MFA Financial Inc (MFA) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the MFA Financial Inc. second-quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Ms. Alexandra Giladi. 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. which reflect 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 were 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; MFA's ability 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, uncertainties and factors, including those described in MFA's annual report on Form 10-K for the year ended December 31, 2011, its quarterly report on Form 10-Q for the quarter ended March 31, 2012 and other reports that it 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 second-quarter 2012 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 second-quarter 2012 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; Hal Schwartz, Senior Vice President and General Counsel; Kathleen Hanrahan, Senior Vice President and Chief Accounting Officer; Shira Finkel, Senior Vice President; and Goodmunder Christiansen, Vice President.

Today, we announced financial results for the second quarter ended June 30, 2012. Recent financial results and other significant highlights for MFA include the following. Second-quarter net income per common share of $0.20 or earnings per common share. Book value per common share of $7.45 as of June 30, 2012 compared to $7.49 as of March 31, 2012.

We continue to focus on adding longer-term financing for our non-agency mortgage-backed security holdings. On June 29, 2012, we added a $350 million three-year repurchase agreement to finance non-agency MBS assets.

On July 31, 2012, we paid our second-quarter 2012 dividend of $0.23 per share of common stock to stockholders of record as of July 13, 2012.

Our REIT taxable income exceeded core earnings in the first half of 2012 primarily due to the fact that for non-agency MBS acquired at a discount, core earnings are reduced by credit reserves for estimated future losses while taxable income is reduced by realized losses only when they actually occur. We typically distribute approximately 100% of our REIT taxable income and consequently, dividends exceeded core earnings in the first two quarters of 2012.

We currently anticipate that our REIT taxable income and core earnings will trend closer together in the second half of 2012.

At quarter end, our debt-to-equity ratio, including the liabilities underlying our lien transactions are 3.6-to-1. In this low interest rate environment, core earnings per share was $0.20 versus $0.21 in the first quarter.

Our agency portfolio had an average amortized cost of 102.9% of par as of June 30, 2012 and generated a 2.95% yield in the second quarter.

Our non-agency portfolio had an average amortized cost of (technical difficulty) of cost as of June 30, 2012 and generated a loss-adjusted yield of 6.75% in the second quarter.

While housing fundamentals remain moderate to weak, we believe that we have appropriately factored this into our cash flow projections and credit reserve estimates. Our non-agency mortgage-backed security loss adjusted yield of 6.75% is based on projected defaults that are approximately twice the amount of underlying mortgage loans that are presently [60-plus] days delinquent. These underlying mortgage loans were originated on average more than six years ago so that we have access to an average of 74 months of payment history.

In the second quarter, we continued to add multiyear financing that serves to reduce our reliance on short-term funding for non-agency mortgage-backed securities. While this longer-term financing is incrementally more expensive than short-term financing by approximately 100 basis points, we continue to believe the certainty of the committed term more than justifies the additional cost.

Before I turn the call over for questions, I just wanted to give a brief mention to the recently publicized proposals that are being considered by some county and local governments, and particular, San Bernardino County, California, to use the power of eminent domain to seize certain mortgages from existing mortgage holders. Although these proposals are still in their preliminary stages and we do not yet know whether they will ultimately be acted upon, we are taking this matter very seriously and are working with other mortgage investors and trade groups to make sure that our voice is heard in this debate, with the objective of protecting the interest of our stockholders.

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) Steve DeLaney, JMP Securities.

Stewart, your book value was essentially flat in the second quarter. And I guess that is -- well, you know, treasuries, agency bonds were moving. It looks like the non-agency paper was pretty flat; in fact, maybe some of the weaker paper was even down. But that sentiment seems to have changed here since early July.

I wondered if you guys could just give us a little color on what you are seeing as far as price action and the types of bonds you own. And I guess importantly, what does that mean for the kind of yields you get on new investment and the impact on your book value?

Steve, let's do this. I'm going to turn it over to Craig to talk about the non-agency side and what he is seeing in the market relative to non-agencies. Then from that, we will turn it over to Goodmunder to talk about the agency side. So Craig.

