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Edited Transcript of MFA earnings conference call or presentation 21-Feb-19 3:00pm GMT

Q4 2018 MFA Financial Inc Earnings Call

New York Feb 26, 2019 (Thomson StreetEvents) -- Edited Transcript of MFA Financial Inc earnings conference call or presentation Thursday, February 21, 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. - Co-CIO

* Craig L. Knutson

MFA Financial, Inc. - President, CEO & Director

* Gudmundur Kristjansson

MFA Financial, Inc. - 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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* Douglas Michael Harter

Crédit Suisse AG, Research Division - Director

* Eric J. Hagen

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

* Stephen Albert Laws

Raymond James & Associates, Inc., Research Division - Research Analyst

* Steven Cole Delaney

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

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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. Fourth Quarter Earnings Call. (Operator Instructions) And also as a reminder, today's teleconference is being recorded.

At this time, we will turn the conference call 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. 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 the 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 SEC.

These risks, uncertainties and other factors could cause MFA's actual results to differ materially from those projected, expressed or implied in any forward-looking statements it makes. For additional information regarding MFA's use of forward-looking statements, please see the relevant disclosure in the press release announcing MFA's fourth quarter 2018 financial results.

Thank you for your time. I would now like to turn the 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 Fourth Quarter 2018 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.

The fourth quarter of 2018 was a very challenging period for financial assets. Stocks rode a roller coaster, particularly in December, with daily swings in the Dow of 500 points or more for much of the last 2 weeks of the year, after dropping almost 2,000 points in the 4 trading days preceding Christmas, down 650 on Christmas Eve alone. The Dow closed up over 1,500 points in the final 4 trading days of the year. Bonds saw wild swings as well between November 8 and year-end with 2s, 5s and 10s rallying between 50 and 60 basis points. And finally, high-yield widened by nearly 180 basis point also between November 8 and year-end.

Levered investors in both Agency mortgages and mortgage credits experienced significant value declines as these assets widened, with corresponding book value reductions commensurate with the amount of leverage deployed. While not immune to these movements, MFA fared better than most of our peers with a modest book value decline of 4.2%, due largely to our asset selection and low leverage.

And while wider credit spreads negatively impacted pricing on our mortgage credit assets, this spread widening was very much a technical phenomenon and in no way a result of deteriorating credit or diminution of projected cash flows. Because some of our assets affected by this market volatility are accounted for at fair value, price declines in the corresponding unrealized losses on these assets during the quarter flow through income and drove GAAP income lower.

As we look back past the market turmoil that prevailed at the end of the year, we are extremely proud of our investment achievements in 2018. We made fantastic progress in our stated initiatives in newly originated whole loans, which we now refer to as purchased performing loans. These are Non-QM loans, fix and flip loans, single-family rental and, additionally, a few pools of seasoned performing loans. During 2018, we grew this portfolio by over $2 billion as we capitalized on our efforts initiated beginning in early 2017.

Our investment team spent considerable time and energy to establish relationships with originator counterparties in order to source loan volume, and this hard work is now bearing fruit as we've been able to acquire meaningful size of purchased performing loans, particularly in the second half of 2018. 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.

Please turn to Page 3. MFA's GAAP earnings per share was $0.13 in the fourth quarter as unrealized losses on fair value assets flowed through our income statement. The 2 primary drivers of this were CRTs about $0.04 per share and Agency MBS together with swap hedges about $0.03 per share. We acquired over $5.7 billion of assets in 2018, growing our portfolio by approximately $2.2 billion. Needless to say, we successfully deployed the proceeds from our follow-on equity offering in August. We paid a Q4 dividend of $0.20 to common shareholders on January 31, which is the 21st consecutive quarter in which we paid a $0.20 dividend.

Please turn to Page 4. Fourth quarter investment activity was very strong as we purchased approximately $1.6 billion of assets and grew our portfolio by more than $550 million in the quarter. Over $1 billion of these purchases were whole loans and split approximately 70-30 between newly originated loans and nonperforming loans. Our acquisition of Non-QM, fix and flip and single-family rental loans again increased over the third quarter to approximately $700 million in Q4.

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.

Please turn to Page 5. As we have stated previously, our expanding investments in newly originated loans or purchased performing loans is beginning to have a meaningful influence 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 on our balance sheet.

