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Edited Transcript of MFA earnings conference call or presentation 2-Aug-18 2:00pm GMT

Q2 2018 MFA Financial Inc Earnings Call

New York Sep 5, 2018 (Thomson StreetEvents) -- Edited Transcript of MFA Financial Inc earnings conference call or presentation Thursday, August 2, 2018 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bryan Wulfsohn

MFA Financial, Inc. - SVP

* Craig L. Knutson

MFA Financial, Inc. - President, CEO & Director

* Gudmundur Kristjansson

MFA Financial, Inc. - SVP

* 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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* Douglas Michael Harter

Crédit Suisse AG, Research Division - Director

* Eric J. Hagen

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

* Richard Barry Shane

JP Morgan Chase & Co, Research Division - Senior Equity Analyst

* Steven Cole Delaney

JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst

* Vivek Agrawal

Compass Point Research & Trading, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, welcome to the MFA Financial Inc. Second Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to 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. 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, 2017, 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 second quarter 2018 financial results. Thank you for your time.

I would now like to turn this call over to MFA's Chief Executive Officer 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 would like to thank you for your interest in, and welcome you to MFA's second quarter 2018 financial results webcast. With me today are Steve Yarad, CFO; Gudmundur Kristjansson, Senior Vice President; Bryan Wulfsohn, Senior Vice President; and other members of senior management.

MFA had a solid quarter, and we are particularly pleased with our investment activity in the second quarter of 2018. Our investment portfolio centered largely around residential mortgage credit assets continues to produce strong results while maintaining stable book value. MFA's muted interest rate sensitivity, coupled with our low leverage multiple, provide these return with a much lower risk profile than our peers. We experienced unprecedented runoff of our residential mortgage credit assets during 2017, which challenged us to reinvest this capital. Our investment team spent considerable time and effort last year seeking new counterparties and establishing relationships in order to source loan volume. These efforts are now bearing fruit as we've been able to acquire meaningful size in each of the last 3 quarters.

MFA's reputation as a reliable buyer of residential whole loans has enabled us to purchase significant volume of whole loans, including in some cases, transactions with limited competition. At the same time, we continue to analyze new investment opportunities. As we have demonstrated over many years, MFA has the intellectual capacity to understand, evaluate and price assets that are difficult to value.

Please turn to Page 3. We generated earnings per share of $0.17 in the second quarter and paid a Q2 dividend of $0.20 to common shareholders on July 31. This is the 19th consecutive quarter in which we paid a $0.20 dividend. Our taxable income for the second quarter was $0.22, and our estimated undistributed taxable income as of June 30 was $0.11 per common share. Our book value declined slightly in the second quarter to $7.54 per share, due primarily to our investment strategy, coupled with low levels of leverage. MFA's book value has been very stable, with less than a 3% variance between the high and low book value over the last 7 quarters. And a quarter-over-quarter average book value variance of less than 3 quarters of 1%.

Our new investments exceeded our runoff in the second quarter of 2018 by almost $150 million, as we purchased or committed to purchase nearly $900 million in residential whole loans.

Please turn to Page 4. MFA's residential mortgage credit investment strategy continues to provide attractive returns, as strong credit fundamentals drive earnings and book value. Residential mortgage whole loans, including REO, now totaled $3.6 billion, with approximately half of our equity allocated to these assets. Most notably, much of the growth in our residential whole loan portfolio has been through the purchase of newly originated performing loans. As we will discuss later on in this presentation, we have close to $1 billion invested in these loans, including Non-QM, fix and flip and single-family rental loans. 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 from holders of credit-sensitive whole loans. And our efforts to source these new assets began over 1 year ago.

This progression involves establishing and then cultivating relationships with origination partners performing corporate due diligence, negotiating loan purchase and servicing agreements, performing loan level due diligence and coordinating settlement and funding processes. In addition, through our willingness and ability to explore various arrangements, including flow agreements, strategic alliances and also 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.

For our credit-sensitive whole loans, we've committed significant resources to our asset management efforts. We recognized 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 is 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 second quarter of 9.89%.

