MFA Financial Inc (MFA) 2014 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to MFA Financial, Inc.'s second-quarter 2014 earnings call. (Operator Instructions)

And also as a reminder, today's teleconference is being recorded. At this time, we will turn the conference call over to your host, Ms. Danielle Rosatelli. 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 of 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, [contend], 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 those described in MFA's Annual Report on Form 10-K for the year ended December 31, 2013, and other reports that it may file from time to time with the Securities and Exchange Commission. These risks, uncertainties, and other factors 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 2014 financial results.

The discussion today also contains certain non-GAAP financial measures. Information relating to comparable GAAP financial measures may be found in the second-quarter 2014 earnings release and earnings presentation slide, each of which has been filed with the SEC and posted on our website at MFAFinancial.com. Thank you for your time.

I would now like to turn the call over to Bill Goren, MFA's Chief Executive Officer.

Thank you, Danielle. If you could please move to slide three.

Good morning, everyone. I would like to welcome you to MFA's second-quarter 2014 financial results webcast. With me today are Craig Knutson, MFA's President and Chief Operating Officer, Gudmundur Kristjansson, Senior Vice President, Steve Yarad, CFO, and other members of senior management.

In the second quarter, we generated net income of $75 million or $0.20 per common share. The dividend per share was $0.20, consistent with the first quarter. Book value per common share increased approximately 2% to $8.37 as of June 30, 2014 from $8.20 as of March 31. Based on continued improvements in the loan-to-value of the loans underlying our Non-Agency MBS portfolio and other factors, we again transferred a sizable amount of approximately $25 million from credit reserve to accretable discount.

In the quarter, we continue to identify attractive investment opportunities across the residential mortgage asset universe. We've expanded our investment team and, as a result, we are positioned to significantly grow our [holdings] of securities back by re-performing nonperforming loans to $495 million while moving forward with the acquisition of approximately $60 million of credit-sensitive residential whole loans.

We did acquire a small amount of Non-Agency MBS, $14 million, while opportunistically selling $26.5 million of Non-Agency MBS, realizing a gain of $7.9 million.

This is the eighth consecutive quarter we realized gains from selected sales of Non-Agency MBS based on our projections of future cash flows, relative to market pricing. We did not acquire any agency MBS in the quarter.

MFA remains positioned for more variable monetary policy by the Federal Reserve which shall be determined by measures of the labor market, or inflation, and other incoming economic data. By pursuing our wider residential mortgage strategy, we continue to find opportunities to generate attractive net interest rate spreads without increasing interest rate exposure. In the quarter, our net interest rate spread remained in excess of 2.4% for an estimated effective duration, a measure of our interest rate sensitivity, decreased to 0.65.

It's important to remember that equity sensitivity to changes in interest rates is impacted by both duration and the leverage utilized. We continue to maintain a leverage ratio of approximately 3 times as measured by debt-to-equity.

Asset selection is what drives both our income and our interest rate sensitivity and I'd like to point out several aspects of MFA which I believe set us apart. First, we hold 5.6 billion face amounts of Non-Agency MBS with an average amortized cost of approximately 75% of PAR and a credit reserve of approximately $1 billion. These assets generated a loss-adjusted yield of 7.7% in the second quarter.

Second, we continued to maintain our historical preference for adjustable rate, hybrid, and step up MBS. 68% of all our MBS fall into these three categories.

Third, we continue to acquire residential mortgage credit assets, both securities backed by RPLs or NPLs, or credit-sensitive residential whole loans that deliver attractive yields relative to interest rate exposure.

And fourth, none of our Agency MBS are 30-year fixed rates.

Moving forward, so turning to slide four, you see that despite change in interest rates and varying prepayment speeds, our key metrics again remain generally consistent. Second quarter's yield on interest-earning assets, 4.26% with net interest rate spread 2.42 and debt-to-equity ratio of 2.8 times.

Turning to slide five, you see the book value increased in the second quarter, due to appreciation in both the Agency and Non-Agency portion of our portfolio.

Turning to page six, Gudmundur will give some more detail about the interest rate sensitivity of MFA's assets and our hedging strategies.