For the year 2018, all loans held at carrying value produced $101 million of interest income. This is versus $36 million in 2017. Notably, more than half of the $101 million of interest income in 2018, $56 million for the year, was from purchased performing loans, and $27.5 million of this $56 million for the year was in the fourth quarter alone. Now to put these numbers in perspective, our legacy reperforming or purchased credit impaired whole loans generated a little over $11 million of interest income in each quarter of 2018 for an annual contribution of approximately $45 million. We would expect that this portfolio will continue to produce income at this approximate level in 2019.

Now, if we consider that the purchased performing whole loans generated $27.5 million of interest income in the fourth quarter and we assume no net growth for these loan categories in 2019, this $27.5 million annualized is $110 million, which together with $45 million from reperforming loans is over $150 million of interest income from carrying value loans, an increase of $50 million or 50% over 2018. As we continue to grow our balance sheet, we'll begin to add more leverage, particularly on our residential whole loan portfolio.

Our debt-to-equity ratio increased slightly from 2.3x to 2.6x in the fourth quarter. We would expect this leverage ratio will continue to increase modestly as these whole loan 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 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, it 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 most recent quarter of 10.65%.

Please turn to Page 6. To summarize our strategy and initiatives for 2019, 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 part of managing a mature portfolio and 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've managed our CRT portfolio by selling many of the seasoned securities that are trading at very tight spreads and high dollar prices, in most cases over 110, in favor of newer deals with wider spreads and prices closer to par. Notably, the new REMIC structure CRTs, which we expect to see more of in the future, will not be accounted for at fair value, but will be treated as available for sale assets. And finally, we'll look to optimize our capital structure through the use of additional leverage, including securitizations. That said, our leverage will likely still be at the lowest in the peer group.

Please turn to Page 7. Recent developments and communication from the Fed has significantly altered expectations of future Fed action in interest rates. For levered investors, a more dovish Fed posture is obviously encouraging. Recent headlines advertising a housing slump are in our opinion somewhat misleading. While transaction volume is down, this is largely attributed to affordability issues, which is caused by higher prices and lack of inventory.

So while lower transaction volume may be bad for real estate brokers, it's not necessarily bad for holders of credit-sensitive mortgage assets. There is a nationwide home supply shortage, given simply the level of household formation and the persistent low supply of new homes. While affordability is down from its most affordable level seen in 2011 and '12, it is still at precrisis normal levels last observed in 2000 to 2003.

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

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

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Thanks, Craig. For the fourth quarter of 2018, MFA's net income to common shareholders was $57.1 million or $0.13 per share. As Craig noted, while we continue to make solid progress in growing our residential mortgage portfolio, including through purchases of performing loans, which are meaningfully impacting our earnings, our results this quarter were impacted by market volatility that made for a difficult trading environment and a good risk off sentiment.

Despite rates rallying significantly, wider credit spreads negatively impacted fair value of our CRT securities and Legacy Non-Agency MBS. And wider mortgage basis negatively impacted the net fair value of our 30-year Agency MBS and related hedges. Due to our election of the fair value option on CRT securities and 30-year Agency MBS and because we are not applying hedge accounting to the swaps of economically hedged agencies, the valuation changes on those positions are recorded in earnings each quarter.

The unrealized losses arising on these positions in Q4 drove the $0.06 sequential quarter decline in net income. However, it should also be noted that trading conditions have largely stabilized since year-end. And while our January 2019 results are still subject to final management reviews, we have seen a partial recovery in the values of these positions, particularly on CRT securities. As a result, we estimate that January book value increased over December by approximately 1.5%, excluding any adjustment to first quarter 2019 dividends.

Please turn to Page 8, where we present additional detail on the key drivers of net income for this quarter, which were as follows. Net interest income this quarter was approximately $3.2 million higher than the prior quarter, reflecting continued growth in purchased performing loans. This increase is even more significant when considering the prior quarter net interest income includes approximately $3.4 million of accretion on the early payoffs of Non-Agency MBS that had been purchased for a discount, while the current quarter includes approximately only $0.6 million of accretion on early bond payoffs.

As discussed, credit spread widening resulted in lower year-end valuations on our CRT securities, which led to a reduction in unrealized gains on the portfolio. The losses on CRTs contributed roughly negative $0.04 to the Q4 results. In addition, despite a rally in rates in the fourth quarter, widening mortgage basis resulted in net unrealized losses on 30-year Agency MBS and related hedges contributing negative $0.03 to the Q4 results.

