MFA Financial Inc (MFA) 2014 Q4 法說會逐字稿

Ladies and gentlemen, good morning. Thank you for standing by. Today's conference is assembled and welcome to the MFA Financial Incorporated Fourth Quarter Earnings Conference Call. At this time, all lines are in a listen-only mode. (Operator Instructions). And as a reminder, this conference is being recorded. I would now like to turn the conference over to Danielle Rosatelli with some opening statements. 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 reflects management's beliefs, expectations and assumptions as to MFA's future performance and operation.

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 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 fourth 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 fourth quarter 2014 earnings release and earnings presentation slides, 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 this call over to Bill Gorin, MFA's Chief Executive Officer.

Thank you Danielle. I'd like to welcome everyone to MFA's Fourth 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 2014, we continued to build a more robust business strategy. MFA converted to a holding company structure, which increased our investment flexibility. We've built out our team and the analytics for whole-owned investments. As a result, we were able to expand our investment focus across a wide range of credit sensitive residential mortgage assets. In the fourth quarter, we generated net income of $76 million or $0.20 per common share. The dividend per share was $0.20, which was consistent with the prior three quarters of the year.

Book value per common share declined less than 2% to $8.12. Based on continued improvements in the loan-to-value ratio of the loans underlying our Non-Agency MBS portfolio and other factors, we again transferred a significant amount, approximately $14 million from credit reserve to accretable discount. Now turning to page three -- seem to have a technical difficulty. Page three, executive summary. Now despite the low interest rate environment, we continue to identify and acquire attractive credit sensitive residential mortgage assets. It's been more than 8.5 years since the last federal funds rate increase. The unemployment rate has declined and may continue to decline in 2015. Yet, the labor force participation rate remains low. Inflation remains low in the US and borders on deflation in Europe and Japan. Interest rates remain low across the yield curve on a global basis.

Commodity prices are weak and the strong dollar is impacting US companies. As a result, future US Federal Reserve actions remains data dependent. But we remain positioned for more flexible monetary policy by the Federal Reserve that is responsive to measures of labor markets, indicators of inflation, international developments, and other economic data. We continue to limit the interest rate sensitivity of MFA's portfolio. Our net duration as of year-end was 0.56. Our leverage ratio was 3.3 to 1 and 71% of our mortgage-backed securities are adjustable, hybrid, or step up.

Turning to page four, in the fourth quarter, we continued to identify attractive investment opportunities across the residential mortgage assets universe. We doubled our holdings of securities backed by re-performing non-performing loans to approximately $2 billion, while tripling our holdings of credit sensitive residential whole loans to $351 million. We acquired $70 million and opportunistically sold $20 million of Non-Agency MBS issued prior to 2008, realizing a gain of $12.2 million. This is the tenth consecutive quarter we've realized gains through selected sales of Non-Agency MBS based on our projections of future cash flows relative to market pricing. Again we did not acquire any Agency MBS in the quarter.

Turning to page five, as you can see MFA's yields and spreads remain attractive. Despite the interest rate environment, our yield on interest earning assets and our net interest rate spread actually trended up. Now, we've broken this slide into a comparison of the third and fourth quarters on both a GAAP and non-GAAP basis. As you recall, when we acquire and report non-agency assets with the same counterparties we've accounted for these assets and related repurchase agreements as linked transactions. This service effectively reduced MFA's assets and liabilities, and that's what cause the difference between our GAAP and non-GAAP numbers. Starting in 2015 due to the adoption of the updated accounting standards, repurchase agreements, linked transaction accounting will no longer apply, no more linked transactions. And accordingly, our balance sheet and income statements will reflect these non-agency assets and related liabilities.

Turning to page six, MFA's booked value declined less than 2% in the quarter. As you know, our net income and our dividends are both $0.20 per share. So the change in book value is mainly attributable to the changes in Non-Agency MBS in the fourth quarter and this change is due three factors. One, there was some realized gains; two, there was an approximate quarter point downward move in the value of our non-agency holdings; and third as we have explained in prior quarters, the discount accretion on our Non-Agency MBS, increases our amortized cost. This lowers other comprehensive income, which is a component of stockholders' equity and increases the earnings, which are dividended out.

Gudmundur will now present the next three slides, which are an update on MFA's interest rate sensitivity, the relationship between agency and non-agency prepayment speeds and the relationship between premium amortization and discount accretion.

