MFA Financial Inc (MFA) 2016 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the MFA Financial Incorporated Fourth Earnings Conference Call. At this time, your telephone lines are in a listen-only mode. Later, there will be an opportunity for questions-and-answers, with instructions given at that time. (Operator Instructions) And as a reminder, today's conference call is being recorded.

I would now like to turn the conference over to your first speaker, Danielle Sardone. 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 operations. 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 2016 financial results. Thank you for your time.

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

Thanks Danielle. I'd like to welcome everyone to MFA's fourth quarter 2016 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 other members of Senior Management.

In the fourth quarter of 2016, we continued to execute our strategy of selective investments within the residential mortgage universe. With many years of experience in analyzing and investing in such assets, and thanks to our permanent capital REIT structure, we have the staying power to hold these assets throughout fluctuations in market value.

Turning to page three, despite this period of historically low interest rates, we remained well positioned to generate attractive returns. In the fourth quarter, we generated EPS of $0.18 per share. Despite interest rate increases in the quarter, book value per share was little changed at $7.62 versus $7.64 at the end of the third quarter. As we have said repeatedly, a lower duration portfolio and lower leverage leads to a more stable book value. We continue to identify and acquire attractive credit-sensitive residential mortgage assets, such as three-year step-up securities and credit sensitive residential whole loans.

Turning to page four, MFA began operations nearly 19 years ago and the Company has generated strong long-term return to investors through volatile markets and through various interest rate and credit cycles. Since 2000, we've generated annualized shareholder returns of approximately 15% per annum. And over the last 10 years have generated annualized shareholder returns of approximately 13%. 2016 is a particularly good year, with total shareholder returns of approximately 29%.

Turning to page five, we lay out MFA's investment strategy. In 2017, we'll continue to focus on credit sensitive residential mortgage assets. The credit assets we've acquired continue to perform very well, and tend to be short-term and have less interest rate sensitivity. Many of our assets are purchased at a discount. So we actually benefit from increases in prepayment rates.

Investor expectations of more rapid growth due to potential for tax reform or increased infrastructure spending have negatively impacted interest rate sensitive assets. While on the other hand, they've positively impacted credit sensitive assets. This is consistent with our fourth quarter book value performance. While we're currently actively engaged with many attractive investment opportunities. In this very short term, we're moving cautiously on committing capital.

Our strategy does require staying power, which gives us the ability to invest in and hold long-term (technical difficulty) was low enough to accommodate potential declines in marks, and let's say, is able to invest significant amounts at advantageous prices, while other investors may be facing capital outflows. And as a reminder, we're internally advised and compensation is not based on growth or size.

Turning to page 6, our mortgage assets run off due to amortization, allowing reinvestment opportunities in changing interest rate and credit environments. In the fourth quarter, we were a buyer of three-year step-up securities, residential loans and CRTs. In the quarter, our three-year step-up securities, our re-performing and non-performing loan portfolio and our holdings of credit risk transfer securities each grew. As we had expected, the shrinking legacy non-agency universe has produced very strong technical support for the asset and we're generally more of a seller than a buyer of this asset type. We did not acquire any agency or legacy non-agency MBS in the quarter.

Turning to page 7, as you can see, MFA's yields and spreads remain attractive and relatively consistent, despite the interest rate environment. At the end of the fourth quarter of 2016, MFA had undistributed taxable income of $0.16 per share of common stock.

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

Turning to page 9, Gudmundur will present update on MFA's interest rate sensitivity.

Thank you Bill. Turning to page 9, we'll review the interest rate sensitivity of MFA's assets and liabilities.

MFA's overall interest rate risk remains exceptionally low and changed only modestly in the quarter, despite large changes to interest rates. Our asset duration increased modestly by 13 basis points in the fourth quarter, as some of our 15 year agency MBS and longer to reset agency hybrid ARMs extended as rates rose. However, it is worth emphasizing that at 135 basis points, our total asset duration remains exceptionally low. We didn't add any new swap hedges in the quarter and as a result, our swap duration declined 10 basis points to minus 2.7. Overall, MFA's net duration increased by 16 basis points in the quarter, but remains very low at 71 basis points at the end of the fourth quarter.

MFA continues to pursue a strategy of minimizing interest rate risk in our portfolio. In addition to low net duration, it is important to keep in mind that MFA's portfolio has very little sensitivity to changes in long-term interest rates, due to the fact that our assets are either very seasoned, had adjustable coupons or a short repayment profile, or a combination of all three. MFA's strategy of minimizing sensitivity to interest rates served us well in the fourth quarter, as we will discuss in more detail on the next slide.