Thanks, Bill. On slide six, we show MFA's net duration as well as the duration of our assets and hedging instruments. With the combined effect of lower interest rates, no new Agency MBS purchases, and aging of the Agency MBS portfolio reduced our total asset duration to 1.9 in the second quarter from 2.1 in the first quarter. We had $476 million of short swaps maturing in the second quarter, while adding $200 million of five-year and seven-year swaps. The net result was a lengthening of our hedges to minus 3.9 from minus 3.6 in the first quarter and a slight reduction in the notion of balance of (inaudible).

In aggregate, our net durations declined modestly in the second quarter to 65 basis points from 83 basis points in the first quarter, primarily due to lower rates. We continue to maintain our net portfolio duration below 1 and will continue to limit the interest rate risk in MFA's portfolio through asset selection and interest rate hedges. Now I'll turn the call back over to Bill who will discuss our asset allocation.

Thank you, Gudmundur. So turning to slide seven, we present our assets, yields, and spreads broken out into what is now five categories. These are Agency MBS, seasoned Non-Agency MBS, MBS backed by re-performing loans and non-performing loans, credit-sensitive residential whole loans, and cash and other.

In the quarter, we continued to find investment opportunities and the market value of our assets include the impact of link transactions improved slightly. While our Agency and Non-Agency MBS holdings declined due to runoff and some Non-Agency MBS sales, our holdings of securities backed by RPL/NPLs and credit-sensitive residential whole loans grew. The approximately $500 million of RPL/NPL securities shown in column 3 are an example of the type of residential mortgage asset that fits very well into our investment strategy when available at advantageous prices.

These assets are unrated, seniormost tranches backed by re-performing or nonperforming loans of the 2005, 2006, and 2007 vintage.

The average credit support is in excess of 50% of unpaid mortgage balance, so we are comfortable with the mortgage credit exposure. Now the coupon on these securities increased by 300 basis points if the asset has not been retired by the end of the third year so we are comfortable with the interest rate exposure. In addition, because these assets trade near par due to their credit enhancement and the three-year reset, we're comfortable utilizing the debt-to-equity ratio of approximately 4 times.

Turning to the right column, the total column, you can see that leverage of 2.9, average yield of 4.27, and interest rate spread of 2.42 are generally in line with the first quarter.

So turning to slide eight, Craig Knutson will now provide some details as to the improving housing metrics impacting MFA's portfolio.

Thank you, Bill. The credit metrics on the loans underlying our Non-Agency portfolio continue to improve. LTVs continue to decline due to home price appreciation and principal amortization, delinquencies have declined as fewer current loans become delinquent and foreclosure pipelines are liquidated, and loans are on average 98 months seasoned, over eight years.

In addition, since over half of these loans were refinancing the previous mortgages, we know that these homeowners have been living in the homes for more than eight years. As Bill mentioned previously, we again lowered our estimates of future losses in the portfolio and transferred almost $25 million from our credit reserve to accretable discount. All else equal, this increases the yield that we'll recognize over the remaining life of the bonds.

Turning to slide nine, so these graphs illustrate the LTV improvements over the last 2 1/2 years. On the left, we display the average portfolio LTV. Note that the green line shows that the total portfolio LTV has declined from 105% two years ago to just below 80% today and the gray line indicates that even the LTV of delinquent loans has dropped from over 100% a year ago to 85% today.

On the right, we depict the percent of loans with LTVs over 100%. While lower average LTVs shown on the left are obviously a good credit metric, we still worry about the underlying loans with LTVs above the average and, in particular, the so-called underwater loans or those with LTVs over 100% where the loan amount is greater than the value of property.

Note the orange line on the graph on the right. This portrays the percent of current loans that are underwater. While not delinquent at present, these are loans that we worry about becoming delinquent in the future. A year ago, approximately 1/3 of the current loans in our portfolio were underwater.

Today, they have declined to nearly 10%. Even the delinquent loans, the gray line on the right, have seen significant LTV improvement. A year ago, half of the delinquent loans were underwater. Today, it's half of that.

Page 10. On page 10, we illustrate the LTV distribution of current loans in the portfolio. Again, we focused on the at-risk loans where the homeowner owes more on the mortgage than the property is worth. As of June 30, less than $200 million of face amount of current loans had LTVs over 110%. This is only about 4% of the current loans.