Results this quarter also reflect higher net gains from sales of residential mortgage securities as we continue to selectively take advantage of market opportunities to manage our mature Legacy Non-Agency (technical difficulty) and rebalance our CRT portfolio. In addition, we also disposed of certain lower coupon Agency MBS.

Further, the results continue to reflect the strong contribution from residential whole loans measured at fair value through earnings. Approximately 60% of income on these loans for the quarter reflects cash income from coupon receipts and related to loan liquidations. Finally, (technical difficulty) prior quarter due primarily to the higher loan servicing and acquisition costs associated with loan portfolio growth.

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

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

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Thank you, Steve. Turning to Page 9. The fourth quarter was another successful quarter for our investments team, as we acquired approximately $1.6 billion in the quarter and grew our portfolio by $565 million in the quarter. This is the fifth consecutive quarter of portfolio growth. Most of the acquisitions were focused on the whole loans portfolio, which continues to benefit from our multiyear effort to expand our investment universe to include Non-QM, fix and flip and SFR loans. We opportunistically sold $77 million of older CRT securities, which had benefited from strong credit performance as well as $47 million of lower-yielding, lower coupon 15-year fixed rate Agency MBS as rates declined at the end of the quarter.

Turning to Page 10. 2018 was a strong year for portfolio growth and a year when we saw the full benefits of our strategic push into newly originated loans that we began back in 2017. We purchased approximately $5.7 billion of assets in 2018 and grew our investments portfolio by approximately 22% in the year. We doubled our holdings of residential whole loans and REO to approximately $5 billion, which now accounts for about 41% of our assets, up from approximately 24% at the end of '17. The large growth in whole loans was largely attributable to our strategic push into Non-QM, fix and flip and SFR loans began in 2017 and really took off in 2018 when we acquired in excess of $2 billion across these loan products compared to approximately $100 million in 2017. We're glad to see our effort to introduce new loan products bear fruit and expect that they will continue to add meaningfully to our portfolio going forward.

Turning to Page 11. Despite over 3 years of rising rate and 9 Fed Fund increases, MFA's net interest rate spread on interest-earning assets has remained steady and attractive. This is the result of our thoughtful and adaptive investment strategy which is focused on acquiring credit-sensitive assets and benefit from positive credit fundamentals as well as emphasizing assets in short duration which either through a floating rate coupon or rapid repayment of principal have supported our portfolio performance in a rising rate environment. Also importantly, the rise in funding costs has been mitigated with strategic uses of interest rate swaps and the terming out of fixed rate whole loan financings through securitizations, of which we currently have about $660 million outstanding.

Turning to Page 12, where we share the yield, cost of funds and spreads for our holdings as well as the equity allocated to each asset class. As we can see, our largest equity allocation is towards whole loans at carrying value with yield at 5.67% in the quarter. The leverage on our whole loans increased modestly to 1.2x in the quarter, and we expect to continue to utilize more leverage there as the flow of newly originated loans expands.

Turning to Page 12 -- sorry, turning to Page 13. Here we review MFA's interest rate sensitivity. Our asset duration changed little in the quarter and remained relatively low at 164 basis points at the end of the quarter. We added $580 million of interest rate swaps in the quarter to hedge some of the growth we've experienced in the newly originated loans. In addition, we also show our securitized debt as part of our hedging instrument as these fixed rate nonrecourse borrowings essentially term out and lock in our funding cost, similar to what interest rate swaps and term repos would do. Our net duration remains relatively low and measured 96 basis points at the end of the quarter. On this slide, we've also added the table to the right, showing our portfolio sensitivity to parallel changes in interest rates. For 100 basis points parallel increase in rates, we will expect our portfolio to decline by approximately 1.2% or about 4.3% of MFA's equity. As we can see, due to our low asset duration, low leverage and preference for credit-sensitive assets, MFA's interest rate sensitivity remains low both as measured by net duration as well as estimated change in portfolio value for parallel shift in interest rates.

Turning to Page 14. MFA's investment and risk management strategy continues to limit quarterly book value fluctuations through various market conditions. In one of the most volatile quarters in recent memories, where rates declined significantly and credit and mortgage spreads widened substantially, MFA's book value held reasonably well and declined by a modest 4% in the quarter.