Let's turn to page 10. Interest rates rose dramatically in the fourth quarter with most of the increase occurring after the surprise result of the Presidential Election on November 8. The market appears to have priced in increased economic growth and higher inflation expectations in the short to medium run, as a result of the new administration's expected economic policies. As a result, we saw large increases in interest rates in the fourth quarter, with the 10-year treasury yield increasing 85 basis points in the quarter and the two-year treasury yield increasing 45 basis points in the quarter, resulting in a significant steepening of the yield curve. In fact, the 85 basis points increase in the 10-year treasury yield was the largest quarter-over-quarter increase in the last 16 years, even larger than the second quarter of 2013, which was the beginning of the taper tantrum.

Longer-term bonds suffered large price declines in the fourth quarter. For example, 10-year treasury declined by approximately 7 points and 30 year, 2.5% coupon agency MBS declined by approximately 6 points. The fourth quarter is a good reminder of the risks of owning long-term fixed income securities.

MFA has consistently, over the last couple of years, emphasized our belief that our portfolio has little sensitivity to interest rates, due to its low net duration and limited sensitivity to long-term interest rates. The fourth quarter large increase in long-term interest rates provided us with a great opportunity to test those beliefs and measure the empirical interest rate risk embedded in our portfolio. Our seasoned short and primarily credit sensitive assets performed well in the fourth quarter, as market participants predictably showed a strong preference for shorter assets to defend against rising interest rates.

In the fourth quarter, MFA's book value was a little changed, declining only 30 basis points during one of the most volatile quarters for interest rates in a long time. We are quite pleased that our strategy performed as expected and that we have been able to balance protecting book value in a rising rate environment with delivering stable income for our shareholders. Going forward, we will continue to limit interest rate risk in our portfolio and believe MFA is well positioned for a period of heightened interest rate volatility.

Turning to page 11, in addition to low sensitivity to interest rates, we want to remind our investors that we also believe that MFA has limited sensitivity to changes in prepayment rates. The graph on this slide shows the magnitude of MFA's agency MBS premium amortization and legacy non-agency MBS discount accretion since 2013. As we can see that the discount accretion has been doubled the premium amortization in most quarters during this period. This is primarily due to the fact that the legacy non-agency MBS purchase discount of approximately 27 points is much larger than the agency MBS premium amount of approximately 4 points.

Prepayments on our legacy non-agency MBS continued to be positively impacted by home price appreciation, incrementally better access to credit and the fact many of the underlying loans still have mortgage rates considerably higher than current market rates. In addition, the agency MBS portfolio prepayment volatility has declined over time with seasoning and higher rates. Given this and the fact that prepayments on our agency and non-agency MBS portfolios tend to trend together, we do not believe the changes in prepayments will materially impact MFA's earnings.

With that I will turn the call over to our President and Chief Operating Officer, Craig Knutson who will talk about our credit assets and credit fundamentals in more detail.

Thank you. Gudmundur. If you turn to page 12, the residential mortgage credit market continues to enjoy both fundamental and technical support. Interest rates and mortgage rates although up modestly in the last two months, remain low by historical standards. According to the most recent report from the National Association of Realtors on existing home sales, total existing home sales for the calendar year 2016 were 5.45 million units. This is the highest level since 2006. Median existing single-family home prices were up 4% versus December of 2015. This marked the 58th consecutive month of year-over-year gains.

Finally housing inventory continued to decline. Total housing inventory at the end of December was 1.65 million units, down 10.8% versus November. This is the lowest level of housing inventory since the National Association of Realtors began tracking this number in 1999. According to a recent CoreLogic national foreclosure report as of November 2016, foreclosure inventory is down 30% in the last year and November marked the 61st consecutive month of year-over-year declines. Foreclosure inventory was down 2.4% in November versus October and has declined every month in 2016 through November. Clearing out foreclosure inventory is an important step in producing home price appreciation, as distressed inventory tends to hold prices down. In addition, borrowers with equity in their homes are less likely to default in the future and can also refinance their mortgages at low current rates, which generates prepayments on our existing loans.