Please turn to Page 5. We've had good success through our efforts to expand our universe of investment assets, and adding newly originated performing whole loans to our asset mix. We've added a reliable and consistent source of new investments, while we can still pursue periodic opportunities to add credit-sensitive whole loans. Recent purchases have reduced our excess cash balances, but we have substantial borrowing capacity on unlevered assets that we can tap to fund future acquisitions. Because MFA has lower leverage, less interest rate exposure and reduced prepayment sensitivity than other similar companies, our returns are achieved with materially less risk. And our substantial liquidity, together with our low level of leverage, provides us with significant dry powder to take advantage of spread widening and/or other market opportunities that arise, whether they be in credit or rates.

Please turn to Page 6. We were able to purchase over $1 billion of assets in the second quarter, including nearly $900 million of residential whole loans. Efforts have begun over a year ago to add new asset classes are beginning to have a material effect on our balance sheet. Our portfolio acquisitions exceeded runoff by almost $150 million, and we deployed approximately $90 million of additional capital during the quarter, as our incremental investment assets utilized less leverage than the assets that ran off.

And finally, the hard work by our asset management team has had a meaningful impact on outcomes and returns of our existing credit-sensitive whole loan assets.

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

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

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Thanks, Craig. For the second quarter of 2018, MFA's net income to common shareholders was $66.6 million. Our earnings this quarter reflects lower net interest income and net other income as well as higher operating and other expenses than the prior quarter.

Please turn to Page 7, where we present additional information on the key items impacting net income this quarter. In reviewing our results, you will note that there were 3 items driving the second quarter decline in net income. The first item was lower net other income, which was mostly due to lower income from loans accounted for at fair value. This portfolio, which primarily includes nonperforming loans, continues to perform well and in accordance with our overall return expectations. However, income from fair value loans was lower than in the previous quarter by roughly $6 million.

The key components of this difference are as follows: one, cash coupon income was $14.9 million, which was $1.3 million more than the prior quarter; two, net unrealized mark-to-market gains were $4.6 million, which was $9.1 million less than the prior quarter; three, gains on transfers to REO, liquidation gains and other cash receipts totaled $12.9 million. This was $1.7 million more than the prior quarter.

The second item was lower net interest income, which was $3.2 million less than the prior quarter. This is largely attributable to portfolio sales and runoff occurring at the beginning of the quarter, while investments occurred later in the second quarter, with the closing of most of the high-yielding loan purchases as well as an RPL/NPL MBS acquisition occurring after quarter-end.

The third item was higher operating and other expenses, which were up approximately $3 million compared to the prior quarter. This increase was mostly due to the impact of the timing of recognition of expense related to certain share-based compensation awards to directors and employees, which resulted in more G&A expense being recorded this quarter at typical run rate of 1.4% to 1.5% on an annualized basis of shareholders' equity. As we have noted on our recent earnings calls, those contributed to other income to MFA's overall earnings, including the price accounted for fair value due to our accounting election of the fair value option may result in quarterly fluctuations in the overall level of MFA's net income.

Going forward, to the extent that we continue to expand our investments in residential whole loans through further acquisitions of Non-QM, fix and flip and single-family rental loans that we anticipate we would account for a carrying value, we would expect the contribution of net interest income to our overall results should increase.

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

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Gudmundur Kristjansson, MFA Financial, Inc. - SVP [5]

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Thank you, Steve. The second quarter was another successful quarter in terms of acquisitions. As we purchased approximately $1.1 billion of assets and grew our portfolio by approximately $150 million. This is the third quarter in a row where we have both grown our portfolio as well as acquired in excess of $700 million of assets. Most of the purchases were focused in our residential whole loan portfolio, which grew by 25% in the quarter and is now our largest asset class.

As Craig pointed out earlier, the robust pace of acquisitions in the quarter is partly due to our efforts to expand into newly originated performing whole loans, and we're very excited about the investment options at our disposal going forward.

We sold $104 million of CRT securities and $75 million of Agency MBS in the quarter. The Agency MBS we sold were all low-yielding 15-year 2.5% coupons, which we opportunistically sold at the end of May when rates rallied close to the lowest of the quarter.

Turning to Page 9. Despite nearly 3 years of rising rates and 7 Fed Funds increases, MFA's net interest rate spread on interest-earning assets has remained steady, but our yield on interest-earning assets has increased by approximately 125 basis points. This is the result of our disciplined investment strategy, which has been focused on acquiring credit-sensitive assets that benefit from continued strong credit fundamentals as well as our preference for short duration and floating-rate assets. In addition, our interest rate swaps and increased competition to fund our credit sensitive assets have kept the repo costs from rising as fast as Fed Funds.