So on the non-agency side, since June 30, we've seen some strong buying. Again, it depends on the specific bond and the collateral underneath it and, obviously, credit enhancement associated with it. But I would say in general, non-agency prices on the types of assets that we traffic in are probably up about two points on the close to $6.5 billion face. And yields today at those higher prices, I would say they are generally in the low sixes.

Okay, and your existing portfolio I think was what -- 6.75 for the second quarter -- 6.75?

I think that's true. 6.75, yes.

So you probably lost a half point or so in yield at the margin?

On new purchases, that is probably about right. Again, it depends. There could be bonds that could be a little below six, and there could be bonds that are in the high sixes. But in general, I would say they are in the low sixes now.

Since you guys -- on your non-agency portfolio, obviously, you own those bonds at a discount and you are going to do better probably in a rising rate environment with a better economy. Is it -- since you really -- I don't know if you look at that as allocating any of your swaps there. But it would seem that with the price move, you are -- at least the fair value of the non-agency portfolio, standalone, should certainly be higher versus June -- in terms of making a positive impact on your book value.

That's generally right. Again, what we are thoroughly discussing or what Craig is discussing is the fact that in the market in terms of non-agencies, he has seen (technical difficulty) price increase.

And that is -- Steve, as you know, price increase is relative to the face amount of these assets, not the market value. So we have about $6.4 billion face of non-agencies. So upward movement in price there, obviously that change in price is times $6.4 billion. So it would impact book value in the quarter.

Okay. Appreciate it, guys. Thank you.

Goodmunder, do you want to discuss the agency side?

Sure. So, Steve, on the agency side, we have seen prices appreciate, especially on the kind of lower coupon, slightly longer assets that the curve has flattened after quarter end. And the yields that we are seeing in terms of what we are purchasing, we are seeing hybrids around 160 basis points and the 15 year fixed are closer to 2%, which would put spreads in terms of the new assets around 130 basis points, when you include the cost of hedges.

Operator, next question.

Bose George, KBW.

Thank you. Actually, this is Ryan O'Steen on for Bose. I was just curious where recent purchases have been concentrated and where you see the most relative value right now between non-agency and agency.

This is Bill Gorin. I would say that we've been investing across both asset classes, looking to keep the asset allocation approximately where it has been.

The answer to the last question, we mentioned that the value of the non-agency MBS have gone up due to appreciation in the asset class. So in order to keep the same ratio, we've also had to buy agencies in addition to non-agencies in this quarter.

Okay, thank you. And then just second of all, on your swap portfolio, it looks like you have about $530 million or so of swaps rolling off in the back half of the year. What type of (inaudible) maturities are you looking to replace those with? Just kind of your strategy in general for replacing those swaps as they roll off.

What we do is we look at the interest rate sensitivity of the entire portfolio, which includes agencies and non-agencies. And it is not that, gee, we have a swap today; if it goes away, I have to replace it necessarily the next day. It is incrementally are we adding interest rate risk to the assets, and therefore, do we need to hedge against that?

And incrementally, we have been not looking to increase our interest-rate exposure on the asset side, so it is not clear that we need to replace or incrementally add swaps in our current strategy.

Okay. Thank you so much.

Douglas Harter, Credit Suisse.

Thanks. I was wondering if any of the decline in non-agency yields in the quarter was related to adjustments in the forward curve.

Yes, to some extent, it is, obviously, on hybrid securities. So fixed-rate securities are not really affected by that. But the forward curve was a little bit lower. I don't recall exactly -- it wasn't a significant number; I think it was less than 25 basis points.

Should we expect that to be a bigger impact in the third quarter, given the decline in rates?

Well, I think we reset our forwards as of the end of -- so it would have been end of February -- end of May. So it would be May to August, I guess; it would be the end of August. So the forward curve may be marginally flatter now than it was at the end of May, but I am not sure there is a big difference. And again, remember that it is only on those securities that are -- only on those non-agencies that are adjustable.

Okay, thanks. And then on the new three-year repo facility that you added at the end of the quarter, was any of that utilize sort of included in those numbers that you show of your longer-term financings at quarter end?

