MFA Financial Inc (MFA) 2011 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the MFA Financial Inc., fourth-quarter 2011 earnings release. For the conference, all the participants are in a listen-only mode. There will be an opportunity for your questions. Instructions will be given at that time. (Operator Instructions)

As a reminder, today's call is being recorded. With that being said, for opening remarks I'll turn it over to Ms. Alexandra Giladi. Please go ahead.

Good morning. Information discussed on this conference call today may contain or refer to forward-looking statements regarding MFA Financial Inc., which reflects management's beliefs, expectations and assumptions as to MFA's future performance and operations. When used, statements that are not historical in nature, including those containing words such as will, believe, expect, anticipate, estimate, plan, continue, intend, should, could, would, 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, changed in the prepayment rates on the mortgage loans securing MFA's investment securities, MFA's ability to borrow or 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, uncertainties and factors, including those described in MFA's annual report on Form 10K 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 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 the press release announcing MFA's fourth quarter 2011 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's fourth quarter 2011 earnings call. With me this morning are Bill Gorin, President, Steve Yarad, Chief Financial Officer, Ron Freydberg, Executive Vice President, Craig Knutson, Executive Vice President, Hal Schwartz, Senior Vice President and General Counsel, Kathleen Hanrahan, Senior Vice President and Chief Accounting Officer, and Shira Finkle, Senior Vice President.

Today we announced financial results for the fourth quarter ended December 31, 2011. Recent financial results and other significant highlights for MFA include the following. Fourth-quarter net income per common share of $0.19 and core earnings per common share of $0.22. Book value per common share was $6.74 at the end of the fourth quarter, versus $7.16 at September 30, 2011 due primarily to price weakness within the non-agency MBS sector. Book value per common share has since increased to $7.10 at January 31, 2012 due principally to a rebound in the value of non-agency mortgage backed securities during the month of January.

We continue to increase our focus on financing structures that reduce our reliance on share term repurchase agreements, collateralized by non-agency mortgage backed securities. In the fourth quarter, we entered into a three-year collateralized financing arrangement that effectively provides $300 million of financing for non-agency mortgage-backed securities, and subsequent to year-end, we increased the amount financed under this arrangement to $500 million.

On February 9, 2012, we sold $433 million in principal amount of non-agency mortgage backed securities as part of a resecuritization. In connection with this transaction, $186.7 million of senior bonds rated AAA by DBRS were issued to third party investors via a trust. These bonds, with an average life of 1.9 years, priced are priced at a 2.75% yield. As required by GAAP MFA will consolidate the resecuritization, will account for this transaction as a financing.

At year-end, our debt to equity ratio, including the liabilities underlying our linked transactions, was 3.7 to 1. Our agency portfolio had an amortized cost of 102.6% of par as of December 31, 2011, and generated a 3.14% yield in the fourth quarter. Our non-agency portfolio had an average amortized cost of 72.8% of par as of December 31, 2011 and generated a loss-adjusted yield of 7.06% in the fourth quarter.

We continue to selectively find value in the agency MBS market. In addition, we continued to implement our strategy of identifying and acquiring Non-Agency mortgage backed securities with what we consider to be superior loss-adjusted yields at prices well below par. We believe that we continue to run on a very cost effective basis for the benefit of our stockholders. For the three months ended December 31, 2011, our cost for compensation and benefits and other G&A expenses were $6.6 million or 1.06% on an annualized basis of stockholders' equity as of December 31, 2011. Our goal remains to continue positioning MFA to generate double-digit returns on equity over time.

In the fourth quarter, our non-agency portfolio experienced a modest price decline averaging 3.2 points. However, during the month of January, the value of these assets has increased. We believe that the factors impacting non-agency MBS prices in the fourth quarter were continued negative housing market news, concerns about the sovereign debt exposure of the European banking system, and the desire of dealers to reduce inventory.

While housing fundamentals remain weak, we consider that we have appropriately factored this into our cash flow projections and credit reserve estimates. In two installments, one in the fourth quarter of 2011 and one in the first quarter of 2012, we entered into a three-year collateralized financing arrangement that effectively provides $500 million of financing for non-agency mortgage backed securities. While this multi-year financing is incrementally more expensive than short-term repo financing by approximately 100 to 150 basis points, we believe the certainty of the committed term outweighs the additional cost.

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

(Operator Instructions) We'll first go to the line of Steve DeLaney with JMP Securities. Please go ahead.

Good morning, everyone. Stewart, just looking at the -- over the last couple quarters, the trend between core EPS and your dividend, it would appear that for 2011 that your taxable EPS likely exceeded core EPS. I guess would you agree with that and is there accounting differences in place such as the timing of recognition of losses on non-agency securities for tax versus GAAP? Are there accounting nuances in place that would likely cause taxable EPS to be slightly higher than core as you look out into 2012?