Turning to Page 10. Here we show the yield, cost of funds and spreads for our holdings ordered by equity allocation. As we can see, our more significant holdings continue to generate attractive yields and returns. Given the current yield of our assets and the yields we're seeing in the marketplace, we believe that with the appropriate amount of leverage, we will continue to generate attractive returns for shareholders.

Turning to Page 11. Here we will review MFA's interest rate sensitivity. MFA's asset duration increased modestly in the quarter rising by 14 basis points to 161 basis points at the end of the quarter. This was primarily due to the fact that we added nearly $900 million of residential whole loans in the quarter. During the quarter, we opportunistically added $100 million of 3-year interest rate swap hedges when rates rallied at the end of May, while $50 million of short swaps rolled off in the quarter, resulting in a $50 million increase in the swap's notional balance. The hedge duration declined 10 basis points to minus 1.7 as our swap shortened naturally over time.

In addition to market value protection, our interest rate swaps currently has approximately 44% of our repurchase agreements. Overall, MFA's net duration increased 17 basis points in the quarter to 119 basis points at the end of the second quarter. Even though our duration has drifted out modestly over the last few quarters, it is important to keep in mind that our overall interest rate sensitivity remains low, as the majority of our assets continues to be primarily sensitive to mortgage's credit, and as such continues to benefit from a strong labor market and sustained home price appreciation. Our interest rate risk management decisions are based on both the outlook for interest rates and the economy as well as the absolute levels of interest rates.

As such, we believe that interest rate risk is more balanced today than it was a few years ago. When Fed Funds were close to 0%, the 3-year treasury yielded only 75 basis points, and the 10-year treasury yielded only 150 basis points. So although we continue to reduce interest rate risk in our portfolio, we believe a more balanced approach is currently appropriate after rates have risen substantially from their historical lows.

Turning to Page 12. MFA's investment and risk management strategy continues to consistently deliver book value stability, limiting the quarter-over-quarter book value changes we have experienced. Since 2014, the largest quarter-over-quarter change in book value has been 4%, with the average change in book value of less than 2%. A big factor in achieving this has been our strategy of maintaining a low and stable asset duration as we can see from the orange line on the graph on this page.

Finally, we believe that by consistently protecting book value, MFA will have a staying power to take advantages of new opportunities as they arise.

With that, I will turn the call over to Bryan Wulfsohn, who'll discuss our credit-sensitive assets in more detail.

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Bryan Wulfsohn, MFA Financial, Inc. - SVP [6]

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Thank you, Gudmundur. Turning to Slide 13. The economy and housing fundamentals continue to benefit mortgage credit. The unemployment rate was 4% in June, down from 4.3% a year ago. There is a dearth of homes available for sale with 4.3 months of supply in June. Inventory stands at $1.2 million, which is near a 10-year low. We believe this will -- this lack of supply will keep upward pressure on home prices. And according to the latest release from the Federal Reserve Board, the reported mortgage delinquencies were down at 3.5%.

Turning to Page 14. We again had success in acquiring residential whole loans, adding nearly $900 million in the second quarter. We were active in adding Non-QM, rehab and SFR loans, in addition to legacy loans. We completed a non-rated securitization of NPL and RPL loans in the second quarter and another subsequent quarter-end. We have seen legacy loan volumes year-to-date greater than that of last year. This was largely due to one $10-plus billion trade that occurred in the second quarter. Returns on nonperforming loans continue to be consistent with our expectation of 5% to 7%. Again, as a reminder, our whole loans appear on our balance sheet on 2 lines. Loans held at carrying value $1.9 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 carrying value for newly originated loans and reperforming loans and fair value for nonperforming loans.

Turning to Page 15. Our RPL portfolio continues to perform well. Nearly 90% of our portfolio is less than 60 days delinquent. In addition, although 11% of our portfolio is 60 days delinquent or greater, almost 30% of those loans have been making payments over the last 12 months. We're happy to see prepayments fees perform better than expectations. We can cease fees remaining in this range as borrowers gain access to new financing options as a result of improving credit.

