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Edited Transcript of MFA earnings conference call or presentation 6-Nov-19 3:00pm GMT

Q3 2019 MFA Financial Inc Earnings Call

New York Nov 30, 2019 (Thomson StreetEvents) -- Edited Transcript of MFA Financial Inc earnings conference call or presentation Wednesday, November 6, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bryan Wulfsohn

MFA Financial, Inc. - Senior VP & Co-CIO

* Craig L. Knutson

MFA Financial, Inc. - President, CEO & Director

* Gudmundur Kristjansson

MFA Financial, Inc. - Senior VP & Co-CIO

* Harold E. Schwartz

MFA Financial, Inc. - Senior VP, General Counsel & Secretary

* Stephen D. Yarad

MFA Financial, Inc. - CFO

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Conference Call Participants

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* Charles Douglas Arestia

JP Morgan Chase & Co, Research Division - Analyst

* Eric J. Hagen

Keefe, Bruyette, & Woods, Inc., Research Division - Analyst

* Henry Joseph Coffey

Wedbush Securities Inc., Research Division - MD of Equities Research

* Kenneth S. Lee

RBC Capital Markets, Research Division - VP of Equity Research

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the MFA Financial Inc. Third Quarter Earnings Call. (Operator Instructions) As a reminder, your conference is being recorded.

I would now like to turn the conference over to your host, Mr. Hal Schwartz. Please go ahead.

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Harold E. Schwartz, MFA Financial, Inc. - Senior VP, General Counsel & Secretary [2]

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Thank you, operator, and good morning, everyone. The information discussed on this conference call today may contain or refer to forward-looking statements regarding MFA Financial, Inc. which reflect management's beliefs, expectations and assumptions 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, 2018, 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 third quarter 2019 financial results.

Thank you for your time, and I would now like to turn this call over to MFA's CEO and President, Craig Knutson.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [3]

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Thank you, Hal. Good morning, everyone. I'd like to thank you for your interest in and welcome you to MFA Financial's Third Quarter 2019 Financial Results Webcast.

With me today are Steve Yarad, our CFO; Gudmundur Kristjansson and Bryan Wulfsohn, our co-chief investment officers; and other members of senior management.

Rates markets experienced continued volatility in the third quarter of 2019. Global growth slowdown concerns and trade tensions contributed to a decision by the Fed to cut rates at the end of July. August brought a furious rates rally, with 10-year rates plunging from 2.14% in mid-July to 1.45% by Labor Day and 2-year rates falling by approximately 40 basis points during the same period. We witnessed an abrupt reversal in the first 2 weeks of September when 2-year rates retraced almost this entire 40 basis point range, while 10-year rates backed up 45 basis points. The Fed again reduced the funds rate in the middle of September and then followed with a third rate cut last week. We also witnessed some surprising illiquidity in the repo markets in mid-September with overnight funding rates as high as 5% for a brief period before decisive action by the Fed settled these markets.

Needless to say, for levered investors in mortgage assets, this environment has been extremely challenging. While we cannot claim to have anticipated the stunning developments in rates markets, MFA's investment strategy is very much intentionally not dependent on accurately predicting interest rate moves, and we are happy to report that the market turmoil in the third quarter had very little impact on our financial results.

MFA's investment acquisition strategy, particularly our focus on purchased performing loans, in which we include Non-QM, fix and flip and single-family rental loans, is proving to be a durable model. The groundwork that we laid beginning in early 2017 gains further traction as our origination partners grow their businesses, at least in part through MFA's continued appetite to purchase loans.

Additionally, during the third quarter of 2019, MFA made investments in the form of capital contributions to several of our origination partners. MFA's reputation as a reliable buyer of residential whole loans and dependable capital partner has enabled us to source significant volume of whole loans, including in some cases, transactions with limited competition. Despite the difficult mortgage environment, we continue to make investments that provide solid returns on equity.

Please turn to Page 3. MFA's GAAP earnings per share was $0.20 in the third quarter, and we paid a $0.20 dividend to common stockholders on October 31. MFA has paid a $0.20 dividend now for 24 consecutive quarters. Core earnings was also $0.20 per share in the third quarter. We acquired $1.1 billion of assets in the third quarter, including $918 million of whole loans. Our investment portfolio decreased slightly during the quarter, but this was primarily due to opportunistic sales of high coupon 30-year fixed rate MBS in order to shed prepayment exposure prior to some high monthly prints.