Thanks, Bill. On slide seven, which we should see momentarily, we show the interest rate sensitivity of our portfolio as measured by net duration as well as the duration of our assets and liabilities. The duration of our assets declined 20 basis points to 1.6 at the end of the fourth quarter from 1.8 at the end of the third quarter. The decline was caused by the continuing seasoning of our portfolio, the cumulative effect of falling mortgage rates, which would be expected to shorten cash flows, and because new acquisitions in the fourth quarter primarily consisted of RPL and NPL/MBS that have low sensitivity to interest rates. The duration of our hedges declined modestly to minus 3.6 at the end of the fourth quarter from minus 3.7 at the end of the third quarter, as our hedges shortened naturally over time. We did not add any new interest rate hedges in the fourth quarter. And finally, our net duration also declined modestly to 56 basis points at the end of the fourth quarter from 62 basis points at the end of the third quarter. As you can see, MFA continues to limit the interest rate risk in its portfolio and is well positioned for increased interest rate volatility and a more uncertain monetary policy.

Now we're going to move to slide eight. As the 10-year treasury yield has fallen from approximately 3% at the end of 2013 to about 2% currently and 30-year mortgage rates have declined approximately 75 basis points to 3.75% during the same period, the market focus on prepayment concerns have increased. It is therefore worthwhile to review the prepayment profile of MFA's portfolio. First, it is important to keep in mind that our Agency MBS were acquired at an average premium of approximately 4% while our legacy Non-Agency MBS were acquired at an average discount of approximately 25%. Therefore, if pre-payments on both asset classes increase at the same rates, we would expect the impact to be a net positive to MFA, as the legacy non-agency MBS discount is about six times larger than the agency MBS premium. Second, as you can see on slide eight, historically, changes in prepayment speeds in MFA's agency and legacy Non-Agency MBS has generally trended together increasing at the same time and decreasing at the same time.

Now, let's move on to slide nine. Here we compare MFA's Agency MBS premium amortization and legacy Non-Agency MBS, this is an accretion over time. Keep in mind that premium amortization is a negative for our earnings while discount accretion is a positive for our earnings. As we can see from the graph between 2011 and 2012, premium amortization and discount accretion were roughly similar. But since Q1, 2013, our legacy Non-Agency MBS discount accretion has increased significantly while our Agency MBS premium amortization has declined modestly. The increase in Legacy Non-Agency discount accretion was caused primarily by the cumulative transfer of approximately $450 million of credit reserve to accretable income since 2000 and Legacy Non-Agency MBS portfolio in 2012. Currently, the Legacy Non-Agency MBS discount accretion is more than double the Agency MBS premium amortization.

In summary, the cost prepayments on Agency MBS and Legacy Non-Agency MBS generally trend together and discount accretion is a significantly larger component of our income than premium amortization. We are not concerned about the impact of increased pre-payments on our portfolio.

With that I will turn the call over to Craig, who will talk about our non-agency holdings.

Thank you. Gudmundur. So turning to page 10, as Bill said earlier, we purchased $1 billion of RPL/NPL MBS in the fourth quarter, doubling our holdings of these assets. As we've said before, we particularly like these assets be to their low sensitivity to interest rates and what we believe to be low credit risk, while at the same time providing low-double digit ROEs. The low duration is due primarily to the 300 basis point coupon step-up that occurs after three years, which gives us confidence that they will have at most a three-year final. In fact, historically most of these deals have been called well prior to their three-year soft final. And while the underlying loans certainly have credit risk, the combination of significant credit support approximately 50% and the locked out nature of the cash flows on the subordinate piece ensure that the senior bonds are well protected and as credit protection increases as the deal seasons.

Turning to page 11, the credit metrics on the loans underlying our Legacy Non-Agency portfolio continued to improve. LTVs continued to decline due to home price appreciation and principal amortization, delinquencies have declined as fewer current loans become delinquent and foreclosure pipelines are liquidated. The loans are now on average 105 months seasoned, nearly nine years old and in addition, since over half of these loans were refinancings, so those -- these were not purchased money mortgages, we know that these homeowners have actually been living in these homes for more than nine years. As indicated in our press release, we again lowered our estimates of future losses in the portfolio and we transferred over $14 million from our credit reserve to accretable discount. All else equal, this increases the yield we will recognize over the remaining life of the bonds.

Moving on to page 12, on page 12, we illustrated the LTV distribution of current loans in the portfolio. In particular, we focused on the at-risk loans, where the homeowner owes more on the mortgage than the property is worth. Although these mortgages are current, the borrowers are not delinquent at present. These are the loans that we worry most about transitioning to delinquent in the future because of the fact that the borrowers are under water. As of December31, less than $200 million face amount of current loans had LTVs over 110%. This is only about 4% of the current loans in the portfolio.