Turning to Page 16. We believe our oversight of servicing decisions and active management of the portfolio produces better economic outcomes. This slide shows the outcomes for loans that were purchased prior to June month end 2017, therefore, owned for more than 1 year. 33% of loans that were delinquent at purchase are now either performing or paid in full. 43% have either liquidated or are REO to be liquidated. And 24% are still in nonperforming status. We are very pleased with our performance since modification as over 81% of our modifications are either performing or have paid in full. These results continue to outperform our initial expectations for re-performance.

Turning to Page 17. We believe our loan asset management team continues to improve upon their already impressive results. The team has worked in concert with our servicers to more quickly get loans to re-perform as well as limit and reduce timelines to resolution. This is evidenced by the 2 charts on the right-hand side of the page. On the top chart, you can see improvement in re-performance rates as 28% of NPLs acquired in 2016, held for 15 months, are making monthly payments or had paid in full. This compares to 19% in 2015 and 17% in 2014. On the lower chart, you can see our resolution timeline performance improved year-over-year. 30% of loans were resolved after 15 months for loans acquired in 2016 versus 22% in 2015 and 18% in 2014.

Turning to Page 18. We have begun purchasing newly originated loans that do not meet the qualified mortgage definition as defined by the CFPB. 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. To date, we have acquired over $700 million and are working with origination partners on strategic relationships. We believe underwriting of these loans is prudent. The portfolio has a weighted average loan-to-value ratio of 67% and a FICO of over 700. Leverage is attainable through either warehouse lines and securitization. We target asset yields of approximately 5% and an ROE of low double digits utilizing appropriate leverage.

And now, I'd like to turn the call back over to Gudmundur to walk you through our rehab and SFR loans.

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Gudmundur Kristjansson, MFA Financial, Inc. - SVP [7]

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Thank you, Bryan. Turning to Page 19. As of June 30, MFA held and had undrawn commitments to fund approximately $250 million of business purpose loans. Approximately $190 million of these for 3 quarters are rehabilitation loans and the remaining quarter are single-family rental loans. MFA's rehabilitation loans are short-term business purpose loans collateralized by residential properties made to non-occupant borrowers, who intend to rehabilitate and sell the property for a profit. The average term is about 13 months, but the average life is closer to 7 to 9 months as most projects are completed prior to maturity.

To put this into a little bit of context, as of June 30, we had funded in total at loan origination or through subsequent rehab draws, approximately $188 million of rehab loans are receiving approximately $25 million of loan payoffs. We believe these loans fit nicely into MFA's investment framework of minimizing interest risk, while extracting returns from exposure to residential mortgage credit. On average, the initial loan proceeds to purchase price of property is approximately 81%, while the total loan to repaired value of the property is approximately 64%. We believe these loans offer an attractive risk-reward profile with expected yields ranging from [6 in 3] quarters to 8 in the quarter depending on loan characteristics. And with the appropriate leverage either to warehouse or capital markets, we expect ROEs to be in the low to double digits.

MFA single-family rental loans are long-term business purpose loans to finance nonowner occupied 1 to 4 family residential properties that are rented to 1 or more tenants. Majority of these loans are 5-1 hybrids. And on average, the credit metrics are fairly conservative. The average LTV is 68%. The average FICO is approximately 740, and the debt service coverage ratio, which is the ratio of rental payments to the sum of principal, interest, taxes, insurance and homeowners association fees is 1.5x. We expect the single-family rental loans to yield between 5.5% to 6% depending on loan characteristics. And with appropriate leverage, we expect return equities to be in the low double digits. We're excited about the addition of Non-QM, rehab and SFR loans to our investable universe and believe they will offer attractive returns going forward.

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 active in the investment market. We have maintained our disciplined pricing approach, which sometimes means we don't win bids. We are investing for the long term, so we are keenly aware that reaching too much for investments can lock in years of suboptimal returns. We have seen very good progress in expanding our investment opportunity set within the residential mortgage space by adding what we believe will be reliable, recurring and growing volume with newly originated performing whole loans.

We cannot always predict what the next attractive investment opportunity will be, but we're quite confident that we will have a seat at the table, the expertise to understand and structure the transaction and ample capital to be able to invest in meaningful size. This concludes our prepared remarks.

Operator, would you please open this call for questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions)

We'll go to the line of Doug Harter with Crédit Suisse.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [2]

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Just, I guess, if you could touch, I think, one thing we've heard is that, that loan spreads really tightened significantly kind of with that $10 billion-plus portfolio purchase you referenced. Just your thoughts on the ability to continue to replace runoff going forward with attractively priced deals?