As previously mentioned, we made $100 million of capital commitments to several origination partners during the quarter. These range from new or additional equity contributions, in all cases, minority stakes, to preferred stock investments, some of which could include warrants from common equity to convertible debt investments, also with warrants. This strategy is consistent with our approach whereby we provide capital in the form most suitable for our origination partners.

Our book value was essentially unchanged at $7.09 per share, and our economic return for the quarter was 2.5% or 10.1% annualized. We've introduced a new measure of book value, economic book value to highlight the fair market value of a significant class of our assets, loans held at carrying value, which were $4.97 billion as of September 30. Because GAAP accounting stipulates that these assets be shown at carrying value on our balance sheet, their fair value, which is now $5.12 billion or $145 million more than the carrying value, is not reflected in our reported book value. Since the fair value of these assets represents the expected value if we were to sell them, we believe that their inclusion in economic book value more accurately represents the value of our assets.

Please turn to Page 4. Third quarter investment activity was very strong as we purchased approximately $1.1 billion of assets, including $918 million of whole loans. The majority of our whole loan purchases were purchased performing loans, Non-QM, fix and flip and single-family rental as our acquisition of these assets slightly exceeded our investments in these assets of $913 million in Q2. The process of acquiring these assets is very different from that associated with our other asset classes, as we generally purchase these loans directly from originators rather than from The Street or through bulk offerings.

Through our willingness and ability to explore various arrangements, including flow agreements, strategic alliances and minority equity investments, we've been able to partner with originators to source attractive new investments while enabling them to grow with support from MFA as a reliable provider of capital. We were also, during the quarter, able to purchase an additional $133 million of RPL/NPL MBS.

Please turn to Page 5. As we have shown previously, our expanding investments in newly originated loans or purchased performing loans are beginning to have a meaningful impact on our interest income. These loans are included in our loans held at carrying value on our balance sheet. Recall that we also include loans purchased as reperforming loans or purchase credit impaired loans in our loans held at carrying value.

In the third quarter, all loans at carrying value produced $64.2 million of interest income. This is versus $101 million for all of 2018 and $57.9 million in Q2 of 2019. More notably, $53.6 million of this $64.2 million was from purchased performing loans, up from $46.9 million in the second quarter. As we continue to grow our balance sheet, we will add marginally more leverage, particularly on our residential whole loans held at carrying value. We would expect this leverage ratio will continue to increase modestly as our portfolio assets can easily support leverage of 3 to 4x whether through repo borrowing or securitizations.

For our credit-sensitive whole loans, we've committed significant resources to our asset management efforts. We recognize that by immersing ourselves in the complicated and sometimes messy details of managing credit-sensitive loans that we can achieve better outcomes and improved returns. As good as our third-party services are, there's a tangible benefit to direct oversight and involvement in decision-making.

And finally, our legacy Non-Agency portfolio continues to perform well and contribute materially to our financial results, generating a yield in the most recent quarter of 10.3%.

Please turn to Page 6. To summarize our strategy and initiatives for the rest of 2019 and into 2020, we expect to continue to increase our investments in purchased performing loans, specifically Non-QM, fix and flip and single-family rental. When and if we are able to grow our other existing asset classes at attractive levels, we will obviously continue to do so. And as always, we are constantly evaluating new investment opportunities. Given our track record, we are usually among the first to see new opportunities as we have demonstrated the ability and willingness to help structure these deals and [invest in size].

We'll likely continue to execute strategic sales of legacy Non-Agency MBS. This is all part of managing a mature portfolio that includes sales of bonds at relatively high prices with little additional upside, sales of callable bonds at a premium and sales of low loan count or odd-lot position [sizes] at attractive round lot levels.

We have managed our agency CRT portfolio by selling the seasoned deals trading at very tight spreads and high dollar prices earlier in the year before the rally in rates caused prices of these securities to weaken due to prepayment concerns. This portfolio is now $378 million, which is nearly half what it was in early 2018.

And finally, we'll look to optimize our capital structure through the use of additional leverage, including securitization. That said, I think our leverage will still likely be the lowest in the peer group.

Please turn to Page 7. Market conditions have been difficult for many in our space, particularly as volatility in the rates markets have made investments in Agency MBS challenging. Because MFA's investment strategy is much more mortgage credit focused, we've been able to continue to make sizable investments in assets that produce attractive returns. We just don't have the exposure to prepayments that most of our peers do, and our business and earnings power is much less tied to the shape of the yield curve. Our stable book value and consistent earnings are a result of an investment strategy that does not depend on accurately predicting interest rate changes and executing reactionary investments and hedging activities.