You mean in terms of balance sheet or in terms of cost of funds?

I guess I was thinking balance sheet. I guess that ultimately flows together, but in terms of balance sheet, on that table where you show your longer-term financings.

We closed it at the very end of the quarter, so it didn't affect our income statement at all -- or for one day, I guess. But it should show up in the balance sheet number.

Okay. Thank you.

Joel Houck, Wells Fargo.

I guess my question is on the agency portfolio. You mentioned average amortized cost base of 102.9. That implies it is more generic collateral. We've seen a huge move in the spec pools; a lot of your peers continue to like that trade.

Can you maybe talk about your strategy needs and see why you have not played that trade to a large extent? And also, your comfort level with kind of maintaining prepayment speeds in the back half of the year.

First of all, what we do, we don't buy -- generally don't buy [TBAs]. They are not generic pools. So we do look at the specifics of -- certainly on the agency -- on both agency and non-agency, but certainly relative to your question on the agency side. But to be more specific, Goodmunder, would you like to address that?

Yes, so our amortized cost of 102.9 is relatively low compared to some of our peers. But a big part of that reason is we have an older portfolio. Some of the assets we acquired a few years ago, whether that is three, four, or five years ago, required close to par. So therefore, the amortized cost of that is very low.

Now the bonds we are buying today is -- we are buying what we see in the marketplace, and in general, prices are about 103.

Now, as I come -- as you talk about the specified story, I would just like to mention that on the 15-year side, in excess of 70% of our portfolio is in some type of prepayment protected story, whether that is lower loan balance or higher LTV paper. And we've been very happy with that story. But we are also highly aware of the prices that we pay for those securities.

And the way we've played it and the way we like to do it is we like to pay -- like to buy those prepayment protected stories when is the payup is lower or limited, and when it is closer to the TBA, not when you have to pay two or three points for that prepayment protection. But, like I said, 70% is in prepayment protected stories on the 15-year side.

On the hybrid side, it is more of a bond-by-bond basis, because it is harder to source collateral with specific characteristics. But we will look for things that we like, and it is basically a mix of seasoned and new origination.

Joel, one thing to take into account, amortized cost is very important, prepay speed is very important. But what is most important is how much yield the agencies are generating for how much interest-rate risk you are taking. And our agency portfolio yielded 2.95% in the quarter without any 30 years. So we think the inputs of price and prepay speed, we are very happy with the returns we are getting from the agencies relative to the fact that we own no 30-year agency assets.

You guys are certainly shorter duration than a lot of your peers. I guess given the exposure on the non-agency side that you have, I mean, when you think about the agency strategy, does is make more sense to have more longer duration agency and maybe take a little more interest-rate risk, given that you are kind of hedged with the non-agency book?

So the question is how much interest rate risk do you have and how much should you add. And I think what we are saying is we are not looking to add interest rate risk with interest-rate-sensitive assets yielding what they yield.

Okay. And then maybe talk about your outlook for prepayment speeds in the back half of the year.

Prepayments have trended up. I think they will continue to trend up over the next couple of months. We should probably see the kind of high-water mark for speeds the next couple of months. And absent any further rate rallies, I think they should then stabilize in the back end of the year.

I think one of the things to keep in mind, Joel, however, is the fact that having a -- what was our CPR -- about 20, if I remember correctly? Having that with less than a three-point premium is very different than having a very low CPR and paying 108 or 107. So it is a very different kind of strategy.

Okay. Thank you very much.

Rick Shane, JPMorgan.

Thanks, guys. Actually, you started to address in your response to the last question part of my question here, which is about speeds. And I think what you really were talking about was the agency side of the book.

On the non-agency side, is there anything you are seeing either in the origination or primary markets to suggest that speeds are going to continue to increase there at this point?

I think it is pretty clear that on the jumbo side, so nonconforming balance, originations are still pretty low. We have -- and you will see this in the Q that comes out -- the three-month average voluntary speed on the non-agency portfolio was a little more than 7%. So you will see the top-line CPR print of 15.8%. It is a little less than half voluntary and the other half is involuntary.