On page 11, we graph the transition rate of loans in the portfolio. That is the rate at which loans transition or deteriorate from current to 60 days delinquent. After peaking in 2009, this credit metric has steadily declined and today is back to the levels exhibited pre-housing crisis in late 2007.

Finally, on page 12, we illustrate the establishment and maintenance of our credit reserve for expected future losses on the Non-Agency portfolio. Of the approximately $1.4 billion of purchase discounts, we still hold nearly $1 billion or 17% of the face amount in credit reserve.

And with that, we would like to turn the call over for questions.

(Operator Instructions) Dan Archer, FBR Capital Markets.

Hey, good morning, thanks for taking my call. I appreciate it. First question, on the Non-Agency side, good result on bringing more accretable discount in. But it looks like we saw the overall yield on the Non-Agency side compress a little bit. Were there any ARMS that maybe had -- that returned maybe from a fixed to now of a floating-rate and had a little bit of a stepdown in the coupon there? Anything like that that drove the yield down maybe like probably 11 basis points?

Well, good question. Could be that some of those have reset and coupons have reset down. It's more likely do more to the forward curve. So, the forward curve is a little bit more flat than it was last quarter.

I think that probably -- again, there are a lot of pieces but that probably cost about 15 basis points and then we get a slight improvement from assumptions.

Okay, got it. On the credit-sensitive side, new category there. Is there any intent to maybe look to leverage those because it looks like right now they are all unlevered?

They are -- at this point, it's still pretty small. It's $59 million. But there certainly are opportunities to lever that and as that portfolio grows, we will certainly look to do that.

Okay. Do you have any sort of sense as to what you think you should get on those on an unlevered basis or kind of just same 10% to 12% total return goals?

Yes, I think it's safe to assume that we are low double-digit ROEs. There's warehouse financing, there's also RPL securitizations some point. But the size right now is not really large enough to look at that.

Okay. And then maybe just one more on the credit-sensitive since it is new. We got the loss adjusted yields there which looked great but can you maybe just compare what the coupon interest is versus the loss-adjusted?

So the coupon is -- I believe it's about 5.5 or so. So obviously we purchased those at a discount as well. So, most of it is obviously coupon income.

Okay, and your loss adjusted assumptions assume up to PAR or up to 90% of PAR?

It probably assumes about 30% defaults.

30% default. Okay. We will try back into that number then. Thanks.

Steve DeLaney, JMP Securities.

Thanks, everyone, and congratulations on another solid quarter. Dan covered the new CSL product. Just a couple things to pick up on.

First, you give leverage measures in the 2.93 for the portfolio -- do I assume that includes linked transaction and is that why it's different from the GAAP figure of 2.8?

That's exactly right, Steve.

Okay, so we will go with those --

And the big difference will be in the RPL/NPL MBS. That's the big difference.

Right, got it, got it. Okay, and then Craig, just on market color, we read that BlackRock had done a couple of large block trades and I guess in the last three or four weeks, I think the first one was subprime but then the second was all day option ARM. Could you just comment on whether those large $3 billion plus trades had any impact on market prices or -- and in addition, if they presented any buying opportunities for MFA?

So Steve, we had a pretty light quarter. We did not buy anything on those lists, but they traded exceptionally well and as near as we can tell, the bonds were pretty much all put away to end buyers. So very orderly, albeit large liquidations, but they both traded extremely well.

Okay, great. So no reason to think that any -- after you had a nice move in book value in the second quarter, that those large blocks had any adverse impact on the portfolio as we sit today.

No, they really didn't.

Okay. And then just one last thing. Craig, you guys have done a great job of showing us how with property improvement -- home price improvement -- that your average LTV has come way down to the 80% range. Could you also comment -- on the flip side of credit is borrower behavior and how that meant improvement in fewer people being underwater -- are you seeing a decline in actual default rates as well and have you done anything to [call it] change your forward CDR assumption?

Well, we did have a slide on the transition rates. So that's really the key thing that we look at and, obviously, it's great that those transition rates have declined, but it's still -- I think it's about a 0.6% which on an annualized basis is probably about 7%.