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

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Okay. Yes, I think, you are correct that the larger pool and other similar larger pools tend to trade at a somewhat tighter spread level versus pools of smaller size. So -- but where we tend to play in the market, the spread still remain attractive to us not attractive necessary every day, but we still see opportunities of where we can acquire assets at attractive spread level.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [4]

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Got it. And how is the flow of those -- that sized pool spend?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [5]

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Mean -- again -- yes, I mean, in the last couple of weeks, we've seen upwards of $6 billion trade. So -- and again, this is not all in one pool. There are several pools. So we've seen opportunities to put capital to work.

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Operator [6]

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Next, we'll go to the line of Steve Delaney with JMP Securities.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [7]

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Congratulations on the progress with your whole loan strategy. The thing that struck me in the report other than, obviously, the broadening and the diversity of the resi credit assets was on Page 10, and what I would at least characterize is short-term underperformance in Agency MBS. And I'm assuming a lot of that had to do with short reset hybrids. We saw this with Capstead's report last week. So my question, I guess, to you Gudmundur is given the CPR challenge there, because of the flattening curve, that's significant amount of assets. I think it's well -- it's $2 billion overall in the agency. And I think the hybrids are about 60%. Any thoughts to do something significant and strategic to free up that capital and use it to help grow your whole loan strategy, which also gives you protection under the SEC exemption?

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Gudmundur Kristjansson, MFA Financial, Inc. - SVP [8]

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Thanks, Steve, for the question. Well, first of all, I -- we did sell $75 million of lower-yielding agency MBS in the quarter. We took the opportunity when rates rallied to take some chips off the table. What I would say is we haven't been liquidity constrained. In fact, probably the opposite, as of last 2017, we were -- we're seeing a lot of runoffs from paydowns from RPL/NPL securities. So the -- it was more about finding assets. And so it hasn't really been a factor that we've tied up capital that we can't use to find more attractive investments, so that's one. And so there hasn't been the need to kind of rotate out of the agencies to invest in high-yielding assets. However, going forward, as you've seen, we're gaining a lot of momentum in some of our new initiatives. And so if it comes to a point in time that we got our liquidity constraints and we need to rotate our capital, that's certainly on the table to rotate out of the Agency MBS. What I will say though, in the bigger picture, the equity allocation to the agency MBS portfolio is only about $250 million, so it's less than 10% of our portfolio. So in the grand scheme of things, it doesn't really impact the bottom line too much. And -- but it's certainly something we consider to the extent we needed to have that capital.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [9]

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That's helpful. Yes, I mean, obviously, I was focusing on asset size, but you're correct. I mean, it's the equity that is really freed up. Shifting over to the financing of the whole loans, and especially, I'm focusing on the newer production flow business. Just curious, your short-term financing strategy there or opportunities and does -- as you aggregate, should we assume that you'll try to seek a securitization exit or financing solution?

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Gudmundur Kristjansson, MFA Financial, Inc. - SVP [10]

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In short, the answer is yes. I mean, we're -- we would look to utilize both warehouse lines and the securitization for financing. That's just really initially, right. Because of our capital situation we didn't really -- we haven't really had the need to add much in terms of financing these loans. But as we continue to grow the portfolio, we would look to add financing whether it be through warehousing and/or securitization.

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

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Yes, Steve, much of those purchases were bought unlevered, but it's just because we had excess liquidity and excess cash. That's not so much the case now. You'll see that on the balance sheet at quarter end. So I think it's right to assume that we'll begin to add leverage initially through warehouse lines, but ultimately, we'll look to securitization as well.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [12]

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And Craig, the obvious, I guess, the best possible financing would be Federal Home Loan Bank if that window is -- was available or might become available. I guess, any thoughts on what's going on in Washington around that? And I don't know if you have had chances to look at legacy captive insurance companies that might be available. I know one of the large commercial REITs actually bought a legacy captive and used that to sort of jump into the resi securitization model. So just any thoughts on the whole better home loan bank financing of non-agency whole loans as a future opportunity?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [13]

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So we're certainly involved in efforts to try to resurrect that or extend that as the case may be. Quite frankly, it's hard for me to imagine that, that we'll see progress through Washington given how things are these days, but it certainly is a possibility. It will be nice, but it's certainly not something that we feel that we need. So I guess, the best way to describe it is, it's like a lottery ticket and they haven't drawn the numbers yet. And you make sure you take the ticket out of your jeans before you throw them in washing machine, but we're certainly not betting on it.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [14]

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Got it. And clearly, you're saying you don't need that to have to make the whole loan strategy work for you, as we hear that loud and clear?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [15]

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Not at all. It will be nice to have, but we certainly don't need it.