As we can see on the graph on this page, since 2014, MFA's quarterly book value changes have been modest with an average quarterly book value change of less than 2% and a largest book value decline of 4%. As before, we continue to believe that by consistently protecting book value, MFA will have the same power to take advantage of new opportunities as they arise.

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

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

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Thank you, Gudmundur. Although we saw market volatility in the fourth quarter, the economy and housing fundamentals continue to benefit mortgage credits. The CoreLogic National Home Price Index was up 4.7% in December from the year ago. Home price growth has been normalizing after an extended period of significantly outpacing CPI. While we benefit from outsized home price growth, our investment strategy does not depend on it.

The unemployment rate was 3.9% in December and 4% in January. The increase in recent months was a result of people reentering the labor force. In addition, we continue to see a steady march higher in the number of people employed as a percentage of the working age population. We continue to see slight increases in housing inventory. Overall, levels are historically low on a nationwide basis. We believe these low levels of supply will support further home price growth. According to the latest release from the New York Fed, the reported 90-plus day mortgage delinquencies are down to precrisis level of around 1%.

Turning to Page 16. We are pleased to report that our investment team has sourced over $1 billion residential whole loans in the fourth quarter and over $3 billion for the year. Majority of the growth in 2018 came from our investment in newly originated loans. Seasoned loan supply was robust last year with almost $80 billion in supply, and we expect volumes in that space to moderate in 2019. And the performance of our seasoned portfolio continues to outperform our expectations at the time of the purchase. Again, as a reminder, our whole loans appear on our balance sheet on 2 lines: loans held at carrying value, $3 billion; and loans held at fair value, $1.7 billion. This election is permanent and is made at the time of acquisition. Typically, we elect carrying value for our purchased performing loans and reperforming loans and fair value for nonperforming loans.

Turning to Page 17. Our RPL portfolio continues to perform well. 86% of our portfolio is less than 60 days delinquent. In addition, although 14% of the portfolio is 60 days delinquent or greater, almost 30% of those loans have been making payments over the last 12 months. We are happy to see prepayment speeds coming faster than our expectation as the portfolio was purchased at a substantial discount to par. We could see speeds remaining in this range as our borrowers gain access to new financing options as a result of improving credit.

Turning to Page 18. We believe our asset management team's oversight of servicing decision and active management of the portfolio produces better economic outcomes. The team has worked in concert with our servicing partners to more quickly get loans to reperform as well as limit and reduce timeline to resolution. This slide shows the outcomes for loans that were purchased prior to December month-end 2017, therefore, owned for more than 1 year.

32% of loans that were delinquent at purchase are now either performing or paid in full, and 38% have either liquidated or REO to be liquidated. And 30% are still in nonperforming status. We are very pleased with our performance. Since modification is over 76%, our modifications are either performing or are paid in full. These results continue to outperform our initial expectations.

Turning to Page 19. We have been successful in adding to our portfolio of 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 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 of higher debt to income ratios and so on.

We believe the underwriting of these loans is prudent. The portfolio has a weighted average loan-to-value of 65% and a cycle of over 700. To date, we have acquired over $1.8 billion of UPB, including approximately $400 million so far in 2019, and continue to work with our origination partners on strategic relationships. We are encouraged by the growth of the asset class as our origination partners saw significant volume growth last year.

Leverage is attainable through warehouse lines and securitization. The securitization market for these assets is still in nascent stages, as volumes more than tripled last year from $4 billion in 2017 and could experience significant growth again in 2019. 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 fix and flip and SFR loans.

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

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Thanks, Bryan. Turning to Page 20. Our acquisitions of business purpose loans continued to expand in the fourth quarter, as we added new relationships and worked to expand existing ones. Since we started acquiring business purpose loans at the end of 2017, we have acquired approximately 4,400 loans with over $900 million in UPB and undrawn commitments. We are excited about our progress, and we'll continue to work towards expanding our acquisitions of business purpose loans in 2019.

During the fourth quarter, our holdings of fix and flip loans grew by approximately $170 million to $495 million UPB, with additional undrawn commitments of $50 million at the end of the quarter. Credit metrics and performance continues to be strong, and our target yield for this asset class is around 7%. Our holdings of SFR loans grew by $65 million in the quarter to $145 million at the end of the fourth quarter. Similar to the fix and flip loans, credit metrics and loan performance continues to be strong. Our target yield for SFR loans is around 6%.

