MFA Financial Inc (MFA) 2015 Q4 法說會逐字稿

Ladies and gentlemen, we do appreciate your patience, and welcome to the MFA Financial Inc. fourth-quarter earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, 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 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, should, could, would, 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, 2015, 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 2015 financial results. 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 would like to welcome everyone to MFA's fourth-quarter 2015 financial results webcast. With me today are: Craig Knutson, MFA's President and Chief Operating Officer; Gudmundur Kristjansson, Senior Vice President; Bryan Wulfsohn, Senior Vice President; Steve Yarad, CFO; and Terry Meyers, Senior Vice President, Director of Tax; and other members of Senior Management are also present.

In 2015, we continued to execute our strategy for expanding investments within our residential mortgage asset investment universe. As opportunities in the residential mortgage asset sector are identified, MFA had the focus and the requisite capabilities to analyze the investment and to be a significant investor.

Turning to page 3, despite the low interest rate environment, we continue to identify and acquire attractive credit-sensitive residential mortgage assets, such as credit sensitive loans and three-year step-up RPL/NPL securities. In the fourth quarter of 2015, we generated net income of $69.7 million, or $0.19 per common share. The dividend was again $0.20 per share, and book value per common share at December 31 was $7.47.

Turning to page 4. MFA began operations nearly 18 years ago, and has generated strong long-term returns to investors, through volatile markets and through various interest rate and credit cycles. Since 2000, we have generated annualized shareholder returns of approximately 14%, and over the last 10 years, have generated annualized shareholder returns of 13.5%.

Turning to page 5. We have laid out MFA's strategy for 2016. First, we continue to focus on high value-added credit-sensitive residential mortgage assets. The credit assets we've acquired continue to perform well. The credit assets we have acquired also tend to have less interest rate sensitivity. Second, our strategy does require staying power, and the ability to invest in and hold long-term, distressed, less liquid assets.

We have permanent equity capital. Our debt-to-equity ratio of 3.4 times is low enough to accommodate potential changes in marks. This is why, historically, we have been able to invest significant amounts, at advantageous prices, while other investors were facing capital outflows. Our significant market cap is relevant to investors and to counter parties, and potential mortgage industry partners. Let me add that being right sized is a two-way street, and we refrain from raising the equity base during the last cycle of industry equity growth, as we wanted our existing shareholders to capture the benefits of our investment strategies. As reminder, and I am sure you know, we're internally advised, and compensation is not tied to size.

Turning to page 6. In the fourth quarter, we continued to identify and acquire credit-sensitive residential mortgage assets. We increased our holdings of credit-sensitive residential home loans to $895 million, and our holdings of three-year step-up RPL/NPL securities to $2.6 billion. In the fourth quarter, we did not acquire any agency MBS or legacy non-agency MBS.

Turning to page 7. As you can see, MFA's yields and spreads remain attractive, despite the interest rate environment.

Turning to page 8. We present yields and spreads for our more significant holdings. Given the leverage we're utilizing, or may utilize in the future, each of these asset types are generating attractive returns to MFA's shareholders.

Turning to page 9, Terry Meyers, our Director of Tax, will present slide 9, which is an update on items that will be impacting taxable income.

Thank you, Bill. As can be seen from the slide, the Company's undistributed taxable income as of December 31, 2015 was approximately $0.02 per share. As we look forward to 2016, certain events during the first half of the year are expected to significantly impact our taxable income, but will not impact our GAAP income.

These items include the recognition of taxable income from the qualified liquidation of one of our REMIC securitizations, and from the Company's receipt of certain amounts it expects in connection with the Countrywide settlement. We estimate that the REMIC liquidation will generate taxable income of approximately $0.19 per share, and that the Countrywide settlement will generate taxable income of approximately $0.05 per share.

I will now turn the discussion over to Gudmundur.

Thanks, Terry. We're going to move to slide 10.