I would say 7% voluntary is generally below our long-term expectation, in the assumptions that we have on these securities -- I'm sorry -- it is higher than our long-term average, which is probably closer to 5%. But we are not seeing dramatic prepayment speeds on non-agencies. That's for sure.

Got it. Which actually is a good segue to the second part of my question, which is that you guys make a pretty clear statement that core earnings and re-taxable earnings are going to converge in the second half of the year. And I think the implication is that core -- or that re-taxable earnings will trend down towards core earnings. I would love to get clarification on that.

I'm assuming that the reason you see that occurring is that you don't see speeds picking up on the non-agency stuff, and that you are just going to have incremental credit losses coming through. And as you run the credit through, that will drag on -- that will -- drag is probably an overstatement, but cause a modest erosion of the re-taxable.

Yes, your interpretation is correct. The taxable will be trending downwards towards the core. That is correct.

And you are right; we are not making a more optimistic forecast, but you will have continued impact of losses. For taxable purposes, we can't assume losses that haven't occurred; but as they actually occur, the taxable income should be closer to the core income.

Got it. So you are not making an assumption that you're going to get prepayments that come through that basically eliminate the loss risk. And so it is a pretty conservative assumption.

It is. And let me just add -- when we started this strategy and as we continue the non-agency strategy, it is never with the idea that all of a sudden that non-agency -- the pre-pays or non-agencies were going to pick up dramatically. That was never it. It was looking at the underlying cash flows and the constancy of those underlying cash flows.

Got it. Great, guys, thank you very much.

(Operator Instructions) Stephen Laws, Deutsche Bank.

Thanks for taking my question. I guess to follow up on the last comment, can you maybe talk to how you see the trend with taxable versus core as we look out past the second half of the year. If tax was running over core and over the lifetime of those assets, I believe that the GAAP income and taxable should be the same, just recognized differently. How do you expect that to trend? Will there be a period in '13 where we see core earnings above taxable? Could you maybe talk to that a little bit?

So, you are right -- over the lifetimes, they will be the same, but the lifetime is yet another 23 years. And it is very hard to model exactly -- we can model how many defaults and severity over the life, but it is hard to know in which month which servicer is going to actually foreclose. So we can't fine-tune it that well. But you're right -- over 23 years they should match. And taxable has exceeded core and we expect it still will exceed core, although by a smaller amount.

Great. And one question, just kind of -- maybe just in general on the financing side. You added some longer-duration repo [I think] multiyear financing there. You've had some securitizations. There were, I believe, some re-REMICs in the past.

Can you maybe talk about the pros and cons of those, what the securitization markets are like today? And then are you seeing any just changes in your terms or simply tone from counterparties in Europe, given maybe specific problems they have that are not related to MFA, but that are changing the way they do business, given the environment in Europe?

I'm just going to add something before I think Craig will give you some detail. Our strategy has been from the beginning to try and rely less on shorter-term financing, and much, much greater emphasis on longer-term financing. And it is a strategy we have followed going on for a significant period of time, and we are going to continue to do that.

So as we said in the opening remarks and what is in the press release, we think that the additional cost is well worth not having the rolled-over risk. So if you put that in context. And Craig, if you could handle the specifics, please.

As you know, we've done four re-securitizations to date. We did not do one in the last quarter, but we did this $350 million structured facility, which in many ways is economically similar to a re-securitization. The re-securitization market still exists. To date, there is still only one rating agency, which is DBRS.

So while we did a transaction -- I think we closed it in February this year, is our most recent one. But the economics of this structured facility that we did are substantially similar to a re-securitization.

To the extent that one or several of the other rating agencies come back into that market, it may make that a more viable alternative. So we continue to stay on top of that and we will take advantage of it when it presents itself.

But the economics are definitely comparable. Securitization market is available. But when someone offers us long-term repo on non-agencies, we will take it, knowing we could always do re-securitizations in the future.

Sure. And then lastly, just kind of general comment of counterparties in Europe. Any change in tone you're noticing from them, or no?

