MFA Financial Inc (MFA) 2017 Q1 法說會逐字稿

Thank you, ladies and gentlemen, for standing by. Welcome to the MFA Financial, Inc. first quarter earnings call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, 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, 2016, 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 first quarter 2017 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. Welcome, everyone, to MFA's First Quarter 2017 Financial Results Webcast. With me 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 first quarter of 2017, we continued to execute our strategy of selective investment within the residential mortgage universe. We have 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 3. Despite this period of historically low interest rates, we remain well-positioned to generate attractive returns. In the first quarter, we generated earnings per share of $0.20. Book value per share was little changed at $7.66 versus $7.62 at the end of the fourth quarter. As we've said repeatedly, a lower-duration portfolio and lower leverage leads to more stable book value. We continue to identify and acquire attractive, credit-sensitive residential mortgage assets such as 3-year step-up securities and credit risk transfer securities.

Turning to Page 4. We began operations nearly 18 years ago. And the company has generated strong long-term returns to investors through volatile markets and through various interest rate and credit cycles. Since 2000, we've generated annualized shareholder returns of approximately 15% and over the last 10 years have generated annualized shareholder returns of approximately 14%. Over the last 12 months, total shareholder return has totaled 31%.

Turning to Page 5. 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 well, tend to be short-term and have less interest rate sensitivity. Many of our assets were purchased at a discount. So we actually benefit from increases in prepayment rates. Investor expectations of more rapid growth due to the potential for tax reform or increased infrastructure spending have positively impacted credit-sensitive assets. Our strategy does require staying power, which gives us the ability to invest in and hold long-term distressed less-liquid assets. We have permanent equity capital. Our debt-to-equity ratio is low enough to accommodate potential declines in marks. MFA is able to invest significant amounts at advantageous prices while other investors may be facing capital outflows. We invest with a focus on long-term performance.

Turning to Page 6. While the Fed funds rate has increased, yields on credit-sensitive assets remained flat as investors have priced in more positive credit scenarios. In the quarter, we did not replace all of our runoff due to credit asset pricing and our strategy of allowing agency MBS runoff. However, we are seeing an ample supply of credit-sensitive loans. We are currently actively engaged with many potential attractive opportunities which we believe will lead to investments later in 2017.

Turning to Page 7. Our mortgage assets run off due to amortization, paydowns or sale, allowing reinvestment opportunities in changing interest rate and credit environments. In the first quarter, we were a buyer of 3-year step-up securities and CRTs. As we'd expected, the shrinking legacy non-agency universe has produced very strong technical support for this asset. And we're generally more of a seller than a buyer of the asset. We didn't acquire any agencies in the quarter.

Turning to Page 8. As you can see, our yields and spreads have remained attractive and relatively consistent despite the interest rate environment. At the end of the first quarter of 2017, MFA had undistributed taxable income of $0.26 per share of common stock.

Turning to Page 9. We present yields and spreads for our more significant holdings. Given the leverage we're utilizing and may utilize in the future, each of these asset types are generating attractive returns to MFA shareholders.

Gudmundur Kristjansson will now present an update on MFA's interest rate sensitivity and the impact of prepayments on MFA's portfolio.

Thank you, Bill. Turning to Page 10. We review MFA's interest rate sensitivity. MFA's asset duration declined 6 basis points to 129 basis points at the end of the first quarter as our purchases in the quarter consisted of 3-year step-up securities and CRT securities, both of which show little sensitivity to interest rates. Our asset duration continues to remain exceptionally low and, at 129 basis points, is among the lowest levels in the mortgage REIT space. Due to the limited interest rate sensitivity of our acquisitions in the quarter, we had no need to add new interest rate hedges. Our hedge portfolio currently consists of $2.85 billion of interest rate swaps and has a negative duration of 250 basis points. MFA's net duration was little changed in the quarter and remains exceptionally low at 69 basis points as of the end of the first quarter. With the Fed committed to a sustained gradual tightening of monetary policy and elevated uncertainty around government, tax, infrastructure and trade policies, we believe the potential for large changes in interest rates remains elevated. Therefore, MFA's investment strategy continues to emphasize low overall interest rate sensitivity as well as limited sensitivity to long-term interest rates specifically. We believe our strategy will continue to serve us well in protecting MFA's book value as it did in the fourth quarter of last year and other previous episodes of large changes in interest rates.