On slide 10, we are going to look at the interest rate sensitivity of MFA's assets and liabilities. MFA's asset durations was approximately unchanged in the fourth quarter, at 141 basis points, despite interest rate rising by about 35 basis points across the curve in the fourth quarter. This was primarily caused by a continued growth in our holdings of credit-sensitive loans and RPL and NPL securities, both of which exhibit limited interest rate sensitivity, while our more interest rate sensitive agency MBS and legacy non-agency MBS continued to run off.

The notional amount of our swap hedges remains unchanged, at approximately $3 billion at the end of the fourth quarter, but the hedge duration declined about 30 basis points, to minus 3.4 at the end of the quarter, as our swap hedges shorten naturally over time. In aggregate, MFA's interest rate sensitivity remains very low in the quarter, and net duration was almost unchanged, at 59 basis points at quarter end.

With that, I'll turn the call over to Craig.

Thank you, Gudmundur. On page 11, as I'm sure everyone knows by now, the FHFA adopted a final rule last month that excludes captive insurance companies as eligible Federal Home Loan Bank members. Thus, the Federal Home Loan Bank membership of our captive insurer will terminate in a year. We had $1.5 billion of advances, all using agency MBS collateral, at year-end 2015, and as of the final rule adoption.

Because the term of our advances is longer than one year, we will have no roll over issues with our advances, but all of these advances must be repaid by February 19, 2017. We have already reduced these advances from $1.5 million to $1.2 billion, and please keep in mind, with our agency MBS pay-downs running at approximately $75 million per month, we expect about $900 million in pay-downs over the next year. So while we are disappointed in losing the Federal Home Loan Bank of Des Moines as a leading counter-party, and a partner in housing finance, this development has really very little impact on our business today.

Turning to page 12. Although the general health of the US economy is the subject of nearly daily debate these days, the residential mortgage credit market enjoys significant fundamental and technical support. The labor market and employment numbers continue to improve, interest rates and mortgage rates remain very low. Case-Shiller National 20-city and 10-city indices were all up over 5%, year over year. Sales of existing homes rose 6.5%, to $5.26 million in 2015.

According to a recent CoreLogic National Foreclosure Report, the US national foreclosure rate is now down to 1.1%. We last saw that level in November of 2007, and foreclosure inventory is down 23.8% in the last year. Total housing inventory is declining. Available listings are down 3.8% from a year ago. Seriously delinquent, defined as 90-plus days, mortgages are down 23% year over year, and underwater homes are down 21% year over year.

Turning to page 13. We made good progress on growing our credit-sensitive residential home loan portfolio in the fourth quarter, increasing this asset class to $895 million as of December 31, nearly tripling the size of this asset class during 2015. The supply picture for 2016 looks very promising, with continued selling expected from GSE's, large banks and other market participants. And just to remind you, these residential home loans are qualifying interest, for purposes of the re-qualification and the 1940 Act exemption.

Moving to page 14. Our credit-sensitive home loans appear on our balance sheet in two lines. Loans held at carrying value, which is $272 million, and loans held at fair value, which is $623 million. This election is permanent, and is made at the acquisition time. Typically, we elect carrying value for re-performing loans and fair value for non-performing loans.

We added additional warehouse borrowing capacity during the fourth quarter, and we now have three warehouse lines, with aggregate borrowings of approximately $488 million. We've also added additional staff to help with the asset management function associated with this portfolio. We're excited to have the ability to oversee servicing decisions on troubled loans, and we believe that we can achieve improved returns on these loans through thoughtful and diligent asset management.

Moving to page 15. We purchased approximately $345 million of RPL/NPL mortgage backed securities in the fourth quarter, while experiencing pay-downs of about $189 million. This portfolio was at $2.6 billion at year end. We continue to like these assets, due 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. Spreads on new issued deals have widened somewhat recently, and we've been able to invest at attractive yields of as high as 4.5% recently.

Finally, moving to page 16. The credit metrics on the loans underlying our legacy non-agency portfolio continue to improve. 79% of the loans underlying our legacy non-agency portfolio are now amortizing. This principal amortization, together with home-price appreciation, continues to drive down LTVs. Delinquencies are also curing. 60 plus-day delinquencies of this legacy portfolio, as of December 31, have declined to 13.5%. On this page, we illustrate the LTV distribution of current loans in the portfolio.

