tell. We continually reevaluate all of our assumptions, so it's not just loss assumptions. It's default, loss severity and prepayments -- to adjust those over time. I think you know in the past we've had -- there have been times where we've increased our credit reserve due to those adjustments. But it's something that we look at every quarter, and we feel pretty comfortable with those loss reserves. But it's really way too soon to tell.

The 6% structural support, is that current or is that original?

No, that's current.

That's current? Okay. Can you venture to guess just very roughly what percent of the bonds are not yet in a first loss? Is it --

I would -- it's just a guess. I'm sure it's more than 90%, and it could be 95% of the bonds still have credit support. One of the considerations there is obviously you buy bonds and the credit support goes away over time, and we certainly expect that. That's why we have that credit reserve. But when we look at securities and we purchase securities, especially with an eye towards resecuritization, bonds that have credit support are easier to resecuritize than bonds without credit support. So I think our natural -- again, everything depends on the price, but I think we certainly take into account the fact that a bond without credit support is more difficult to resecuritize when we value it in the first place.

Makes sense. Thanks very much for the comments, and good job on the quarter.

Bose George, KBW.

Good morning. Actually I have a follow-up on the Non-Agency purchases. I was curious about the dollar prices and loss-adjusted yields on that compared to -- what you bought this quarter compared to what it was like in the first quarter.

So in the first quarter, I think we pretty much consistently said yields were probably be between 6% and 7% loss adjusted unlevered. In the second quarter, for the first two months of the quarter, they were probably still in that same range. In the month of June, I would say they're probably closer to 7%. So still in that range.

Did we find bonds that yield between 7% and 7.5%? Yes we did. Do we still find bonds that yield in the 6s%? We do.

As far as dollar price, I think our average purchase price for the quarter was in the low 80s. So I think fairly consistent with where we were in the first quarter, although June was somewhat opportunistic with some price softening. And having just completed a resecuritization, we were in a little bit more of an aggressive buy position.

Okay, so June was presumably kind of lower than that low 80s number?

I think so, yes.

Great. Then just switching to the loss reserve, just for taxable income, since you can't really create a loss reserve, I'm curious, when the losses do happen, how GAAP and tax accounting reconcile when the losses actually do hit.

As Craig mentioned, the vast majority of our Non-Agency mortgage-backed securities do a credit enhancement so there's almost no real losses being experienced on GAAP basis. You're right. There is some differential between tax and GAAP, and our taxable income is somewhat higher, and I think we are approximately $0.02 under-distributed as of the moment. So it's not a large differential at the moment.

Okay, great. Thanks.

Jason Arnold, RBC Capital.

Good morning guys. I had a quick follow-up on the resecuritization. I was curious if you could comment on investor demand for the deal and then on pricing in terms if you had seen any changes or moves there.

Sure. So the deal was priced, we sold the AAA piece which is approximately the top 35%, which is about a two-year average life security at LIBOR plus 125, which is comparable to the deal that we did in the fourth quarter, a little bit wider than the deal that we did in the first quarter. But I think if you look back at credit spreads when we did our deal in the first quarter, which is the early part of February, it was pretty much a tight in the market. So it's certainly in the context of where we got deals done before. The deal was DBRS only rates, which does not have perhaps the same wide appetite that multiple rating agencies would. But again, the execution was very similar or spot on to where we had done prior deals.

Great, thank you. Then I guess I was also curious if you could update us on repo availability and haircuts, primarily on the Non-Agency side. Are you seeing any change to haircuts or rates here? Then while, to me, repo on the agency side seems extremely likely to see any major changes, investors still seem to have this on their minds. So maybe you comment on that side as well.

I'm going to ask Ron Freydberg to give you the detail, and then I would have just a couple of general remarks. Do Ron?