Turning to page 13, we again grew our RPL and NPL home loan portfolio in the fourth quarter, adding approximately $100 million in new purchases. Net of run-off, this portfolio grew by about $60 million in the fourth quarter. We expect continued additional supply in 2017, with selling expected from GSEs, large banks and other market participants.

Turning to page 14, our credit sensitive whole loans appear on our balance sheet on two lines; loans held at carrying value, about $590 million, and loans held at fair value, about $815 million. This election is permanent and is made at the time of acquisition. Typically, we elect carrying value for re-performing loans and fair value for non-performing loans.

We added a fifth warehouse line in the fourth quarter and now have aggregate home loan borrowings of approximately $830 million, with additional capacity and appetite from those lenders to increase this leverage, should we choose to do so. Our asset management team is managing delinquent loans and OREO properties together with our servicers in order to enhance outcomes on these property liquidations.

Turning to page 15, we purchased approximately $450 million of three-year step-up securities in the fourth quarter. We continue to like these assets due to their low sensitivity to interest rates in what we believe to be low credit risk. Despite their very short duration, we've seen some modest price appreciation in this asset class, as heavy buyer interest has pushed yields lower on new issued deals, despite higher interest rates and higher funding costs after the Fed raise in December.

Turning to page 16, the credit metrics on the loans underlying our legacy non-agency portfolio continued to improve. 89% of the loans underlying this portfolio are now amortizing. This principal amortization, together with home price appreciation, continues to reduce LTVs. Delinquencies are curing. 60-plus day delinquencies, as of December 31 for this portfolio were 12.5%.

On this page, we illustrate the LTV distribution of current loans in the portfolio. The red bars on the right hand side represent at-risk loans, where the homeowner owes more on the mortgage than the property is worth. These are loans we worry about transitioning to delinquent and defaulting in the future, because the borrowers are underwater. As you can see, these red bars are disappearing.

Please also note the increasingly large green bars on the left side; loans with LTVs below 80% and below 60% are attractive refinancing candidates. And 79% of the current loans have LTVs of 80% or lower. Again, a combination of low rates available today versus the current rates on most of these mortgages and a 30-year amortization term on a new mortgage, versus the 20-year remaining term on these loans today can offer homeowners substantially lower monthly payments. Of course, given our deeply discounted purchase price of these assets, we're very happy when the underlying loans prepay.

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

Thanks, Craig. To summarize, we continue to identify and acquire attractive, credit sensitive residential mortgage assets. Our credit sensitive assets continue to perform very well. And as I think we hopefully illustrated in the fourth quarter and hopefully illustrated during the last taper tantrum, MSA's strategy is well positioned for changes in prepayment rates, monetary policy, and/or interest rates. So that completes today's presentation.

Operator, could you please open up the lines for questions?

(Operator Instructions) Jessica Levi-Ribner, FBR.

Just maybe bigger picture; how you're thinking about the market for distressed loans and CRT and all of that, given the new administration, the kind of promise to deregulate the banking sector, does that change your view at all and how do you think about navigating that?

So I think the change is to the positive, in that one of the concerns over the last couple of years has been the regulatory environment and the impact on financing for assets. And clearly we've seen that trend improve substantially over the last couple of months. So we see that as a positive. In addition, to the extent that there is a pro-growth tax reform or infrastructure spending, again that should help credit sensitive assets, while not necessarily helping in interest rate sensitive assets.

I would just add that, well again, we don't really know and cannot predict with certainty what will happen in the future. We've certainly heard plenty of talk about GSE reform and so I think in terms of the supply of that product and supply of risk transfer, I don't think I've heard anybody say that the GSE roles and housing finance should be larger in the future, not smaller. So I think -- and that is a significant source of expected supply. We certainly don't think anything [is indicated] to change that.

Bose George, KBW.

It's Eric on for Bose. I'm curious if you know the re-default rate in your RPL portfolio and how you see that trending over the next year or so? And maybe you can give us some context around the primary drivers that you see behind re-default in the market today.

On our RPL portfolio, when you're looking at, I guess, our portfolio as a whole, we own -- half of the portfolio is re-performing and half the portfolio is non-performing. So on RPLs, there hasn't been that much history on the re-default rate, bit what you have seen is as the loans get more consistent pay history, they're less likely to default. So, initially, you could say we were expecting a third of our RPLs purchased to re-default. I think we're seeing the performance is better than that and we think with the improving fundamentals, improving home prices and the like, we expect that continue to trend better over time.