Through our considerable efforts to partner in creative ways with a handful of originators, we are confident that we'll be able to source additional volume of purchased performing whole loans for the foreseeable future. As we continue to grow these portfolios, we are increasing the earnings power of our business. MFA's investment initiatives are firing on all cylinders. We remain optimistic that we will continue to drive earnings through balance sheet growth.

And now I'd like to turn the call over to Steve Yarad, who will provide further details on the financial results for the quarter.

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Stephen D. Yarad, MFA Financial, Inc. - CFO [4]

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Thanks, Craig. In the third quarter of 2019, MFA's net income to common shareholders was $91.8 million or $0.20 per share. GAAP earnings were consistent overall with the prior quarter and again covered dividend distributions. In addition, core earnings, which excludes the impact of unrealized gains and losses on certain investments in residential mortgage securities and related hedges that are included in GAAP earnings each period was also $0.20 per common share.

Please turn to Page 8 where we present additional information on the highlights of MFA net income this quarter, which were as follows: Other income was $0.01 per common share higher this quarter and reflected the following. One, a continued strong contribution from residential whole loans measured at fair value through net income. Consistent with prior periods, the majority of income generated by fair value loans reflects coupon and other cash receipts. Two, higher net income impact of realized gains on sales of residential mortgage securities as we continue to opportunistically manage these portfolios. And three, improved performance of our 30-year Agency MBS and related hedges.

Net interest income was $0.01 per common share lower this quarter. The key drivers of MFA's third quarter net interest income include: One, as Craig noted, the continued growth of that portfolio of purchased performing loans, which drove net interest income for residential whole loans 25% higher than the prior quarter. Two, lower amounts invested in residential mortgage securities. Portfolio runoff is reinvested primarily in whole loans. In addition, the prior quarter included approximately $3 million of accretion income recognized on the early redemption at par of legacy Non-Agency securities that have been held at a discount. And three, the inclusion of a full quarter of interest expense on our convertible bond that was issued last quarter in June.

Finally, operating and other expenses were consistent overall with the prior quarter. SG&A expenses this quarter were 1.5% of equity, and this is in line with our expected run rate.

And now I'll turn the call over to Gudmundur Kristjansson, who'll provide more details of our investment activity and portfolio performance for the third quarter.

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Gudmundur Kristjansson, MFA Financial, Inc. - Senior VP & Co-CIO [5]

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Thanks, Steve. Turning to Page 9. The third quarter was another active quarter for our investments team as we acquired approximately $1.1 billion of assets and sold approximately $330 million of assets in the quarter. We continue to grow our holdings of residential whole loans at a strong pace, purchasing over $900 million in the third quarter. 2019 has been a strong year for whole loans acquisitions as we have on average purchased in excess of $900 million of whole loans in each quarter this year. This robust pace of acquisition is primarily due to our success in expanding our pace of acquisitions of Non-QM, fix and flip and SFR loans this year.

Portfolio runoff was elevated in the quarter as we experienced an increase in early redemptions of NPL/RPL MBS, and we strategically sold $257 million of higher coupon 30-year Agency MBS at a gain of $2.8 million to reduce the prepayment risk in our Agency MBS portfolio as we expect prepayments to remain elevated. We also opportunistically sold $77 million of legacy and CRT securities in the third quarter, realizing $14.9 million of gains.

Turning to Page 10. We continue to execute on the strategic plan we laid out in 2017 as our holdings of Non-QM, fix and flip and SFR loans continues to grow and add meaningfully to earnings. Our success in incorporating these new loan products into our investment strategy continues to be the primary driver of portfolio growth. Since the third quarter of 2017, our whole loans portfolio has grown from about 19% of our investment portfolio to approximately 54% as of the end of the third quarter. The main reason for this growth has been the Non-QM, fix and flip and SFR loans, which have grown from 0 in the third quarter of 2017 to over $4 billion at the end of the third quarter of 2019.

In addition, non-QM, fix and flip and SFR loans now account for approximately 60% of the whole loans portfolio and approximately 1/3 of the total investment portfolio. We are extremely happy with the progress we made on incorporating these loan products into our investment strategy and are excited to continue to grow these holdings in the future.