Turning to Page 11. As we can see from the graph on Page 11, the discount accretion on our legacy nonagency MBS portfolio continues to dramatically outpace the premium amortization on our agency MBS portfolio, with the gap increasing further in the first quarter. The primary reason for this continues to be the fact that the 28-point average purchase discount on our legacy nonagency MBS portfolio is significantly larger than the 4-point average purchase premium on our agency MBS portfolio. In addition, continued strong home price appreciation and incrementally better access to credit for legacy nonagency borrowers continues to positively impact prepayments on our legacy nonagency MBS. The mortgages backing our agency MBS portfolio are on average 6.5 year old. These borrowers have seen record low interest rates and had ample opportunities to refinance over the last 7 years but have chosen not to. They have shown less sensitivity to changes in interest rates, and therefore, the prepayment volatility on our agency MBS portfolio has declined over time. Due to the continued tailwinds from mortgage credit and reduced prepayment volatility on our agency MBS portfolio, we do not expect that changes in interest rate would cause large changes in prepayments that could negatively impact MFA's earnings.

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

Thank you, Gudmundur. Turning to Page 12. The residential mortgage credit market continues to enjoy both fundamental and technical support. Interest rates and mortgage rates 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 March increased 4.4% to 5.71 million units. This is the highest level since February of 2007. Median existing single-family home prices in March were up 6.8% versus March of 2016. This marked the 61st consecutive month of year-over-year gains. Finally, housing inventory continues to decline. Total housing inventory at the end of March was 1.83 million units, which is down 6.6% versus March of 2016. And according to the March 2017 CoreLogic National Foreclosure Report at year-end, there were 1 million U.S. mortgages that were seriously delinquent. This compares to a peak delinquency in January of 2010 of 3.7 million mortgages.

Turning to Page 13. While January was a relatively light month in terms of supply of credit-sensitive whole loans, February and March witnessed a return to more normal supply levels. Reperforming whole loans traded at tight levels despite higher funding costs after Fed funds increases in both December and March. Nonperforming whole loans have also traded at expensive levels. This is perhaps due partly to a strong bid from Wall Street banks in order to be able to offer homeowner relief to satisfy settlement agreements with the Department of Justice. Although we have been an active participant in bidding these whole loan packages, we did not win any of these bids in the first quarter. Although at times frustrating, we have maintained our patient and disciplined investment process. Nevertheless, we do see ample future supply, and we believe that we'll be able to continue to grow this portfolio over the balance of 2017.

Turning to Page 14. Although we did not add to this portfolio in the first quarter, our asset management team continues to actively manage our existing portfolio. During the first quarter, in our nonperforming or fair value portfolio, we brought 200 loans, approximately $31 million fair value, that were delinquent at year-end to current status as of March 31. We modified 71 loans in our fair value portfolio resulting in unrealized gains of a little over $1 million. We executed 83 short sales or other non-REO liquidations from our fair value portfolio resulting in realized gains of $900,000. In our reperforming or carrying value portfolio, our current loans increased from 73% to 75% since year-end and another 1.5% of the loans that were current at year-end paid off during the first quarter. Finally, we liquidated 84 properties out of our REO portfolio in the first quarter, our best REO liquidation quarter thus far. Again as a reminder, our credit-sensitive whole loans appear on our balance sheet on 2 lines: loans held at carrying value, which is $573 million, and loans held at fair value, $775 million. This election is permanent and is made at the time of acquisition. Typically, we elect carrying value for reperforming loans that we buy and fair value for nonperforming loans.

Turning to Page 15. We purchased approximately $150 million of 3-year step-up securities in the first quarter. This asset class has seen strong demand and new issue levels have not really widened despite hedge funds increases in both December and March. We've seen significant buying from money managers, which has been largely responsible for holding these spreads at tight levels.

Turn to Page 16. The credit metrics on the loans underlying our legacy nonagency portfolio continue to improve. 93% of the loans underlying our legacy nonagency portfolio are now amortizing. This principal amortization, together with home price appreciation, continues to reduce LTV. Delinquencies continue to cure. 60-plus day delinquencies as of March 31 for the portfolio were down to 12.4%. 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 the 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 black bars on the left side. These are loans with LTVs below 80% and are attractive refinancing candidates. And 80% of the current loans now have LTVs of 80% or lower. A combination of low rates available today and a 30-year amortization term versus the 20-year remaining term on these loans today can offer homeowners substantially lower monthly payments. And of course, given our deeply discounted purchase price of these assets, we're very happy when the underlying loans prepay.

And with that, I'd like to turn the call back over to Bill.