So unfortunately, I don't think that number ever goes to zero. Whether it continues to decline from here or not, we will just have to see.

The other thing too -- if I look at our CDR, so the three month CDR, this is the default rate on the whole portfolio was about 3%. But again, that is a somewhat deceiving number because it really depends on how long loans sit in the foreclosure pipeline. So if a lot of loans get liquidated, that CDR number will be higher. If the foreclosure pipeline just builds, then the CDR number won't be as high.

Got it. Appreciate the color and good job, guys.

Operator:

Douglas Harter, Credit Suisse.

Can you talk about the attractiveness of the RPL/NPL today? There's been a lot written about the big run in prices in that asset class since you started talking about last quarter?

Sure Doug. Well, you're right there has been a movement upward in time on these loans. But we continue to find opportunities. Now it was Steve DeLaney that asked about large sales of assets, which were securities. It seems as if the very large sales, whether it be securities or loans, tracks a certain buyer category. And with securities and with loans, the smaller sales are attractive to us and continue to find opportunities there.

Got it. So -- and would that be both on the loan side and on the more senior MBS RPL/NPL securities you are buying as well?

Well on the security side, those are pretty wide last summer. They continue to tighten and they've actually widened back out a little bit, so there are actually couple of deals in the second quarter that we set out on because they got tighter. So again, that ebbs and flows. Those deals typically aren't that large although there have been a couple of big ones. But we've been pretty active in all those new transactions.

Got it. And if you could -- I think you talked about it last quarter, but if you could refresh our memories, one of the types of events rates that you see in the financing on those securities (multiple speakers) yes, on the RPL/NPL. And is there a chance to do more permanent financing like you've done with some of your Non-Agency MBS?

So the haircuts on those typically range from 20% to 25%. Because that asset is so short, I don't think it would a whole lot of sense to try to re-securitize those and again, they're already securitized and they're non-rated to begin with so we are pretty comfortable with running -- as Bill has said in his remarks -- leverage a little bit higher than we do on regular legacy non-agencies because it is such a short security.

The other thing is you will see in that asset allocation table, which shows a higher leverage number for those RPL/NPLs. That's really because there is an unsettled trade there that shows up as a liability -- it shows up with 100% leverage, so when that trade settles, that number will settle in closer to the high three [times] leverage.

Got it, thank you.

Mike Widner, KBW.

I think most of my questions on the RPL/NPL and stuff have been answered. But let me ask you one more. Just thinking about the underlying loans behind the MBS versus the residential whole loans that you are buying today, are those basically the same kinds of loans? You are just buying them in different forms? Or is there a distinct difference between the underlying collateral?

Most of the NPL/RPL securities portfolios is actually NPLs. So the loans that we bought are re-performing loans. But yes, within the re-performing securities, the underlying loans are similar in many ways to the actual loans that we purchase.

Got you. So -- but -- so the residential piece is mostly re-performers, so currently performing?

That's correct.

Okay. And is there a plan to securitize those at some point? Or if you get big enough, obviously, at this balance, it would be kind of hard but is that a securitizable market and a big enough market to think about that?

Absolutely, yes, I think. But as you said, it really depends on the size and it depends on spreads in the marketplace as well.

Yes, I mean that seems to be a category that a lot of people have talked about for a year or two now and just wondering -- is that something we should think about growing substantially or is it more kind of -- so far, it's been obviously, it's pretty small right now I guess the question is do you envision it potentially getting to be very large and to the point where you can securitize? Or is it just a place to put capital right now but tough to really make the economics work for huge purchases?

You're right. It's hard to contemplate a securitization with the size that we have now, but they're opportunistic purchases and to the extent we can continue to purchase those at what we think are good levels, you can expect it to grow.

Great. And then on a different topic, I guess, you've got a $0.20 dividend, there's been some discussion about taxable income versus dividend and core income versus the dividend. How should we think about that now? And I guess specifically, there was a -- and I haven't gone through all the numbers in detail yet, but there was a time when taxable was running below the core or below the gap and --. So how should we think about that versus the dividend right now?