On the Agency side, we've seen some volatility in rates over the last couple of weeks. As of today, rates look like they're settling back to the mid 20s%. We have not seen any change in haircuts. We've not seen any change in the availability, but the market is going through some flux, finish in a couple of weeks. Today with the debt ceiling having been passed yesterday, you've seen the cash providers have come back in in size, so therefore rates have come back to what we saw a couple of weeks ago.

I think the answer, again, Ron was discussing the agency side. Again, repo is certainly ample. You have a slight tickup, you know you have volatile markets. That doesn't really faze us in the least. Then on the Non-Agency side in terms of repo, that is also available to us. We utilize it.

Again, just to remind everybody, during 2008 and 2009, we were able to finance and add repo for Non-Agency securities. So again, it's a matter of having the relationships on the Street and having the right collateral that people feel comfortable with. We've been able to accomplish that going back to 2008 and 2009, and certainly today it's readily available to us in a very positive way.

Excellent, thanks for the color there. Nice job this quarter.

Douglas Harter, Credit Suisse.

Thanks. I was hoping you guys could talk a little bit about how you're viewing the agency opportunities right now, and sort of what direction you might be leaning on the portfolio there.

[Zumunda], I'll turn it over to you to handle that.

We feel -- obviously you've seen rates have come down considerably over the last quarter or so, over the last two weeks we (inaudible) we've got some clarity on the debt ceiling and raising of the debt ceiling. At the same time, we've seen spreads widen to basically compensate for that.

So overall, I think the opportunity is pretty attractive. We are able to invest, depending on in hybrid, so the 15 year space at a spread anywhere from 170 basis points to 220 basis points, depending on how much you hedge and how short or how long you have (inaudible). If you view that historically, that spread is very attractive, so we'll continue to deploy cash there. From the leverage point of view, I think we'll kind of stay where we have been, in the mid 6s%.

Just so you know, reinforce what we've said, we continue to see higher value-added investment opportunities on the Non-Agency side.

I guess, on the agency side, what's your kind of outlook for prepays, given the rally we've seen in rates?

I think prepayments will definitely tick up. We've already seen that in the latest report which you saw in July. That's something that was kind of on the table already before the rally, because keep in mind rates have been rallying since April pretty much. When you look at primary rates, the mortgage curve has also steepened. What that means is the mortgage rate is available to the homeowner on the hybrid side (inaudible) has gone down more than on the 30-year side. So prepayment risk has probably increased a little bit more in the hybrid side, and also on the 15-year side relative to the 30-year mortgages, which basically means that asset selection is even more critical, meaning you've got to stay away from (inaudible) characteristics that can bring on high prepaids.

Thank you.

(Operator Instructions). Daniel Furtado, Jefferies.

Thanks for taking the time guys, and nice quarter. Just two real quick questions. The first is on the re-REMIC. . One, are you providing the name of the re-REMIC or will that be in the

I believe it's in the Q.

Okay, good. Then the second is were there any major structural differences? Because you had really good execution on that deal. Was there any major structural changes from the previous two deals?

I would say the structure was almost a carbon copy of the deal that we did in February. We sold, actually we sold a thicker slice than we did in the October deal, so same as February. We sold more bonds so it was a longer average life than the deal that we did last October.

Excellent. Then the second question is how should we or how do you think about the $2 billion in the Non-Agency ARMs that are at about a six month to reset on the interest rate? Just kind of how do you anticipate that to impact yield or how do you -- how would you guide investors to think about that as we move forward?

The yield that we book is really based on assumptions over the life of the security, so we know when we buy it that the mortgages will reset in six months or one year or two years or whatever it is. So I don't think it should really have that much impact.

We also know, for instance, that hybrids, when they reset, will likely -- the prepayment speed will likely slow down, especially these days where the coupons typically reset to 3% type rates. So I think all those are sort of baked into our purchase assumptions when we buy these securities.

Excellent. Thanks a lot. I appreciate the insight.

Mike Widner, Stifel Nicolaus.