Thanks, Craig. Well, to remind you, we were early in transitioning from what was predominantly agency to investment across the residential mortgage sector. We continue to work hard to identify and acquire attractive, credit-sensitive residential mortgage assets. In the quarter, those assets were 3-year step-up assets and CRTs. The good news is, since we've been in credit, our credit assets continue to perform very well. We believe we're well-positioned for changes in payment rates, monetary policy and/or interest rates.

And with -- this completes our presentations for today. And operator, could you please open up the lines for questions?

(Operator Instructions) Jessica Lebi -- Levi-Ribner, FBR.

One on the credit-sensitive loans that you mentioned. Can you give us kind of -- can you size the pipeline that you think is kind of acquirable, given all the competition in this space? And then, when do you think those could be acquired? You kind of said later in 2017. Can we take that to mean in the back half of the year?

This is Bryan Wulfsohn. We see -- there's going to be ample supply coming through the end of the year. We expect to see actually many portfolios out for the bid in the coming weeks and months. So it doesn't necessarily have to be the back half of the year. It could be this quarter or in short order.

They're there, we're not talking about lead time of quarters. We're talking about lead times of months.

Okay, okay. Understood. And then I guess as a follow-on to that, has the pace of capital deployment picked up so far in the quarter, or are you waiting for some of those bigger portfolios to come online?

We found investment opportunities in April as we do in every month. But what we're saying is, there is a large supply coming. We don't have to invest a lot to stay in place or to grow somewhat. We're talking about $700 million a quarter here, maybe $800 million a quarter. There's much more opportunity than our investment needs.

Okay. And one on the leverage. Leverage ticked down to 2.9 given the agency runoff. Should we expect it to continue to trend down? Or is -- kind of where can we think about your leverage going?

That's actually a 2-part question in my mind. So if we were to continue the strategy of investing less in assets that are levered 9:1 and assets that were levered 2.5:1, yes, overall you would trend down. But let's see when the Fed stops reinvesting in agencies. Our view on agencies could change over time. But other things being equal, yes, if you're not investing in an asset that's levered 9:1 and we are investing in assets that are levered 2.5:1, there should be some downward trend in the overall leverage. That's consistent with the strategy.

Douglas Harter, Credit Suisse.

This is actually Sam Choe filling in. So you guys have really stayed true to the strategy to build out credit-sensitive assets. So I was just trying to kind of gauge your philosophy on whether you would approach incremental investments in the agency space. So I'm trying to get at whether from a tactical standpoint, whether you will consider a temporary deviation from the current strategy.

Well, if it is -- it probably wouldn't be temporary nor a deviation. We invest where we find the most attractive assets and risk-adjusted yields in the residential mortgage space. And if the noneconomic buyer, the Fed, backs off, we might find opportunity, and it might be opportunity for many, many years. So it -- our -- it's not a deviation in strategy. It's let's get the best risk-adjusted yields in the residential space. Certainly, agencies fit there, but we were never comfortable going up against the Fed.

And next we'll go to Boss -- or Bose George, KBW.

It's Eric on for Bose. How do you guys think about taking realized gains in selling securities going forward? Or is the idea just to let that $800 million, maybe a $1 billion per quarter, just run off and replace?

In terms of taking gains, we've consistently taken gains in the legacy market. Part of it is as the overall universe shrinks there, we never wanted to be a disproportionate share of that universe because we think as the universe shrinks, theoretically you could reach a point where there's less liquidity or maybe certain Street firms no longer are involved in funding. So we've sort of taken that down as the market's gone down. And that's where you've seen us realize gains on legacies. But we've done that for years now.

Right, right. On one of your slides, you refer to the technical support in the nonagency market, which I don't think anyone would argue with. But what do you think would actually change that dynamic now? I guess, maybe put another way, how meaningful would a hiccup in the credit market have to be to disrupt those strong technicals?

How meaningful would a disruption in credit?

Hiccup in the credit?

Yes, hiccup in the credit market, disruption in the credit, yes.

It's really about home values, right? That's really where the ultimate sensitivity is. And I think the technicals are certainly very good there as well. Housing starts are low. There's very little inventory. And I think people might say, well gee, we've seen a lot of home price appreciation, don't you worry that there's been too much? And maybe -- and maybe that argues that the values plateau a little bit, but we're a long way away from 2006, 2007 because it's a completely different world. You have much less leverage. LTVs are much lower. There's a lot less speculation. So I think the fact that mortgage credit today is much more healthy, lending is much more healthy than it was. Combined with home values, it's a pretty strong metric.