The first answer to your question is yes.

Okay.

That's the easy part. I always give the hard parts to other people. Bill, you want to start?

Sure. Hi Steve. So, two points. One, taxable income is something we distribute over the course of the year. So it's not necessarily tied to the core or GAAP earnings in any particular quarter. And we have said that throughout the year. So, the goal is through the course of the year to distribute our taxable income. Based on our estimates of taxable income for 2011, obviously, we haven't filed the tax return yet, we believe we end the year $0.01 under-distributed. So basically, Steve, we are distributing our taxable income over the course of the year.

The main differential of 2011 was that you know we booked our income on non-agencies assuming a high percentage of assets default and with high severities. For taxable income, you cannot assume a loss is going to occur in the future that hasn't already occurred. So while we had credit enhancements on the vast majority of our non-agencies, there were no losses being realized.

As a result, taxable income exceeded core and GAAP earnings in 2011. I think the differential will decline in 2012. Although it's early in the year, I expect taxable income will exceed core and GAAP, but I think the differential between taxable and core will be less in 2012. So I know that was a long answer, Steve. Did I address your question?

You did, that was very helpful. Thanks. And I had just one other thing, the swaps, you have about 30% of your swap book at a very high, almost 4% rate, running off here over the next 12 months. Any idea looking forward and looking at the duration of your agency book, which is mostly hybrid ARMs, any thoughts as those run off, how far out the swap curve you will go when you replace those, whether are going to stay three years, are you going to go with as far as five? Have you all considered that at this point?

Sure. I will answer along with Goodmunder. Basically, the duration of the entire company is 24 basis points, which is pretty low and we are very comfortable where we are. We are not adding much interest rate risk to our assets. Therefore, we don't see a lot of need to swap out that interest rate risk. So, it's not clear how high a percentage of what form of swaps we will put on during the course of the year. Right now, we are very comfortable with our interest rate exposure.

Okay. I guess what I'm hearing you say is that it's possible that some of those swaps, that almost one billion won't even be replaced.

It's not clear that it will be dollar for dollar, but even if we did, the cost of the two-year swap, Goodmunder, would be?

In two years, about 50 basis points, give or take.

Yes, okay. That's very helpful. Thanks guys.

Thank you.

And next in line, I have Bose George with KBW. Please go ahead.

Hi, good morning. First just a question on non-agency prices. Have they increased since the end of January and also just where are incremental yields, loss-adjusted yields on the stuff that you are looking at?

I'm going to turn it over to Craig.

So, Bose, the market continues to be pretty well bid since the end of January. It's hard to say because it depends on the bonds and the sector, but I would say, prices are probably up another point or so since the end of January. As far as loss-adjusted yields available in the marketplace today, I would say again it depends on the assets, but they probably range from 6% to 7%.

Great. And then, actually switching to leverage, you guys in the release noted that the leverage was 3.7 times. I just wanted to make sure, does that compare to the 3.5 times last quarter?

Yes.

Okay. And then just one last question on agency prepayments, just curious what the January numbers look like?

Goodmunder?

Well, I mean, prepayments on agency security have been trending down in general over the last couple of months, and we are seeing a similar trend in our own portfolio.

Okay, great. Thanks a lot.

You're welcome.

And we will go to Jason Weaver with Sterne, Agee. Please go ahead.

Hi, good morning, guys. Thanks for taking my question. I think the thing that's been most on my mind is non-agency performance. And this is going to sound almost like Bose's question, but since we have seen most of the upswing since November occur mainly in subprime, I was curious to how correlated higher quality paper such as yours has been since that time and year-to-date?

Jason, I would say they are correlated, but they are certainly not correlated one for one. So if you are looking at the ABX Index for instance, if the ABX Index is up, it's safe to assume that prime assets are also up. But generally, the price of volatility of the subprime paper is a lot higher than it is on the higher quality paper. So, again, it really depends on the asset. The whole sector is definitely better bid beginning the early part of January and continuing into the last couple of weeks. But it really depends, and I would say while the headline numbers in the paper might be that subprime paper is up 10% or so, I'm not sure that's true across the board. Prime paper is certainly not up 10%, but it's up.

And just tailing off of that, are you finding adequate liquidity in your favored asset classes there to add new assets?

Yes. We selectively added some assets in the fourth quarter. And the fourth quarter was pretty choppy. Bid-ask spreads were pretty wide. We have seen a definite improvement in the first quarter, January and February, but assets are still available and the market definitely has a better tone than it did the last quarter of the year. But assets are still available.