On page 13, we show realized losses experienced on the portfolio over the last three years. Now please keep in mind that these realized losses are fully expected and precisely why we have established the credit reserve, which is presently over $900 million. We knew when we bought these bonds and in some cases, at very substantial discounts from par, that we will not get back the full par amount. And also, please note that after realized losses running at approximately $164 million in both 2012 and 2013, losses in 2014 decreased to $90 million. The $916 million credit reserve that we have today has already been reduced by over $400 million for actual losses realized in the last three years. These realized losses occur when the property securing the mortgage loans are liquidated for less the -- than the outstanding loan amount.

In addition, for many of the fixed rate bonds in the portfolio, unrealized losses are generated when mortgage loans are modified through coupon reductions to troubled homeowners. While the loan modification reduces the interest rate paid by the borrower, the bond that we own typically has the contractual fixed rate coupon, so the interest collected from the borrower may be less than the interest owed to the bondholder. In order to cure this interest shortfall, the trustee uses principal receipts to pay interest on our bond. Now this use of principal to pay interest effectively undercollateralizes our bond because the underlying principal balance of the loan is now less than the principal balance of the bond that we own. For some bonds, this loss is recognized in the period that it occurs, and this would be a realized loss. But in most cases, the loss is not realized until the period when the loan balance is reduced to zero, and we still have a bond balance outstanding, which is likely many years from now. At that point, this unrealized loss will become a realized loss.

Moving to Page 14, we have become increasingly active in the credit sensitive residential home loan space, growing this asset class threefold since September 30 to approximately $350 million. We're very excited about this asset class for several reasons, investments in this asset class utilize much the same residential mortgage credit expertise that we have effectively deployed in the Legacy Non-Agency space since 2008; supply dynamics suggest that we will have significant opportunity to purchase these assets as cardholders are obliged to shed them; total supply is estimated at between $500 billion and $1 trillion, with $30 billion to $50 billion of expected annual sales in 2015 and, again, in 2016. Compare this to Legacy Non-Agency, which is the shrinking market with fewer and fewer opportunities to purchase bonds. But don't get me wrong, we're glad to own $5 billion of Legacy Non-Agencies, but it will be virtually impossible to acquire a portfolio like this today.

We're also excited to have the ability to oversee servicing decisions on troubled loans. For instance, by offering modifications to borrowers when such a modification will produce a better net present value outcome than foreclosure and liquidation. Again, compared to Legacy Non-Agency MBS where we have no seat at the table, no visibility into the decision and often see losses pass through to the trust that acceptance. Also, residential home loans are good assets for us, that is, the qualifying interest for purposes of REIT qualification, which most RPL/NPL mortgage-backed securities are not and residential home loans are also qualifying interest for purposes of our 1940 Act exemption, which Legacy Non-Agency MBS are not. And finally, we believe that credit sensitive residential whole loans further round out MFA's focus on credit versus pure interest rate risk.

Turning to slide 15, we are buying these credit sensitive whole loans at material discounts to both their unpaid principal balance and also to the underlying property value. Our $350 million portfolio comprises over 2,300 loans acquired through ten transactions with ten different counterparties. We've established relationships with dozens of key market participants, most of whom are different than our trading partners for Legacy Non-Agency and RPL/NPL MBS. You will also note that we've added some leverage in the fourth quarter to this asset class and we're in discussions with additional lenders to add more financing in 2015. Leverage ratios on this asset class could conceivably grow to 2 times to 3 times debt-to-equity. But additionally, if we were utilize securitization financing in the future, this leverage ratio might increase again as this leverage would be term non-recourse and non-mark-to market. And now I'd like to turn the call back over to Bill.

Thanks, Craig. So you might have noticed as we continue to diversify our residential mortgage assets, our presentation has become a little longer, but let me sum it up. We continue to utilize our expertise to identify and acquire attractive credit sensitive residential mortgage assets. We've substantially grown our holdings of RPL/NPL securities and loans. Our credit sensitive assets continue to perform well. Now we don't say that we know exactly what the Fed will do and when they'll do it, but what's important is that we are well positioned to grow changes in interest rates and or prepayment rates.

Tom, with that I'd like to -- please have you open up the lines for questions.

(Operator Instructions) Dan Altscher, FBR Capital Markets.