Turn to Page 11. MFA's investment strategy, which emphasizes credit risk over interest rate risk, continues to deliver attractive yields and spreads. Our credit-sensitive assets continued to benefit from positive credit fundamentals and lower prepayment sensitivity. Yields on interest-earning assets averaged 5.32% in the quarter, while the net interest rate spread was 182 basis points.

Short-term rates continue to fall in the third and the fourth quarter of this year in response to multiple Fed rate cuts and lower expectations for interest rates and growth in general. Year-to-date, 1-month LIBOR declined by [73] basis points with approximately 63 basis points of that decline happening in the second half of the year. MFA has and continues to be well placed to benefit from falling short-term rates as most of our asset financings are based on 1- or 3-month LIBOR rates and the percentage of repo that is hedged with pay-fixed swaps remains relatively low at about 37%.

Turning to Page 12. Here, we show the yields, cost of funds and spreads for our holdings as well as the equity allocated to each asset class. Our largest asset class in terms of dollar amount invested as well as equity allocated continues to be whole loans at carrying value with over 50% of MFA's equity allocated to it. In addition, whole loans in general, including whole loans at fair value, continue to represent the majority of our equity allocation at around 60% of MFA's equity.

Whole loans at carrying value yielded 5.52% in the quarter, while the leverage for this asset class increased in the quarter to 1.9x debt-to-equity compared to 1.5x debt-to-equity in the second quarter. As we have said before, we expect the leverage on this asset class to continue to trend up over time.

Turning to Page 13, where we take a look at MFA's interest rate sensitivity. Our asset duration changed little in the quarter and remained relatively low at 160 basis points at the end of the quarter. We actively managed our hedge position this quarter unwinding $75 million of higher-paying, longer-dated swaps earlier in the quarter when we sold some higher coupon, 30-year Agency MBS and adding $500 million of 2-year pay-fixed swaps at a rate of 1.39% at the end of August when rates were close to their lows for the quarter. As a result, our swap notional balance increased by $425 million, while the average paid fixed rate on a swap declined 70 basis points to 2.25%.

Finally, our net duration was relatively unchanged and remains relatively low at 114 basis points at the end of the quarter.

Turning to Page 14. We continued to move through various interest rate cycles and experienced large changes in interest rates over short periods of time. It is important to remember that MFA strategy remains focused on maintaining a low and stable interest rate duration while emphasizing credit-sensitive assets over interest rate-sensitive assets. Our strategy has consistently limited quarterly changes in book value.

Since 2014, the largest quarter-over-quarter decline in book value has been 4% with the average change in book value of less than 2%. As before, by limiting book value fluctuations, we believe MFA will have the staying power to take advantage of new opportunities as they arise.

With that, I will turn the call over to Bryan, who will talk about our credit investments in more detail.

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Bryan Wulfsohn, MFA Financial, Inc. - Senior VP & Co-CIO [6]

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Thank you, Gudmundur. Please turn to Page 15. The current state of mortgage credit continues to be supported by housing and economics fundamentals. Housing affordability has ticked up in the recent months as mortgage rates have declined. At the same time, homebuilders have been growing more positive on the housing market over the year.

Home prices continued their year-over-year growth. The CoreLogic National Home Price Index was up 3.6% in August from a year ago. The unemployment rate remained low throughout the quarter and was 3.6% in October. The supply of homes available remained limited and has declined further. All these factors should continue to support stability and growth to home prices. The last reported 90-day mortgage delinquencies are still down at levels of around 1%. And we expect delinquencies to remain low as we believe underwriting standards are still prudent today.

Turn to Page 16. Our loan strategy had another successful quarter of acquisitions. We acquired over $900 million of loans, consisting of over $550 million of Non-QM loans and approximately $375 million of business purpose loans. We were able to add several new counterparties in the Non-QM and the business purpose loan space over the quarter. And as Craig mentioned, we made additional strategic investments in originators over the quarter, which we believe created a stable [source for attractive] assets into our portfolio. And we continue to be pleased with our seasoned loan portfolio's performance with diligent asset -- with our diligent asset management team's oversight.

Our loans appear on our balance sheet on 2 lines: loans held at carrying value, $5 billion and loans held at fair value, $1.5 billion. This election is permanent and is made at the time of acquisition. Typically, we elect the carrying value for purchase performing loans and reperforming loans and fair value for nonperforming loans.