All right, thank you. And really short, just a two-part modeling question on the $300 million collateralized financing, which I guess you mentioned has been increased to $500 million. First, how is that being presented on the balance sheet and what's the actual funding cost pricing associated with the facility?

Steve?

Jason, it's Steve Yarad. If you look at our balance sheet, you will see a couple of line items that relate to the transaction. And you will see that we have on our balance sheet a line item for securities obtained as collateral, and you will also see an obligation to return that collateral on the liability side. And our effective obligation to the counterparty for the liability is shown in that obligation to return collateral.

So that's the $306 million I see there?

And you will see in the first quarter that that will be increased, because of the increase in the transaction we did in January.

Okay. And I know you mentioned that, that was 100 to 150 [BPS] above repo, but is that on a floating base or is that locked in fixed over the three-year term?

So, Jason, it's not a fixed rate. It does flow. There are actually a couple of moving pieces to it. So that's why we describe it as generally approximately 100 to 150 basis points more than 30-day repo would be.

Okay, that's helpful. Thank you.

Thank you.

Operator

And we will go to Mike Widner with Stifel Nicolaus. Please go ahead.

Good morning guys and thanks for taking the questions. Let me just follow up there on Jason's question. I was trying to, between that and the $187 million you did of senior bonds, just trying to get a little closer to what the going-forward all-in funding costs will be on the non-agency piece. So I will give you two options to answer The first one is, do you plan on having the K out today as you usually have the Qs out the same today?

And the answer is yes. The K will probably be out today.

And so, if all of the info is in there, then maybe I can just wait for that and do it, but alternatively you guys were indicating I think the average funding costs of the non-agency is at 173 or 178 or something like that?

178 was the fourth quarter.

So to make all of our lives simpler, any idea as to how does all of this flow through? What do you expect that to look like given the recent transactions about the securitization and the collateralized financings just for the non-agency piece?

As far as the re-securitization, those bonds were sold. That was a fixed rate. So those bonds were sold at a 2.75 yield. It's actually a 2.847 coupon. So again, you should be able to incorporate that. You know the amount and you know the rate, and that won't change. The three-year facility is a little bit more difficult and that's why we tried to basically make it easier to connect the dots by telling you that incremental increased cost of that.

So you're telling me you want me to do math. Is that what I am hearing?

We apologize for that, but I think it's addition and multiplication.

That's tough. You've got a calculator you could send over to me? Well, I appreciate it, I look forward to the K and that will probably help. Just there is lot of moving pieces there obviously and just trying to get down to basis points. But thanks, and I think that's all I have got.

Thank you.

(Operator instructions) And we will go to the line -- please go ahead. And Arren, your line is open, possibly take yourself off mute.

I apologize. I didn't hear you say my name. I was just wondering, you mentioned that part of the weakness in non-agency in the fourth quarter was that dealers were reducing inventory. Can you just talk a little bit what was driving the factor behind that and how that trend has changed in the first quarter?

Sure. Somebody quoted me some trace data the other day and said that from May of last year, dealers reduced inventories by $20 billion. So I can't tell you month-by-month when that happened, but that's fairly significant, and I think dealer inventories were very light in the fourth quarter. I would say across the board, they're still fairly light. There have been a couple of obviously well publicized Maiden Lane II sales and we think some of those securities are still in inventory.

But I think you definitely saw de-risking across the board last year. Bid-ask spreads widened particularly in the fourth quarter. And I think it was a variety of reasons. There's an overall risk-off trade. It was a desire to decrease our risk in inventories across the Wall Street firms, and there was a certain pullback of customer buying interest at the same time.

So just lot of factors, but at the end of the day, I think most people, if not all people would say that those are technical factors. So what we worry most about when we see price declines is, well, gee, are the fundamental assumptions on these securities changing. And pretty much what we hear unanimously is no, nobody has really changed their views on the underlying fundamental cash flows of the securities.

Okay, that's helpful. Yes, it definitely seems like technical factors are playing into this. There had been some concerns about European banks bailing out on some of their mortgage assets. Have you seen any indications of that or any update on that front?

Not really. Keep in mind the fact that the European bank positions in these securities, they are very similar to the securities that have been sold in the Maiden Lane II sales. They are typically LIBOR floaters, a lot of subprime home equity type paper. So very similar to the Maiden Lane II assets. Obviously, the last two Maiden Lane II sales have gone very well. Assets have largely been put away, which is a very, very different situation from where we were last June and July when they finally abandoned those efforts to sell those securities.

So like I say, we haven't seen a lot of selling from European banks, but those securities you can expect are very similar to the Maiden Lane assets that right now have been liquidated pretty efficiently.