Great, good question. First of all, we really don't have a core concept in our press release.

No.

So as we did try to point out in the press release and in my opening remarks, we have a large amount of Non-Agency MBS that are trading well above our cost. And while managing the portfolio, if there are sales, it tends to be a gain. So therefore, our earnings has included a component of gains eight quarters in a row and based on the fact that we find assets to buy and assets to sell, it shouldn't be surprising that we realize gains there.

We had introduced a core concept a couple of years ago when accounting required us to link transactions, that, if you purchased an asset where you financed it, they were a link transaction and we found that confusing for the income statement. The good news is, according to our CFO, linked transactions should come to an end starting next year. So, that's why we just have a GAAP concept and there's not a core concept.

In terms of what drives dividend, you're right, we have to take into account our earnings for GAAP and tax purposes and right now, I believe we are underdistributed or undistributed about $0.11 per share for tax purposes. So long answer, hopefully I was able to help you with the questions.

No, I think that helps. I thought now as I think back that I had heard that comment about not having to use link transaction sometime last year and I thought it was sometime this year that that was supposed to disappear. But I guess either I am misremembering or it's still off in the future.

I think what you might be thinking about with the GAAP guidance on this came out during last -- end of last year and the transition date is January 1, 2015.

Okay, so yes. We've been talking about it for a while, it's still a couple of quarters away, I guess.

That's right.

Okay, well, thanks guys, appreciate it, and good job again.

Joel Houck, Wells Fargo.

Thanks. Have you guys talked already about -- or given an update on the senior sub -- you are buying a senior portion from the banks, supply dynamics, pricing? If you have, forgive me. I jumped on late, but could you give us an update?

I'm sorry, what was the tail end of your question on the pricing?

Pricing dynamics, the supply available and your activity in the quarter on those transactions?

On the RPL/NPL securities?

Yes, the securities you are buying from the large banks.

Sure. So I think -- we added quite a bit during this quarter. We had about $300 million this quarter of those types of securities so it has been a pretty active market. As I said previously, they actually have widened out a little bit in the last couple of weeks. They got to a point where they tightened and we actually sat out a couple of different deals because the yields really got too low for us. So again, that ebbs and flows. We've always said that those opportunistic purchases and they continue to be.

Right. Given the widening we've seen, you would characterize that as attractive today?

Yes, we would. We still think that we can generate high single- , low double-digit ROEs. And as Bill said, because they have this step up coupon feature at the end of three years, we're pretty confident in the price stability and the low interest-rate risk associated with these.

And just one final one on this topic. So, given the lack of interest rate [sensitivity], is it fair to say that this class of securities is favored over more of a kind of fixed-rate pool or a pool that perhaps has a longer duration?

I guess. Again, it would depend on the yield on the fixed-rate pool and that's something that, obviously, we could hedge. So I think if you're saying would we buy the RPL/NPL securities over a legacy non-agency, it would really depend on the two offerings.

But Joe, you bring up a good point. When we buy an asset, we do look at the ROE. We also look at the incremental interest rate sensitivity we're adding to the portfolio. So other things being equal, based of uncertainty as to what's going to happen over the next several years, this does look attractive right now.

Yes, no, thanks, Bill. I guess that's what I was trying to get at is how sensitive you guys are to rising short-term rates over the next couple of years. People all over the place. I'm just trying to get a read on you guys' perspective.

We are very aware -- our read is -- the Fed is quite clear. The cost to society of underemployment, whether it be a discouraged worker not looking for a job or someone not having a job or someone being underemployed and not working as many hours as they like, they believe it's a very high cost to society. As a result, they are ready to take some risks on possible asset inflation and I think that's what Janet Yellen spoke about. That we have this accommodative monetary policy.

Perhaps there is some concern about valuation in biotech stocks for example, but they know the trade-off. And right now, looks like we still have a lot of runway on where short-term rates are, but who knows two years from now and that's why we very much like these assets.

Okay, great, thank you very much.

Rick Shane, JPMorgan.

I guess I'm going to revisit everybody's favorite topic, RPLs/NPLs. Just very quickly, there is mention in the footnotes that your expectation is that the securities will be called prior to the step-up date. Given the amortized cost and the market value, I'm assuming a modest realized gain as that occurs. You guys had also commented they are trading pretty near par, so I'm assuming that there is not going to be much additional appreciation as you approach step-up or as you approach call date?