Right. Last question from me. I mean you guys cite your patient and disciplined approach, especially around the RPL/NPL securities. Does that mean there's parameters that you adhere to with respect to operating in that market? And maybe you can just give a little more color on some of those parameters that you look at closely?

Well, we certainly look at ROE, taking into account that funding costs may trend up with the Fed. We certainly look at the technical flow, (inaudible) we know it's coming, we know the opportunities. You may remember, we were pretty early on 3-year step-ups. We will find the next thing to be early in, too. So that -- we are working on many investment opportunities within the residential sector. That continues. And I have said this repeatedly, we don't have to replace runoff by month or by quarter. We'll get to the right place. And look at the long-term numbers we've put up overall within a period of time. It's funny, yes. You read in the paper about alternative facts. The great news is total shareholder return is replicable by everybody by looking on the Bloomberg. And boy, I'd put up our numbers against anyone in the sector or anyone that manages money. So we don't sit on the money too long but we take our time to make the investments, and we're seeing opportunities now.

Well, nobody would debate that you guys have done a great job.

Thank you.

And next, we'll go to the line of Joel Houseck (sic - Houck) of Wells Fargo.

So you talk about the runoff obviously is higher than what you acquired in Q1 and that you have confidence as that plays out. How much does the recent acceleration in home prices kind of underpin the fundamentals, which gives you maybe the confidence to get more aggressive in your RPL/NPL strategy? Because when -- what we've kind of consistently heard from companies the past year, particularly on the credit side is, if fundamentals are good, spreads are tightening, we're not really looking to put more capital to work. I'm not saying that's been what you guys have been saying. But in light -- it seems like there's been a change here in the last few months, and it's perhaps driven by accelerated HPA. I'm just wondering what your views on the recent uptick in HPA are. What type of assumptions you're making going forward. And then obviously your discount accretion moved up this quarter, which is I think only the second quarter it's done that in the last year, year and a half. So any comments on that would be helpful, guys.

So on -- in terms of home price appreciation, I don't think -- we don't bake in significant home price appreciation into our modeling when we look at whole loans. And as Bill said before, really the discipline there is ROE. So, yes, you can always pay more to buy something and buy it at a lower yield, But we're very cognizant of the ROE. And as Bill also said, we know that our funding costs will likely increase in the future. So that's really the discipline that drives the whole loan investing. We don't have hard-and-fast numbers per se. We buy it here, we don't buy it there. But I think being very cognizant of that ROE is sort of how we approach investments. So it's more than just the yield on the asset. And in terms of the home price appreciation on the non -- on the legacy nonagency portfolio, it's a number of things. It's home price appreciation, but it's also amortization. I pointed out that 93% of the loans are amortizing and they're still in many cases at very low rates, if you look at post-reset hybrids. So we're getting significant LTV improvement, not only through home price appreciation but also through amortization.

So when we bought assets, there's 2 assumptions we did not make. We did not make the assumption home prices would go up. We assumed they'd be flat. The other assumption we did not make was that there would be settlements from banks on the securities we purchased. Now those settlements have totaled, how much Steve approximately?

The 2 that we've had, I think it's cost $100 million.

So it was about $100 million. Now that $100 million of settlement did not go through the income statement, Joel. What it did in the main was reduce our amortized cost, and that's why you see more discount accretion. When $100 million came in, we didn't book it, got to do something with it. We lowered our amortized cost, therefore, there's more of this accretion. But this is a very unique situation. Many companies talk about litigation, settlements, ours is the opposite. Ours is, gee, these large chunks of cash come in. We certainly did not model them in when we bought the assets, but they're working well for MFA and its shareholders.

Would you agree that the overall fundamentals in housing have really accelerated in the past 6 months? Or do you not see it that way?

No, I think the fundamentals have definitely improved. I don't know that they continue to accelerate. I think there are some pockets maybe that have. But again, the technicals are very good. You read all the time about how housing starts are very low and people sometimes say to us, "well gee, housing starts are low. Aren't you worried about that?" Our response is, well, no, not at all because the houses underlying all the mortgages that we own, those are existing houses. So the fewer new houses that get built, the stronger that technical is for existing housing.

There are no further questions in queue at this time. So please continue.

Great. well, thank you, everyone, for joining us today. And we, of course, look forward to speaking to you again next quarter. Thanks.

Ladies and gentlemen, this conference will be available for replay after 1 p.m. today through August 4, 2017, 11:59 p.m. You may access the AT&T teleconference replay system by dialing 1 (800) 475-6701 and entering the access code 423380. International participants may dial (320) 365-3844. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference. You may now disconnect.