Turning to Page 17. Our RPL portfolio continues to perform well. 87% of our portfolio remains less than 60 days delinquent. In addition, although 13% of the portfolio is 60 days delinquent or greater, almost 30% of those loans have been making payments over the last 12 months. And with the recent rally in rates, we have seen prepayment speeds for our RPL portfolio increase. With an amortized cost of $0.84 on the dollar, prepayments are positive. We expect to see elevated prepayment speeds in this lower mortgage rate environment as our borrowers gain access to new financing options, [as] our credit continues to improve.

Turning to Page 18. Our exceptional asset management team's oversight of servicing decisions and active management of the portfolio have enhanced returns. The team has worked in concert with our servicing partners to more quickly get loans to reperform as well as limit and reduce timelines to resolution. This slide shows the outcomes for loans that were purchased prior to September month-end 2018, and therefore owned for more than 1 year. 35% of loans that were delinquent at purchase are now either performing or paid in full and 41% have either liquidated or [REO] to be liquidated. And 24% are still in nonperforming status.

Our modifications have been effective as 76% are either performing or paid in full. We are happy with these results as they continue to outperform our assumptions at the time of purchase.

Turning to Page 19. Again, we had another successful quarter of growth to our Non-QM portfolio. To date, we've acquired over $3.1 billion of unpaid principal balance, including over $1.5 billion this year and continue to work with our origination partners on strategic relationships. A variety of different loan types can be considered Non-QM, ranging from structural features, such as an interest-only period or a term greater than 30 years to the way income is documented such as the use of bank statements for self-employed borrowers or loans with higher debt-to-income ratios and so on. We believe underwriting of these loans is prudent. The portfolio has a weighted average loan-to-value ratio of 66% and a FICO score of over 700.

The credit performance [is performing] as expected, [is] around 1%, [is 6 days delinquent] or greater. Leverage is attainable through the use of warehouse lines and securitization. [And as noted before], securitization execution has improved this year, and we expect to securitize should conditions warrant. With the low interest rate environment we currently live in, yields on these assets trade in the mid-4% range, and we are able to achieve low double-digit ROEs with appropriate leverage.

And now I'd like to turn the call back over to Gudmundur to walk you through our business purpose loans.

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Gudmundur Kristjansson, MFA Financial, Inc. - Senior VP & Co-CIO [7]

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Thanks, Bryan. Turning to Page 20. We had another successful quarter of business purpose loan acquisitions in the third quarter as we purchased over $375 million in UPB and undrawn commitments in the quarter.

Since we started acquiring business purpose loans at the end of 2017, we have purchased over 6,500 loans with over $2 billion in UPB and undrawn commitments. We're excited about our progress and expect to continue to expand our acquisition of business purpose loans in the future. At the end of the third quarter, we have $969 million of UPB of fix and flip loans with additional $126 million of undrawn commitments. Credit metrics continue to be strong and performance has been in line with our expectations. Our target yield for this asset class remains at around 7%.

We held $364 million of SFR loans at the end of the third quarter. Similar to the fix and flip loans, the credit metrics and performance remains strong and in line with expectations. Our target yield for this asset class is in the mid-5% range.

With that, I will turn the call over to Craig for some final comments.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [8]

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Thank you, Gudmundur. In summary, we remain very active in the investment market. We purchased $1.1 billion of assets in the third quarter of 2019. This growth in our whole loan portfolio has resulted in materially higher interest income over the last 3 quarters and we expect further such increases as we move forward in 2019 and into 2020. While we have made excellent progress in growing our asset base, we have further capacity to continue to increase our investments by adding leverage to our balance sheet. This concludes our presentation.

Operator, will you please open up the call for questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from the line of Rick Shane from JPMorgan.

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Charles Douglas Arestia, JP Morgan Chase & Co, Research Division - Analyst [2]

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Charlie, actually, on for Rick this morning. I noticed an uptick in the delinquencies on the fix and flip loan portfolio this quarter. Is there anything in particular that's driving that? Just curious because they're relatively short-term loans. And wondering if that's kind of a typical seasoning curve or if it's growth driven or if there's anything else we should be thinking about there.

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Stephen D. Yarad, MFA Financial, Inc. - CFO [3]

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Yes, that's a good question. Thank you. I think it's just more a function of maturing of the portfolio. It's -- we would expect, over time, as the portfolio seasons, it reaches a steady-state delinquency. And I think based upon what we're seeing, it's in line with our expectations. A 60-plus delinquency rate anywhere between 4% and 8% is quite common for these types of loans. And so we feel like it's in line with expectations.