Good morning guys. Congrats on a solid quarter. So a lot of my questions have been asked, so I'm going to ask you sort of a little bit of a philosophical question about how you guys allocate and specifically I guess thinking about the thoughts on the Agency versus the Non-Agency allocation and the relative attractiveness. Before you answer, let me prefix it with obviously the mix has been moving or at least the preponderance of the asset growth has been moving for two years now in favor of the Non-Agencies. Throughout that time, up until at least last quarter, the prices on those Non-Agencies have been generally rising in terms of dollar prices as a percentage of par. That was in part I think in the broad marketplace a reflection of expectation that housing was improving, the economy was improving, things were getting better, we were heading back to something that was closer to normal. Last quarter and really more recently obviously, the broad market is telling us that it's starting to rethink that, that maybe we are not quite out of the woods yet, maybe the economy is not really recovering. Certainly, the talk out there that comes up now and then is starting to resurface again, that maybe we're actually in a more Japan-like scenario than we had previously thought. You see that in the yield curve as well.

So against that kind of backdrop, I'm wondering what your guys' expectations are and if it changes how you view the asset allocations in terms of what the expected shape of recovery is. Relevant to what you have been doing recently, what you are doing today, particularly the sort of preference for Non-Agency assets, would that change at all if your view was that we were in fact in kind of a much longer, much slower, much weaker recovery than the market had sort of thought we were? If we are in a Japan scenario, would that change your allocations at all?

This is Stewart. I'm going to turn it over to Bill. In terms of asset allocation, we would continue to favor the Non-Agency side.

In terms of housing, I continue, we continue to have a very negative perception in terms of housing. Having said that, that's already baked into the assumptions when we buy the Non-Agencies, which we perceive gives us kind of a leg up. But having said that, Bill, do want to address that?

Yes. So we look at this asset class and the purchase prices, we all know what they are, so the variable is what do you forecast is going to happen in the future. We say the yields are close to 7% where we're basing our assumptions on, how could you be comfortable [their] assumptions taking into account potential downward trends in the economy. So we point to the credit reserve, which was approximately $1.2 billion. I think Steve DeLaney pointed out that's about 22% of the face. Coincidentally, about 22% of the underlying mortgages and securities are 60 days delinquent. So basically if you took a snapshot as to what's current, what's delinquent, basically we have reserved $1 on the dollar against mortgages which are 60-plus days delinquent.

Now, as you know, we own the top tranches, and this is not a subprime or option on our portfolio. It's a jumbo portfolio. So, we think that we've more than taken into account continued downward trends in home prices, a continued very soft economy.

You can draw analogies to Japan, which is inadequate consumption relative to productive capacity, but the huge difference is the demographic change between us and Japan in which you have an older society and less home formation, which is very bad for housing. So while you -- we'll go through a rough patch here because it's very, very difficult, as you know. If you're pristine, you can get a mortgage at excellent rates. If you're not pristine, you can't get a mortgage. So basically, the incremental home is being priced on when the cash buyer can pay or what you could pay if you bought for cash and lease the house out.

We think we continue -- we've proven we've been conservative. In no way were we ever calling a turn in any of our public calls. In fact, what we've always said is we're probably the most pessimistic, and that's who you want picking the assets. So I'm not sure that the change in prices of the assets going to the fourth quarter and first quarter was a reflection of people calling the bottom in housing. We're not sure if it's the new housing news that has impacted the prices going into the second quarter. There was generally bad economic news. There certainly was a lot of new supply or pre-existing supply came to market as we hit certain price levels. As we retreated from those price levels, that incremental supply seems to have disappeared. So we continue to prefer the Non-Agencies on an incremental basis. Consistently, we've said 55% to 60% of our assets are agencies that will continue to be that way. So there hasn't been a large fundamental change here.

We continue to like both the Non-Agency and the agency markets, as Zumunda just kind of alluded to a few moments ago in terms of the available yields that are available on the agency side. So again, these are complimentary asset classes and we think it works quite well for our shareholders.