So Rick, we purchase these securities around about par value and there aren't -- I wouldn't say there are significant unrealized gains on those securities at this point. So -- and as they approach that callback, I wouldn't anticipate that either, so we wouldn't anticipate significant unrealized gains on the redemption of those securities.

Got it. Right now, it looks like it is showing $2 million between market value and amortized cost. So ultimately, $3 million, $4 million potentially?

Yes. They are -- I think a couple of the very early deals we actually bought at a discount. But it's tiny. You're talking $2 million on $500 million, right?

Right.

It will probably be marked to par by the time they're called because the market will anticipate they're going to be called at PAR so --

That's what I would expect.

So we would expect much variability off the PAR price over the three years.

Got it. Okay, great. Thank you, guys.

(Operator Instructions) Jason Stewart, Compass Point.

One quick follow up on the RPL segment. You talked about prices, but there are other characteristics in the market that have changed, for example, the number of months of re-performance. Could you give us an idea for whether prices have all converged or do you feel like you are still getting paid to take risks on, for example, shorter RPL periods?

Well, the NPLs we typically viewed as much shorter than RPLs just because they are liquidations and re-performing loans. In particular, if they've had coupons lowered, typically longer assets. But that being said, we do look at the underlying collateral at these deals as well. It's a similar credit analysis that we do on our securities portfolio. And depending on underlying coupons and LTVs, we might look to have more subordination, for instance, or cheaper pricing.

So, it's a somewhat complicated process of evaluating these but we do take all those things into consideration.

I would also say when you are buying billions, probably all prices converge, but when you're buying smaller pieces, whether it be loans, whether it be securities backed by RPLs/NPLs, whether it be seasoned Non-Agency MBS, all prices don't completely converge. There is variations and the ability to create value by being a selective buyer.

Okay, that's helpful. And then just one 10,000 foot question, if we were to assume that home price appreciation was flat, what part of the portfolio would keep you up the most at night? Where would you likely look to term risk or what parts look still most attractive to you?

Well, the good news is these assets are about eight, nine years old. Many of the loans were actually refi, so people have been in the homes more than eight years and even if home prices stop going up, we're now in the amortization schedule for most of these loans. You have about a 22 years' amortization schedule with low interest rates, which means the principal amortization should improve the LTV 3% to 4% per annum even without home price appreciation. So time is really on our side here.

Okay, thanks.

Stephen Laws, Deutsche Bank.

Frankly, most of them have been addressed already. I did want to follow up on Mike's earlier question about undistributed taxable income. I think you said $0.11 at the end of the quarter. I know in 2011 you paid a small special dividend. I think there were two that hit in calendar year 2013.

Is there any distribution requirements of, say, September 30 for that income or is this just taxable income that's in excess of what's been distributed for this tax year as opposed to last tax year? So, can you maybe give us an update on where you stand on the distribution side?

Yes, we do have a tax expert here and he will correct me, but in terms of taxable income for the year 2014, you really have until September of 2015 when you are required to file your tax returns to distribute all the income for 2014. So we're in good shape distribution-wise and I don't foresee for tax purposes the need for a special dividend.

Okay. Great. So none of the current UTI is related to calendar year 2013 taxable income which would have a distribution requirement of this September 30?

That is correct.

Perfect. Thanks for that clarification and have a good day.

Thank you. At this time, there's no additional questions in queue. Please continue.

I want to thank everyone for listening in on our webcast today. And we look forward to speaking to you all at the end of the third quarter. So thanks very much.

Thank you. And ladies and gentlemen, this conference will be available for replay after 12 PM Eastern time today running through November 4 at midnight. You can access the AT&T Executive Playback Service at any time by dialing 800-475-6701 and entering the access code of 333141. International participants may dial 320-365-3844. Once again, those phone numbers are 800-475-6701 and 320-365-3844, using the access code of 333141.

That does conclude your conference call for today. We do thank you for your participation and for using AT&T's Executive Teleconference. You may now disconnect.