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Operator [16]

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Next, we go to Vik Agrawal with Compass Point.

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Vivek Agrawal, Compass Point Research & Trading, LLC, Research Division - Analyst [17]

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So on the whole loan side, I think you said that there is a long gestation period and I fully appreciate that. At this point, do you feel you have enough partners to work with to get the flow that you would like? Or there's more work to do on that end?

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

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So thanks for the question, Vik. It's an ongoing process. I think we're very pleased with the progress that we had. Our ultimate goal is not to be a conduit, but to have meaningful relationships with a finite group of originators. So I think we're in good shape. I'm not sure, the door has necessarily closed yet, but we've made good progress and it's maddeningly slow from initial meetings to when we actually start funding meaningful size can easily be a year. So these efforts -- we were getting on airplanes in the first quarter of last year to start this process. So it's nice to actually see some tangible progress.

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Vivek Agrawal, Compass Point Research & Trading, LLC, Research Division - Analyst [19]

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I appreciate the slow grinding process for that. Do you see that now that you have established some partnerships that others are coming forward and maybe that gestation period become smaller?

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [20]

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It's certainly possible. It's certainly possible. That's why until now when we had meaningful size, we really haven't talked about it a whole lot.

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Operator [21]

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And now we go to the line of Bose George with KBW.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [22]

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It's Eric, on for Bose. Can you just talk about the run rate expenses that we should expect going forward with some of the newer strategies, including loan servicing costs, in particular?

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Stephen D. Yarad, MFA Financial, Inc. - CFO [23]

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Sure. Thanks, Eric. I mean, I think as you've commented on this call and also the last call, overall, G&A expenses probably aren't impacted too much by some of the new loan assets that we're acquiring, particularly, to the extent that we are able to get them servicing released, because it comes through in the net coupon that we actually receive. So it is difficult to -- as we grow other parts of the portfolio, you'll see that the -- that we have a line on that on our income statement for loan acquisition and other related expenses and that has grown as we picked up more loans in both our credit impaired as well -- credit-impaired assets particularly. So that's more the line that you would expect to grow as we increase those acquisitions over time.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [24]

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And Eric, I think the more expensive loans to acquire into service are nonperforming loans. So that's where the larger expenses are. Performing loans are not that expensive to acquire and they're not that expensive to service.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [25]

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Right. Right. That's helpful. Thanks for also disclosing some of the yields that you expect to capture on some of the newer strategies. I'm just curious if maybe you can share some of your assumptions around delinquencies, and in particular how sensitive that yield might be to things like home price appreciation?

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Stephen D. Yarad, MFA Financial, Inc. - CFO [26]

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I mean, as it relates to Non-QM loans, as you can see in terms of the LTV disclosed at -- in the mid-high 60s number, even if you were to see some sort of delinquencies and liquidations, the severities on those liquidations are going to be extremely low, if existent at all. So really you're talking about -- it's less than a point of expected losses as the loans are currently being originated and what we're acquiring today. If you were to look forward into the future, right, if -- which -- we're not really going to do today, but if that makeup [for] changes, then loss assumptions and these very assumptions might change.

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Gudmundur Kristjansson, MFA Financial, Inc. - SVP [27]

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In terms of the SFR loans, I mean, it's similar to [or a bit above the] Non-QM. I mean, the credit metrics are conservative. The LTVs are low. And also, majority of these are adjustable rate mortgages. So they're not as sensitive to rates, if you will. In terms of the rehab loans, there are short-term loans. And so the returns are fairly stable that's -- if you're thinking about modeling, what's going to drive your modeling assumption is, when you put new assets on 9 months from now. And so that's really the variable, but I think the expectations we have of our yields is that they're going to stay in that range we kind of provided.