The red bars represent at-risk loans, where the homeowner owes more on the mortgage than the property is worth. These are loans that we potentially worry most about transitioning to delinquent in the future, because of the fact that the borrowers are underwater. As you can see, these red bars are quickly disappearing. Please also note the increasingly large green bars on the left-hand side. These are loans with LTVs below 80%, which are attractive refinance candidates.

A combination of low rates available today and 30-year amortization term on a new mortgage, versus the perhaps 20-year remaining term on loans outstanding today, can offer homeowners substantially lower monthly payments. Of course, given our deeply discounted purchase price for these assets, we are very happy when these underlying loans prepay.

And I would like to now turn the call back over to Bill.

Thanks, Craig. So in summary, we continue to utilize our expertise to identify and acquire attractive credit-sensitive residential mortgage assets. We substantially grew our holdings of credit-sensitive mortgage loans and three-year step-up RPL/NPL securities, in the year 2015. Credit-sensitive assets that we own continue to perform well, and we are well positioned for changes in monetary policy and/or interest rates.

This completes our fourth-quarter 2015 presentation. Operator, could you please open up the lines to questions?

(Operator Instructions)

Dan Altscher, FBR.

Thanks, and good morning everybody. I know you have generally been a little bit more hesitant to buy back some stock in recent memory. But I guess with the stock having done what it did through the end of the year, and particularly into January, has that tone around a potential buyback maybe changed at all, at this point?

Thanks for the question. So as you know better than I, most if not all the mortgage REIT sector is trading at some discount to book value. And I believe the situation extends to many types of financial institutions, including major banks. Also, as you know as well as I, MFA has, in general, traded much less of a discount than other companies in the sector. I believe this is primarily due to our investment strategy and execution.

MFA has made high value added, less interest rate sensitive investments within the residential mortgage universe. And it generates very attractive shareholder returns throughout different cycles, which I think we showed up in the early part of the presentation.

Now, many companies with very significant discounts have announced and executed share buybacks. But what really has been the income accretive impact? On the other hand, maintaining permanent capital and liquidity gave MFA the opportunity to make investments in less liquid and out-of-favor investments that, over time, have proven to be very large -- have very large impact in earnings.

It's why we were able to invest many billions -- maybe $4 billion or $5 billion -- in legacy non-agency MBS at deeply discounted prices. Also, as we all read in the papers, there is less liquidity in trading markets, and this trend is continuing. MFA is currently finding very attractive investment opportunities, as trading liquidity declines.

Now, we are disciplined in our capital allocation, which is important. Remember, we distributed approximately $300 million in dividends, in 2015, to shareholders. We are internally advised, and there is no compensation or fees that are tied to equity size.

The positive impact on earnings of lower G&A expense, due to our self-advised structure and our clinical scale, frankly dwarfs the income impact of any share buybacks we've seen. That being said, while this is our current view, we do like to keep all our options open, to best maximize long-term value creation for shareholders. And if facts and circumstances change, we currently do have an existing share buyback authorization of 6.6 million shares, which is approximately $40 million. Hopefully, you can see we've given the subject a lot of thought, and our view is based on many years of experience as a public company.

All right, thanks, Bill.

Sure, Dan.

Yes, no, I think I think the message pretty loud and clear, for right here and now.

On an unrelated topic, certainly there's been discussion, and I think evidence, of increasing, maybe, stress in the repo markets at counter-parties. Can you maybe give us an update or a feeling of how that discussion has gone, in recent times, with some of your counter-parties? In terms of offering capacity, or how they are talking about financing rates? Particularly as a lot of the Basel III starts to work its way in.

If maybe you have any sort of sensed or feeling as to how long -- or how long we are towards implementation? Or what -- is it just SLR-based, or have they even gotten to HQLA? Or anything else besides that, at this point?

I will start with the long term trend, and then we'll get you up to date on the market. This long-term trend has been foreseeable for five or six years, and that is part of the reason we changed direction, going back to 2007, 2008. Certainly, you can't compare the environment now to then. But having lived through that, we had the Company become less reliant on leverage, and that's why, historically, while we might've been 10 times levered, right now, it's a three handle.