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Operator [4]

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The next question is from Eric Hagen from KBW.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [5]

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Actually on the credit for single-family rental and other business purpose loans, can you just describe the servicing of those assets? It seems like it's obviously a little bit of an esoteric servicing model. I mean I'm thinking about the guy who's in the middle of a rehab of the property ready to sell it, but he defaults in the middle of rehabbing it. I mean how does that -- can you describe how that works?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [6]

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Well, Eric, you cut out on the first part of your question. I'm sorry, could you repeat the first part of the question?

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [7]

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Oh, sure. I was just asking about the servicing kind of model of the business purpose loans, specifically for the single-family rental and fix and flip. I mean it just seems like a bit of an esoteric asset class where a default would -- it might be challenging to capture the value of your asset once a borrower defaults on something like that.

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Bryan Wulfsohn, MFA Financial, Inc. - Senior VP & Co-CIO [8]

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Well, thanks for the question, Eric. I think in terms of the single-family rental, the servicing there is more similar to regular resi mortgage servicing. Many of these loans is simply one property, one loan. So that servicing is fairly straightforward. In some cases, it might be one loan, multiple properties. In that aspect, it's -- the servicing is not necessarily more complicated. It's just simply if you have to foreclose, it involves a few more steps. But at the end of the day, the SFR servicing is somewhat similar to regular resi.

In terms of the fixed and flip of the business purpose, you're right, there's more moving pieces. And so in a nutshell, the way that the servicing work is, most cases, we're [requiring] the servicing retained. So the originator stays on as the servicer and that has multiple benefits. First, we're working with experienced people, experienced people in the business purpose space, who have extensive experience managing these types of loans and servicing these types of assets. But also, they have deep relationship with the borrowers. For a lot of these originators and servicers, these are repeat customers who have multiple loans who come back to them over time. So they understand their needs, they understand the dynamics on the ground, in particular, information on the local geography.

And so what happens in practice is that, yes, the loan is -- it's a short-term loan, but there is a draw mechanism. There's an inspection mechanism. So you are -- throughout the lifetime of the loan, you have multiple touch points where you're figuring out, one, how the project is going, have they met their milestones and so on and so forth. So you have a lot of visibility on what's going on, on the ground. And to the extent that something goes wrong, the key piece there is one, the loan was profitably underwritten at the time of purchase, meaning the LTV at the beginning and the LTV throughout the life of the loan is appropriately sized. And then if we need to step in and work through the property, we have the appropriate resources and means to do that. So -- and there's 2 aspects to that. One is we're working with quite accomplished servicers and originators. But also, as you know, from our previous experiences and ongoing experience in working through our nonperforming loan portfolio, we have an extensive experience in loss mitigation, foreclosing on properties, owning and managing REO. And so we feel that all those in-house expertise here, along with the excellent partners that we work with, we're quite well positioned to kind of work through any issues that might arise.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [9]

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And Eric, I'll just add 1 thing that and it defies logic a little bit, but you do see it on fix and flip loans. So an operator may finish a project and the house is listed, and he's on to the next project, and he's committing capital to the next project. And you'll quite often see this where he'll miss a payment or 2 while the house is on the market. And he knows he's going to sell it, he knows he's going to pay off the loan, but he is on to the next thing. So it's a little surprising because you wouldn't necessarily expect it, but it's just a fact, and it occurs somewhat frequently in this space.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [10]

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That was exactly the kind of detail I was looking for. I mean, Craig, you noted that we should expect leverage to tick up a little bit. The model can handle between 3 and 4x. I'm just trying to square this away. I mean you've got some really high-yielding positions that aren't levered very much that are rolling off the portfolio and being replaced with some of the business purpose loans, which you guys have talked a lot about. And admittedly, those can handle higher leverage. I'm just trying to understand if what you're trying to guide us to is earnings increasing over time? Or is this -- is the higher leverage really just there to basically keep earnings level?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [11]

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I mean I would say I look at the additional leverage capacity as a way to grow our assets, right? And so the obvious one is whole loans at carrying value, which is about $5 billion, but it's 1.9x levered. So that's really the glaring example of where we could add more leverage. And as Bryan said, you shouldn't be surprised if securitization enters the picture at some point here. So I don't think -- we're not trying to guide earnings or anything else. It's really how we fund additional balance sheet asset growth. And I think it will be through marginally higher leverage. That said, I think our leverage ratio is 2.8x. So -- and I think it's -- maybe it's ticked up a little bit over the last year, but it moves fairly slowly, right? It's -- 1 turn of leverage is $3.5 billion [of borrowing]. So you don't expect that to change in a quarter.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [12]

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Got it. Okay. And then just one housekeeping. On the warehouse lines that you guys talked about with Non-QM and other whole loans, is that -- is the balance of that embedded in the repo you show on balance sheet? Or I guess [it's not] warehouse, it isn't technically a repo. I'm just trying to understand where that shows up.