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

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And probably those -- the fix and flip loans are probably most sensitive to home prices, but because they're such a short loan, on average around 9 months, you just don't get a lot of home price change in a 9-month period. And, again, the as repaired value LTV is pretty low on those to begin with.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [29]

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Right. That's great. Helpful answer, guys. One more, if you don't mind from me. I think we saw a couple of securitizations from your shelf price, maybe in mid or early July, and I expect maybe we'll see the effects of that in the third quarter, but maybe you can just kind of guide us for what that ROE pickup was -- potentially was from executing those transactions? I think they were NPL deals if I'm not mistaken.

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

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As Bryan said, we did 2 deals. We did one during the second quarter and one actually subsequent to the quarter end. In terms of ROE, I don't really think there is an appreciable difference between that securitization financing and where we have those nonperforming loans finance beforehand. Marginally, maybe you got a little bit more leverage. Obviously, we're not exposed to additional increases in LIBOR going forward, but it would be hard to quantify and say it will make a material change in our financials.

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Operator [31]

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And our next question comes from the line of Rick Shane with JPMorgan.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [32]

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I want to talk a little bit more about the Non-QM acquisitions. Given the coupons there and the targeted yields, can you just talk a little bit about what types of premiums you're paying for those loans?

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Stephen D. Yarad, MFA Financial, Inc. - CFO [33]

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Sure. You can say, obviously, it depends on where the coupons fit, but it's anywhere in the range from -- it can range from 2- to 4-point premium for those types of loans.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [34]

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Got it. And the originators that you're dealing with, what is their alternative source of financing? I'm assuming that these aren't balance sheet lenders, who are you competing with to make these purchases?

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Stephen D. Yarad, MFA Financial, Inc. - CFO [35]

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I mean, we could be competing with larger money managers or -- I mean, you see there are other actors in the place that are -- actors in the marketplace that are coming with Non-QM securitizations. We're probably competing with some of those parties. And then you have just larger money managers that can buy these types of loans just for balance sheet. And they may not employ leverage, so we're competing with those types of market players as well.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [36]

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But it's typically not a really a long list. It's a somewhat limited list. As I'm sure you know Rick, when you sell whole loans, it's very different from selling securities. So some counterparties are easy to close with, some are less so, but I think originators tend to probably limit the universe of buyers to buyers that they trust and they know can close reliably.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [37]

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Got it. Okay. Just 2 more questions, I apologize. One is on these purchases. How confident are you in the [reps and] the warranties in the counterparty risk you're taking? Again, it's a good time in the market but we're all familiar with the history here as well.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [38]

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Yes. So as it stands, I mean, there you get some comforted [reps], but where you really do get comfort is from re-underwriting the loans and have third-party diligence providers re-underwrite their loans as well. And then also make a -- have a check on the property value making sure that's where it's presented. So it's nice to have reps, but it's better to do the diligence and get comfortable that way.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [39]

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Okay. And then, last question, you guys have talked about sort of where you are in terms of starting to grow the balance sheet again. We've basically seen net interest income decline for 12 quarters. Have we hit the inflection point? Or are we approaching the inflection point?

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Stephen D. Yarad, MFA Financial, Inc. - CFO [40]

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Well, again, net interest income, I mean, as we -- I think we started to try to highlight a little over a year ago. More of our income, it comes from not net interest income now, right. It's other income because it's fair value loans. And also keep in mind that when we finance loans that we hold at fair value, which is typically nonperforming loans, when we finance those with some warehouse line for instance, that interest expense, it shows up, up top under interest expense. So that reduces our net interest income, even though the income from the asset doesn't produce any income up there. So it's really more about the geography of the income statement.

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Richard Barry Shane, JP Morgan Chase & Co, Research Division - Senior Equity Analyst [41]

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No. I understand, but again, like within my understanding is with the NPL that should start to recontribute [certainly] in terms of a nonqualified portfolio and not the NPLs, I apologize. That [that] should start contributing to growth of the NII line again?

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Gudmundur Kristjansson, MFA Financial, Inc. - SVP [42]

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Rick, as I said, I think as we continue to expand this strategy and we continue to buy more of these types of assets and we account for them as carrying value ones, as oppose to fair value ones. I think if that continues to occur, we will see a greater proportion of our overall net income from net interest income, but it's going to depend on the overall mix of what types of assets we buy from quarter-to-quarter.

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Operator [43]

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(Operator Instructions) We have no further questions, please continue.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [44]

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Okay. I want to thank everyone for joining us today. And we look forward to speaking to you, again, next quarter.

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Operator [45]

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