Yes, that's helpful. And then, lastly, a couple of modeling questions, which I guess these would probably be in the 10-K, but if you have them handy. Do you have the premium amortization for the agencies in 4Q and the discount accretion for non-agencies in 4Q?

Steve, do you want to handle that?

Yes. So the net premium amortization in the fourth quarter was about $2.4 million, made up of about $11.6 million of premium amortization on the agencies and about $9.2 million of discount accretion on the non-agencies. And so, what was the second question?

No, that was it. Thank you very much.

And we will go to Jay Mccanless with Guggenheim. Please go ahead.

Hey, good morning. After the foreclosure settlement last week, does that change the asset, non-agency asset basket you might be looking at? And what other changes might that have into your asset selection model going forward?

So in all honestly, I don't think it will really change the asset selection, and I am not sure it's clear how if at all that settlement, if you will, will affect the cash flows on these securities. I think we are still waiting for a definitive term sheet. There have been a lot of information about this that's come out, but it's still very unclear exactly how it will be implemented. I don't believe that it will translate to significant payments to any of these trusts. So to the extent that mortgages are modified and the loans have been sold to private investors in these trusts, it's not clear that there is any money from these banks that's going to get put into the trust.

So there may be principal modifications, principal reductions on the securities that we own, which we do see a few of now. But as I think we have always pointed out, principal reductions on loans underlying non-agency collateral, would, if they work, would typically probably be a better outcome than how we have modeled those. So if you take the case of 150% LTV today, if that were to receive a reduction to 100% LTV that's a 33% loss severity. So if that modification works and the borrower does not default that's probably a better outcome because chances are we assume that most of those 150% LTVs default at least a 50% loss severity.

Okay. And then just to follow-on to that, if you did start to see some principal come back in on expected principal, would you have the ability at that point, and this a GAAP question I guess, but would you have the ability to reverse some of the OTTI losses from this past year?

No, there would be no ability to reverse OTTI, and if there were it would be sort of additional principal that impacted our cash flows, depending on how it settles would determine this. But we think that this would be a prospective adjustment to our yield going forward as opposed to a one-time event.

Okay. Great, thank you.

Our next question is from Dan Furtado with Jefferies. Please go ahead.

Thanks for taking my question, guys. I guess this is probably more for Craig, but can you just talk to the 2012 [re-REMIC] transaction and just kind of compare that to the last few in terms of market sentiment, rating agencies? How has this process changed over the last few quarters if at all? Thank you.

Sure, Dan. It was a different transaction. All three of our prior transactions, the CE bonds are structured as floaters. So they were LIBOR plus 125, LIBOR plus 100. In this case, the floater market has really changed and I think much of that is due to the fact that most of the world believes that we won't see higher rates for the next two years or so. So if you are a floater buyer, you are less willing to pay for that protection of higher rates over the next two years. So the floating rate execution, while it was extremely viable a year ago and prior to that, it's not as attractive now as a fixed rate was. So we ended up structuring this as a fixed rate, still sold it inside of a 3% yield, which we thought was pretty good, but that market has certainly changed.

This transaction was the same rating agency as the last two with DBRS only. There really wasn't all that much different about this. We did get marginally more AAAs out of this re-securitization. So it was about 43% AAAs that we sold, which is up from about 35% in the last couple.

Right, okay. Great. Thanks so much. I was just writing that down. Thanks so much, Craig. I appreciate the insight there.

You bet, Dan.

And we do have a follow-up from Arren Cyganovich with Evercore. Please go ahead.

Yes, the CPR speeds on the non-agency fell down I guess 13% in the quarter from they had been pretty steady in the kind of 14% to 15% level. Do you expect that trend to continue or what was the driving factor there?

Arren, just let me -- the change is not large. There is some seasonality as you know, and importantly, the CPR for non-agencies includes foreclosures. So not all prepayments on non-agencies are as good as some others, but we continue to see voluntary prepays in excess of what we modeled in our yield assumptions. So I don't think you can really extrapolate from third quarter to fourth quarter change in CPR.

I would just add one thing. I think our expectations of voluntary speeds going forward are in many cases, are probably lower because -- and always have been. Because for instance, hybrid securities that started out as 5.5% to 6% coupons, as they have reset over the last two years and as the '07 vintage [51s] reset in the next year, those coupons are headed down to 3% or so. So I think it's been our belief all along that when you reduce the homeowners' coupon from 5.5% to 3%, that he's less inclined to prepay.

Okay. Thank you.

And with no further questions in queue, I will turn it back to you, Mr. Zimmerman, for any closing comments.

Thank you very much. We appreciate your continued interest in MFA and we look forward to speaking with you next quarter.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.