The reason we change the investment class was to have higher-yielding assets that frankly required less leverage to generate attractive ROEs. So that's the long term trend. In terms of getting you up to speed on the current market, we will have Gudmundur talk about the agency market and Bryan will talk about the non-agency market.

Yes, the availability of funding remains good. There's nothing, no changes we saw on the fourth quarter or in the first quarter. I think some of the things that Bill mentioned, some of them have largely played out, so the impact has already been felt. And so we're not feeling it incrementally, over time, over the last couple of quarters. Repo rates in general, on the agency side, are about 65 basis points, which is one month LIBOR plus 20 to 22 basis points, which is in line with where it has been over the last year of so.

Yes, and on the non-agency side, repo is still widely available. Demand has remained constant, if not -- we have even seen a tick-up in demand for credit. In terms of spreads, we saw some widening going into the fourth quarter, but haven't really seen any change, thus far, in the new year.

Okay. And then maybe just one other one, and then I'll jump off. Just really to CRTs, to credit risk transfers. Just glancing at the numbers, it looks like you probably added to that book a lot, or somewhat, during the quarter, because I don't think the market pricing was all that helpful.

Has anything changed there, that you're seeing, now, more interest from your end on it? Is it just that the yields blew out, and that made it really attractive? Or were these primary transactions? Or was it increased liquidity in the secondary market that's helping that? Take time -- make that maybe a more developing -- developed market?

Dan, this is Bill, and I will have the experts give you an answer. But just so we are clear, on slide 6, hopefully that shows that we bought 30 million. The change was 30 million in the fourth quarter, of credit risk transfers. So it was just opportunistic buying, on days when spreads were wide. So --

It's Craig. It's really opportunistic, as Bill said. As spreads widen out, they become more attractive. It's difficult to grow that, to buy any sort of size. Some of these trades could be a small as $3 million.

We've also been somewhat particular about the vintages. So the product that we own tends to be the more seasoned product, which has already experience some home price appreciation. So not all those are created equal. But it's still -- in the scheme of things, it is not a very big asset class for us.

Okay, thanks, I appreciate the answers. I will drop off. Thanks.

Doug Harter, Credit Suisse.

Thanks. Bill, before, in your answer, you said you were seeing some trading opportunities around the current market volatility. I was wondering if you could just flesh that comment out, and which asset classes you are seeing there?

Okay sure. So I think Craig spent some time on the three-year step-up RPL/NPL securities. And I believe the average coupon, as of the fourth quarter, was in the 370 handle. Clearly, new deals are being priced with a 4 handle. So to the extent we do have runoff, which we do, the average yield is going up, so continue to find opportunities in the RPL/NPLs.

Legacy non-agency's have widened, and sometimes we are a buyer and sometimes we are a seller of those assets. Generally, the buying opportunities in the first quarter are better than anything we've seen all of last year.

We actually -- even though it is not your question, but to preempt the next question. People have all been asked, what's happened to the value of the assets since the end of the year? So we will give you an update through January. So Craig, you want to take that?

Sure. So legacy is probably -- in the month of January, was probably down about 1 point. Again, be careful, because it really depends what the portion of the legacy market that you speak about. So our portfolio is more of the higher quality, prime, maybe some better quality all day. So there's been less price erosion there than in the lower credit quality paper, but it's probably up about 1 point in January.

Great, that's helpful. And then on the -- to understand the tax benefit that you will get this year, is that a one -- is that just specific to the one securitization that's unwinding? Or will that occur in further years, as well?

I don't know if it's a benefit. (laughter) But sure. That's transaction-specific, so that's a one-time event, with respect to the liquidation of that securitization. There is no follow-on. Once the liquidation occurs, there will be no subsequent impact from the securitization itself.

But that said, we do have one additional REMIC securitization that we did back in 2011, or maybe the beginning of 2012. The [senior] bonds on that have not paid off yet. So I think it would be a lesser effect than the one that's closest now. But -- and I don't know that will even occur this year. That might not be until 2017.