I would clearly agree with that. I guess really what I'm hearing from you is that, if I am interpreting you correctly, that you like the assets, no doubt about that. I don't think anybody on this call or at least anyone that has spoken so far is going to complain about the quality of the assets you've bought thus far. I guess I am thinking more about clearly expectations and even backward revisions to the economy, and GDP growth has been nowhere near as strong as prior reports have said. Unemployment is clearly heading in the wrong direction again, and I don't know if you believe the ADP numbers this morning, but even if you do, it says that things are moving sideways more than improving. Then of course, we have the circus in DC. I don't it's really going to do much to help anything in the economy next year as we focus more on cuts and spending and blah blah blah. So it's not so much a question of do you feel good about the assets that are there as much as it clearly seems that there is a softer tone in the economy than many people had thought. Really it's just -- does that impact at all your decisions? Have you changed anything about your assessments of the collateral or your expectations going forward, or is it just kind of look, this is already what we expected, it's already built into our models, we knew everything was going to be horrible and despite all the recent data, we still like everything just as much as we did before?

We still like the asset class. I believe what's happened in the market and as you look at the economy, it gives us more opportunity rather than less opportunity. With the (inaudible) potentially with a higher yield to shareholders rather than a lower yield.

Certainly a fair point. I guess the question is -- we've certainly heard the story before that oh my God, these things are $0.85 on the dollar. They can't possibly trade lower than that. And all of a sudden it's $0.75, $0.65, $0.55, $0.45 and --

But that's okay. That's perfectly all right. As the markets move, markets are volatile, and again, if we bought a particular asset at $0.80 on the dollar and we feel good about that, that's fine. Generally, what's happened over time is that we have absolutely -- in terms of underestimated in terms of what the absolute returns have been. So theirs have been better than our forecast.

I would say, for the last X years, we've never said we're calling the bottom. What we've said is we had the advantage of a structure of having a permanent capital that we think we do a very good job forecasting what the yield is going to be on the asset, but you need to make sure you have the staying power to realize those returns. So in no way do we try to call bottoms. We get excited when the prices went down. What you should look to management is to make sure that they have liquidity to take advantage of downturns. And I think that's what we did in the second quarter and what we're doing in the third quarter.

It's all fair. Certainly as I look at the delinquency trends on your underlying collateral, I would describe them as stable. So, I certainly don't mean to imply that I worry about the collateral you guys already have or the securitizations you already bought. Just wanted to hear your views on whether or not anything has changed in -- again, the tone in the markets is clearly one of great caution these days. Just wanted to see if you are thinking about things any differently, maybe taking a step toward being a little more cautious right now. But it sounds like your answer is basically you've been cautious all along and adequately prepared. I don't that I would argue with that.

I would reiterate that we have been cautious all along. We'll continue to be cautious, but I think we're making the right investment and I think we're getting very nice returns for our shareholders.

Thanks guys. You've taken way too long to humor my questions.

Jason Weaver, Sterne Agee.

It's actually Henry Coffey. My phone failed on me. When you look at current marks today versus June 30 or during the second quarter, obviously you're constantly -- you're either going to get great reinvestment returns or great book value marks, but rarely both. Have current marks since June 30 changed whole lot, so is this an environment that puts pressure on book values but offers great reinvestment rates, or what is the view kind of short-term?

I assume you're talking about Non-Agencies?

Yes sir.

So, Henry, as far as Non-Agency pricing in the month of July, a week ago, I probably would've told you they were up maybe 0.5 point or so. There hasn't been a lot of trading volume, so it's a little difficult to say. Dealer inventories are also fairly light. So, I think what little trading there is, it's very easy for dealers to jump in and snap up bonds. So I would say it's unchanged, maybe up a little bit in the month of July.

Thank you very much.

Gentlemen, there are no further questions in queue. I'll turn it back to you at this time.

Thank you. I appreciate your interest in MFA. We look forward to speaking with you next quarter.

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