Certainly for non-agencies, we haven't seen any change at all from -- I would say from any of our counterparties, whether it is due to Europe or not. And Goodmunder, I don't -- have you seen anything on the agency side relative to European counterparties?

No, we haven't seen anything.

Ron, what have you found in terms of agency repo?

I would say the same thing that Craig had said. We are also very careful about who we do our agency repo with. Just because people come in and want to give us repo, we don't necessarily sign up to do it with them. But we've seen no change in haircuts. Rates have all been within a reasonable band, and we've seen no issues with balance sheet.

Part of the whole strategy of the Company was to generate these returns without being overly reliant on repo. As a result, we really haven't grown our repo book at all. And our agency -- pure agency repo is about $6 billion, which is very, very manageable in almost any situation.

Yes. And then I guess while you are there, speaking of growing the balance sheet, it seems a number of other companies in the sector have raised capital recently, even though that money is being deployed at ROEs that are dilutive to their existing portfolios.

Can you guys talk about your views on capital here, and that being both common and potentially preferred, seeing a few of those deals. And just how you guys evaluate raising capital, the cost of that, versus the returns available on new investments today.

Again, we always [hover near to] the ground relative to wanting to raise additional capital. But again, you have to have the correct assets that are going to provide the yields. And as you said, to do something that's dilutive doesn't really do one heck of a lot of good.

So to get bigger for the sake of getting bigger has never been part of our strategy. So we continue to look at opportunities, and if and when the opportunities are there, in terms of both of -- on the asset side, sure, we would consider raising additional equity.

Sure. Okay, great. Thanks a lot for taking my questions.

Gabe Poggi, FBR.

Hey, guys. My questions have been answered. Thanks.

Chris Donat, Sandler O'Neill.

Good morning, everyone. Just wanted to circle back on the repo issue, and just see if I can get a little better understanding of -- as you deal with $350 million over three years, do counterparty issues and the risks associated there, do they increase? Or just because it is repo, does that give you some safety?

And then if you could put this in the historical context of the last, say, half-dozen years, where we have seen some repo counterparties exit the stage, just help me think about the risks there.

Again, Ron had said a moment ago, on the agency side we've been very selective and very careful with whom we do repo. We probably do maybe more analysis than the folks do on us when we enter into a repo agreement. And on the non-agency side, we are just as selective and very, very careful and very comfortable with our counterparties.

Can you --

That is the best answer I can give you without giving you names.

Got it. Just in terms of the number of repo counterparties on the non-agency side.

We currently have 13.

Okay, got it. Thank you.

Arren Cyganovich, Evercore.

Just getting back to the overall portfolio allocation, you mentioned keeping the portfolio roughly the same mix at agency and non-agency. We've seen some improvements in the housing market somewhat, stabilization of HPI. When do the fundamentals make it more attractive for you to get more heavily involved on the non-agency side?

We are involved on the non-agency side. And we continue to see -- again, I think Craig mentioned before, somewhere in the low sixes, which seems to us, in a zero interest rate environment, to be a very, very attractive return for our investors.

Fundamentally, you really can't increase your non-agency portfolio to be the majority of your assets because of various limitations for the '40 Act, which we've discussed before.

There is room, though, to increase non-agency relative today to the current mix, is there not?

There is some, and incrementally we have been investing there.

Okay, And then lastly, just a quick question. Do you have the premium amortization on the agency handy for the quarter?

Sure. This is Steve Yarad. The net premium amortization for the quarter, the premiums outweighed the accretion of discount by about $2.6 million, which is around about $0.01 a share.

So say that again. So the premium amortization was how much?

The premium amortization was $12.4 million, and the net accretion of discount was $9.8 million; so net of about $2.6 million amortization and premium.

And that is why we like to invest across mortgage-backed securities, agency and non-agency. You do it, you do have a premium amortization on the agency, you have discount accretion on the non-agencies, and they've been running pretty close.

Thank you.

And there are no more other questions in queue. Please go ahead, speaker.

We would like to thank everybody for your continued interest in MFA. Look forward to speaking with you next quarter. Thank you.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.