Got it, but there could be a similar taxable gain from that in 2017, if things play out similarly?

I think similar, but I think smaller. It's a smaller deal. So it will be similar, but not as large.

Great, thank you.

Joel Houck, Wells Fargo.

Thanks. I may have missed it, but I didn't see it in the slide deck. Can you tell us how much was transferred from the credit reserve to the accretable discount in the fourth quarter?

So let's see (inaudible). In the -- in quarter, we transferred approximately $6 million, taking the total for the year to about $41 million.

Okay. I believe that's in the press release.

Yes.

Okay, all right, thanks guys.

Sure.

Rick Shane, JPMorgan.

Good morning guys, hope you're well. Bill, it's nice to hear your voice. Just a couple of questions. And look, I think Dan really hit the question that most investors are focused on, about buybacks, and I think, Bill, you telegraphed your view pretty clearly.

One thing I would like to talk about is that we've heard some of your peers talk about the relative value in the agency market. It seems, obviously, like you're focused on the non-agency side.

I am curious, with spreads above historical average, in terms of spreads trading above historical average, why you're not pursuing that a little bit more? Do you think that we are approaching a period where spreads are going to be persistently wider, given some of the changes you're seeing in financing markets?

Thanks for the question, Rick. And I don't know why your name gets mispronounced more than everybody else's. (laughter)

I would think it's pretty easy. (laughter)

I agree with you. So you're right about the spreads, but let's take a historical perspective. So historically, you earned what you earned on your equity investment in the agencies, plus your spread times your leverage. So go back, way back when, and your un-levered yield is 4% or 5%, and then you earned your spread of 100 basis points times your leverage. The absolute yield is very low on the un-levered equity. And you're right, with your leverage, you still get to a good spot.

But being that this is the fourth quarter 2015 webcast, I still find it fair to bring up 2013, where the 10 year was very low at the beginning of the year and ended up much higher. So there is some risk to buying 30 year assets, hedging the duration, knowing full well the duration can change. Especially right now, when people aren't sure if the 10 year is going up and down, you're going to have either extension or contraction. But we don't disagree about the spreads. It's the absolute yield, it's the yield on the un-levered portion of your investment, that makes us refrain from growing the agency book at this time.

Go it. It's interesting. We see some value in the agency market, but I hear what you're saying, that there's really two-way risk in that market right now. And that's a lot harder to calibrate. And we're probably in a period of greater uncertainty than we've been in some time.

We agree.

Great, thank you guys.

Thank you.

(Operator Instructions)

Bose George, KBW.

Good morning. Actually an accounting question. The NPLs that you hold at fair value, does the fair value mark through the income statement, is that just the equivalent of interest income?

So Bose, that mark has a couple of components. It includes the coupon interest that we receive in cash during the period. And it also includes an unrealized gain unrealized gain on a loss component. So in our 10-K, which I think you'll see filed a little later today, we have some additional footnote disclosure, which gives you some more detail on that.

Okay, great. And then actually, just in terms of modeling that number, should we just use the discount rate, and assume that if nothing changes on the fair value mark, the discount rate is what your yield is going to be?

Yes, I'd say that's a pretty fair way to model it.

Yes, okay, thanks. And then just in terms of the gain from asset sales this quarter, can you just discuss what drove that?

Yes, sure. Often, we will see a security trade that we own a smaller piece of. So to the extent we know there's a buyer for a larger piece, it's an advantageous time for us to sell a smaller piece, just as an add-on. So typically, that's what's driving the trade in the market. Because we own so many [QSIPs], and we've owned them for a while, so some of them have reduced in size, due to prepays. We will just see what the market is giving us, in a particular QSIP, and often, we're just the add-on seller to when we (inaudible) watch rate.

And those small pieces, you typically trade at some concession to the market. So again, as Bill said, if we can add that onto a larger piece, it's a better execution than we could get in isolation.

Okay, that makes sense, great. Thank you.

And speakers, currently, we have no additional questions in queue. Please do continue.

All right. Thanks a lot, everyone, for participating in the phone call, and we look forward to talking to you next quarter. Thanks, operator.

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