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Stephen D. Yarad, MFA Financial, Inc. - CFO [13]

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Yes. Yes, it does.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [14]

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Okay. What is the balance of the warehouse lines? And what's the cost of financing on that?

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Bryan Wulfsohn, MFA Financial, Inc. - Senior VP & Co-CIO [15]

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The balance -- I mean, again, we have several warehouse lines. And I would say upwards of $3 billion-ish, give or take on the amount we're borrowing on those. And then you would say the cost of financing is anywhere from LIBOR plus 150 to LIBOR plus 200 and change, depending on the asset.

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Operator [16]

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(Operator Instructions) And we'll move to the line of Kenneth Lee.

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Kenneth S. Lee, RBC Capital Markets, Research Division - VP of Equity Research [17]

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Just a brief follow-up on the previous question. In terms of bringing the leverage ratio up, and it sounds as if there could be some opportunity to grow assets within the whole loans portfolio, but as well, you're also ramping up the business purpose loans. But just wondering, in this current environment, where could we see more of the relative asset growth coming from? Is it more from the whole loans or the business purpose loans as it ramps up?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [18]

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Sure. Well, I guess, just as a technicality, we would include the business purpose loans in our whole loans. But I think that's where we expect our -- the majority of our growth to come from is on what we call purchase performing loans, so it's primarily Non-QM, fix and flip and single-family rental. Bryan?

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Bryan Wulfsohn, MFA Financial, Inc. - Senior VP & Co-CIO [19]

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The market size as it relates to Non-QM is probably bigger than the business purpose space, if you're comparing to fix and flip, so -- where you've seen the growth sort of in -- around 2:1, give or take for -- at current, I mean it could stay the same. But if we're able to source additional investments on the fix and flip and SFR side, we could see additional growth there as well.

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Kenneth S. Lee, RBC Capital Markets, Research Division - VP of Equity Research [20]

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Great. And just one follow-up if I may. You talked about a near-term outlook for some strategic sales of legacy non-agencies as well as some agency sales. But just wondering, when you look out towards the near term, what are the potential implications in terms like investment spreads from that activity?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [21]

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Well, I think -- I don't think we've purchased legacy non-agencies in any material size for years. So as I said earlier, it's really managing a mature portfolio. So that portfolio is -- on average, those loans are probably 13, 14 years old. So it's -- examples are selling a bond that's callable at a premium, selling bonds that we think don't really have much additional upside in terms of performance. And then in other cases, it's just selling small pieces, the low loan count bonds or odd-lot positions that would typically trade at a concession to a market price, where if we see that same CUSIP trade in the market, we can get around [a lot of execution] for it. And these sales of legacy non-agencies, we've been consistently managing that portfolio in this fashion for probably the last 5 years. And so I don't really think that will change, but we [don't] expect that, that portfolio will grow, certainly.

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Operator [22]

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And the next question is from Henry Coffey from Wedbush.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [23]

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Another great quarter. When we look at some of these strategic investments you're making in your origination partners, what's -- and the total balance is about [$100 million] or the investments you've made this quarter were about $100 million ?

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Stephen D. Yarad, MFA Financial, Inc. - CFO [24]

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Henry, this is Steve. The investments we made this quarter were about [$100 million]. Total balance is close to $123 million at the end of the quarter.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [25]

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What are the economic -- I mean besides the fact that you probably get equity position, what are the other economic benefits? Is there like a preferred coupon [and] interest rate? Is there some positive access to the origination flow that you wouldn't get without this investment? When you look at the economic returns on that $123 million, what are the components of that?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [26]

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Sure. So as I said, Henry, they range from common to preferred, often with warrants and convertible debt. So yes, obviously, the preferred has a coupon, which without getting into the specifics of it, it's a pretty healthy coupon. It provides a good ROE, same with the convertible debt.