On the same kind of note, I mean as a buyer in the market are you -- would you say more comfortable now with the ability of mortgage servicers to successfully reach retention solutions with homeowners now versus when you guys started entering this market a few years ago?

Yes. I mean we have third-party servicers that contact the borrower on our behalf. But, ultimately, it's the investor's decision on a modification. But we do believe that again the fundamental is getting better. So as you've seen home prices going up, the borrower is more likely to want to stay in their home. You don't really have the strategic defaulters that you may have had two to three years ago. So there is definitely a different conversation that's had.

And one more if you don't mind for me. On the funding side, the funding profile continues to emphasize short dated repo. You guys did talk about the funding facility that you have. But I'm curious how you think about maybe swapping out some of that exposure, if your bias is consistent with the markets that the Fed could move a couple of times this year and next? Thanks.

So, there are alternative ways to finance loans and so far we've been in accumulation mode and the [fine] financing with lines. But as we reach a critical mass of loan ownership, there might be more permanent options available to us, including some fixed rate option. So we hear what you're saying. It's hard to make a prediction on interest rates, but we probably, over time, would look to fix some of the borrowing rates.

Doug Harter, Credit Suisse.

If you could talk about -- looking at incremental RPL purchases, or the step-up, how you think about kind of the tighter spreads and balancing that with the potential that maybe the economy is growing faster and how you think those two things weigh out in return potentials?

So, something that we've said before is, look, we don't have to replace run-off every day, every month, or every quarter. We take a -- as you know Doug, you've been around for a while -- we take a longer-term perspective. We do continue to see niches. Look, we were very, very early on the three-year step-up securities, and we continue to see all the niches develop. But you're right, as we mentioned, interest-rate assets got cheaper in the quarter, fourth quarter, the credit assets did not necessarily get cheaper. So, while we are in contact with opportunities, we are making investments, we are a little cautious in committing capital at this time.

And I guess looking at the non-agency side, you said you were probably -- incrementally probably a better seller of those assets. And I guess sort of along the lines of the economy and the housing market continuing to improve, is there still, I guess, the potential for kind of performance to be better and to continue to release reserves into the accretable discount, or I guess where are we in that?

So, I think, I jotted down some numbers. I think if you go back two years that credit reserve -- so at the end of 2014 that credit reserve was about $900 million, it's now under $700 million. So obviously that has reduced over time. Now that's reduced because we've had actual losses that's reduced because we've changed assumptions and it gets reduced through some sales. So, it's something that we evaluate every single quarter, and to the extent that the fundamentals argue for a reduction in credit reserve, we've done that. I think we've reduced the credit reserve almost every quarter for at least the last three or four years. But it's a quarter to quarter thing and we still have -- whatever -- we still have 20 years or so, or 19 years to go, because these are 30-year mortgages, but it's something that we keep a very close eye on. But that being said with principal amortization, with higher prepayment rates in some of our original estimates, we continue to be very optimistic about our holdings. And part of the reason that we sell is that this universe is shrinking so much that we don't want to have a disproportionate share at the end of the day. So it's sort of why we reduce it as a whole our universe reduces.

(Operator Instructions) Steve DeLaney, JMP Securities.

Good morning everyone and congratulations on what was really an outstanding book value performance in the fourth quarter. Bill, I heard you mention something about taxable income. I think you said $0.16, but I thought that was the figure you are giving for the fourth quarter. Could you give us an update for undistributed taxable income as of the end of the year? This quarter we didn't have a page in the deck as you've done in the past.

Good, thanks for pointing it out. Sorry for the ambiguity. Yes, at the end of the year, the balance was $0.16 per share undistributed. So it's not a fourth quarter number, that is the balance at the end of the year.

Okay, great. I misunderstood that. That's what I wanted to know. And I think it was in the third quarter you mentioned there might be some incremental taxable income coming here in the first quarter from a re-REMIC unwind. Is that still in the cards?

You have a very good memory, Steve, and yes that re-REMIC collapse is in the cards.

Yes, it's in the cards for this quarter.

So, other things being equal, I would expect the undistributed taxable income per share to grow during the first quarter.

Okay, great. Well, thanks again, guys and great job on the book value. You beat us about $0.03, so we need to try to get it a little closer next time, but we'll see if we can get it better. Thanks.

And we have no further questions in queue at this time. You may proceed.

Great. I want to thank everyone for their participation in the call today and we look forward to speaking to you on our next quarter. Thanks, operator.

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