Hey guys. This is actually Cole Allen on for Dan Ulsher. Thanks for taking my call.

Sure.

So first off I guess, I did notice that you guys ticked up the leverage in the whole loans portfolio and you just talked about it going to eventually a 2 to 3 times. What are you guys expectations for how quickly that becomes a 2 to 3 times levered and I guess the reasons that you think behind adding leverage to that portfolio?

So this is a question that we answer one way or the other on every call. We don't manage to a leverage goal. It's a question of adding asset that we think are attractive for the shareholders and if we're growing the portfolio, which we clearly did in the fourth quarter, leverage steps up. So we don't have a goal to change the leverage, we do have a goal to continue to acquire assets that we think will yield high-single digits, low double-digit ROEs. So -- and I can give goal, but you're right, the leverage did pick up and that's because we've substantially grew our assets.

All right. That's very helpful. And then I guess one other quick question on CPRs. It actually seemed like it in general portfolio, CPRs kind of ticked down for the quarter. What have you guys been seeing so far in 1Q as treasury yields have rebounded a little bit?

Hi, this is Gudmundur. Well, I can tell you on the agency side, we've seen actually CPRs trended down in the first quarter from the fourth quarter.

That's very helpful. Thanks so much guys.

Thank you, Dan.

Thank you.

(Operator Instructions) Lucy Webster, Compass Point.

Hey, Good morning, thanks for taking my question. I was hoping you could talk about RPL/NPL market and how you characterize the activities so far this quarter, what you're seeing on a volume and pricing standpoint there?

So just to be clear, Lucy, on the RPL/NPL mortgage-backed securities market or the whole loan market?

Yes, the MBS market.

The MBS market. So, well, the counter was actually quite crowded in December. There are lot of deals that came at the end of December and we were actually lucky that that a lot of securities we picked up in the fourth quarter, we picked up at the end when the market widened out. I think we've seen continued supply into January and February and the market has certainly tightened somewhat from where it was at the end of the year. So if -- just to throw numbers out of the market cut is wide as 4% yield at the end of the year, it's probably back into about 3.5% yields now.

Okay. And then are you seeing any change maybe on the whole loan side to your foreclosure liquidation timelines there?

In all portfolio?

Yes.

In the whole loans [lucy], it's really hard to tell because most of these trades we'd probably only owned for a little more than a month, so it'd be difficult or impossible to sort of discern any trend.

Okay. And then I was just wondering have you guys ever disclosed who does your sub-servicing for you.

We haven't -- we're using Fay Servicing for a substantial portion of it, but they are not the only servicer that we use.

All right. Thanks very much for taking my questions.

Sure.

You're welcome.

Charles Nabhan, Wells Fargo.

If I could follow up on Lucy's question regarding the RPL/NPL MBS market and just get a sense for what you're seeing in terms of competition for those assets?

Well, it really varies. So again, as I said before, at the end of the year, I think there were a lot of deals that issuers wanted to get done before the end of the year. So frankly, there probably wasn't a whole lot of competition then. We've probably seen a little bit more competition in -- certainly, in January and into February, but there is a tremendous volume of these deals. And so if the worse thing that happens is we've put in for an order for $75 million or $100 million and we only get $50 million or $75 million, it's totally a disaster. So there's a lot of supply of this. The existing deals pay down pretty quickly, and you see issuers call deals and then reissue deals to delever them. So I think the supply/demand dynamics are actually pretty good.

Okay. And I apologize if you touched on this, but I wanted to get a sense -- get your thoughts on the CRT market and how you think about that asset class and if we could potentially -- if that's a type of asset you would potentially look at for your portfolio.

So we actually -- I think we have it in the press release, but we -- you'll certainly see it in the K, we have participated to a lesser extent. I think our total holdings of the CRT transactions is about $100 million. We do think it's interesting when they -- again, it's like everything else, we approach it opportunistically if the spreads get wider, which they did in the fourth quarter, they become more attractive to us, less so as they tighten. So we're certainly involved, we like the asset because it really has no duration. They're monthly floaters with no caps.

On the other hand, it's -- the way it's structured, it's not a good (inaudible). It's not a good asset for purposes of the 40 Act exemption. So I think our participation will be somewhat limited, but we certainly see that as attractive, especially as spreads widen out.

Okay, I appreciate the color. Thank you.

Sure.

Thank you.

(Operator Instructions) And gentlemen nobody else is queuing up at this time.

Great, thank you all for joining us today and we look forward to speaking to you again next quarter.

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