In terms of the other economic benefit that you get, it's a couple of things. One, I think to the extent that these originators are successful and they grow their business, and they increase their enterprise value, we have a piece of that. So it remains to be seen, but that's certainly a possibility. But the other thing that it does is that it cements our relationship with these originators. Again, these are minority equity stakes, so these are not controlling interests. But these arrangements could range from a flow agreement to a commitment over time or in some cases, they're even less formal. But it's all part of having sort of an active partnership with a handful of originators. And I'll mention that we haven't made any investments in originators that we haven't bought loans from already. So what we found is there's no better way to get to know an originator and how they think about credit and underwriting than to own loans. So typically, it starts slowly with some transactions and it grows over time.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [27]

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And are we talking about 2 or 3 originators or 10 or 20? How diversified is this position?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [28]

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I would say it's safe to say it's between those 2 number ranges that you mentioned.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [29]

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That's very helpful. You mean 15? When you look at the securitization opportunities, what are the funding dynamics on that, Steve? How does it -- is it just an alternative to LIBOR? Is it a fixed coupon? Is it more of a steady state? Is it at a higher advance rate? Maybe you could go -- and obviously, it would be against the loans with carrying value. Maybe you can go -- give us a sense of what that would look like.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [30]

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We'll have Bryan speak to that.

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Bryan Wulfsohn, MFA Financial, Inc. - Senior VP & Co-CIO [31]

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Henry, one of the things you would be fixing your funding costs, that would be one advantage. The next advantage would be, yes, you can increase leverage. I mean at this point, at -- our company is only 2.8x leverage as a whole, and that asset class is 1.9x, the whole loans at carrying value. So implementing the securitization and adding leverage without adding additional loans just sort of creates additional interest expense on our balance sheet. So the key is growing the asset side and then optimizing the financing side after that.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [32]

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So that the coupon is slightly higher than what you're paying?

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Bryan Wulfsohn, MFA Financial, Inc. - Senior VP & Co-CIO [33]

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The coupon -- no, the coupon would probably be a little bit lower, but then you have to factor in deal costs and the like.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [34]

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And then finally, the reporting of a fair value book value is very helpful and a good prep for CECL. How does that play out when you have a whole portfolio of loans that has never really produced any losses?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [35]

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That's a very good question.

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Stephen D. Yarad, MFA Financial, Inc. - CFO [36]

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I guess, Henry, if your question is, what are we expecting with CECL loan transition? I think we've said it is one of the difficulties that we have, we're somewhat unique given our limited loss history to try and translate our past limited experience and come up with what our CECL reserve will be day 1. We're still working through that. We're getting pretty close to coming up with what we think our transition numbers will be. Well, it's fair to say that we're still running some scenarios and trying to make some elections around discounting or not discounting cash flows. And also, the possibility of even electing fair value option for a portion of our portfolio and avoiding CECL altogether if we were to do that. So it's a little early for us to speculate at this point what our day 1 transition number would be. So I'm not going to do that at this time. But you're right, in sense of we have had limited loss history. And therefore, the -- my expectation at this time is that the day 1 impact of CECL is not going to be that significant to our overall financial position. Although it is fair to say as you transition to a life of loan reserving approach compared to an incurred loss approach that we currently use, that you would expect higher reserves under that model.

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Henry Joseph Coffey, Wedbush Securities Inc., Research Division - MD of Equities Research [37]

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I mean the 2 things that people have said about CECL. One is that it's basically solving a problem that doesn't exist, but the other thing is that because banks have such a strict capital regime to work with, whereas the rating agencies, they've sort of been doing CECL since day 1 and that it creates more flexibility and opportunity for quoting nonbank financial. And have you had any read from the marketplace in terms of what opportunities CECL could create? Or is it really too early to tell?

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Stephen D. Yarad, MFA Financial, Inc. - CFO [38]

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I think it's a little early to tell. I don't think that's really the way we're looking at it, but it certainly will have an impact on the nonbank financial players who aren't used to looking at loan loss reserving in this way.

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Operator [39]

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At this time, there are no further questions in queue. Please continue.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [40]

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All right. Thanks. This concludes our presentation. Thank you for your interest in MFA and for joining us today. We look forward to speaking with you again next quarter.

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Operator [41]

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Thank you. And ladies and gentlemen, this conference will be made available for replay after 12:00 today through February 6, 2020. You may access the AT&T Replay System at any time by dialing 1 (866) 207-1041 and entering the access code 6536257. International participants can dial (402) 970-0847. That does conclude our conference for today. Thank you for your participation, and thank you for using AT&T.