With that, I'll 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. So in summary, we remain very active in the investment market. We purchased over $5.7 billion of assets in 2018 and grew our portfolio by over $2.2 billion. This growth in our portfolio has resulted in materially higher net interest income in the second half of 2018, and we expect further such increases in 2019. While we've made excellent progress in growing our asset base, we still have substantial capacity to continue to increase our investments by adding leverage to our balance sheet.

This concludes our prepared remarks. Tony, would 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) Our first question will come from Doug Harter with Crédit Suisse.

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

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I was hoping you could talk a little bit about the relationships you have on the business purpose loans and the Non-QM side. Any color as to kind of the volume expectations you expect or anything. Are these exclusive relationships, just some more color about these relationships you've built?

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

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Sure. Thanks for the question, Doug. So as we've said before, we have multiple relationships. They're typically not exclusive relationships. And for competitive reasons, we've declined to discuss the specific partners that we've -- that we partnered with. But it's multiple partners across multiple products. It's typically not exclusive. But I think we're -- in many cases, we're a significant, if not majority, purchaser of the production.

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

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Understood. And then you guys talked about the ROE you expect to get on Non-QM. Can you just sort of compare that? You have the -- the target yields look higher on the business purpose loans. Can you just talk about what the leverage opportunity there is and how the ROEs would compare on those?

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Bryan Wulfsohn, MFA Financial, Inc. - Co-CIO [5]

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Yes. I mean, the leverage you can attain through Non-QM loans is probably a bit higher versus business purpose loans. And therefore, the ROEs can be comparable. The ROEs are probably -- are higher on the business purpose side. It's just a question of how much production can you source. We're very happy with what we've gotten and would like to grow that portfolio. And we think we're doing so appropriately.

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Douglas Michael Harter, Crédit Suisse AG, Research Division - Director [6]

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And, I guess, just one last. I guess, how would you compare kind of the duration of those assets? How long you expect them to sort of remain on your book, if you compare a Non-QM versus the business purpose loans?

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Bryan Wulfsohn, MFA Financial, Inc. - Co-CIO [7]

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Sure. So Non-QM, given where speed expectations are today, you're probably around like a 3-year asset, and business purpose loans are plus or minus a year asset, maybe even shorter. So Non-QM is a bit longer than the business purpose side.

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Gudmundur Kristjansson, MFA Financial, Inc. - Co-CIO [8]

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And so on the business purpose, I mean, so the fix and flip, we expect them to have an average life of anywhere -- probably around 9 months from the like, so turnover quickly, as Bryan said. But the SFR loans are going to be similar to the Non-QM loans in terms of average life of duration.

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Operator [9]

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The next question in queue that will come from Eric Hagen with KBW.

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

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I guess, maybe I was a little surprised to see such a strong quarter for realized gains on the loan sales. Just given the widening credit spreads that we saw, weaker asset prices during the quarter, can you just maybe shed some light on what drove the sales and maybe even just the timing of when you completed those?

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

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Sure, Eric. Thanks for the question. Suffice to say, we weren't selling those assets in the last few weeks of the year because the market was in somewhat disarray. So had we not made some of those sales, the book value number could possibly had been a little bit lower. I wouldn't say it was a targeted or a premeditated strategy. I think our approach in both the legacy book and the CRT book has been consistent for -- not for quarters but almost for years. I think in the legacy book, in particular, it's a very mature portfolio, right? The -- it's '05, '06, '07 production. So the youngest bonds there are 12 years old. And so, part of it is just -- it's just sort of a rigorous portfolio trading strategy where we're selling bonds that get up to high dollar prices in the mid high-90s where there's really no further room for credit improvement and price depreciation. So that's one. Two is, we're selling bonds, in some cases, at a premium. They're callable, which obviously is a smart strategy. And then the third is, while these were mostly round lot positions initially, as they pay down and factor down, many of them become odd-lot in nature or the bonds are of very low loan count. And a low loan count bond is subject to monthly fluctuation if you get a bad print, right. If you one loan that's been in foreclosure for 2 years and it liquidates at a really high loss severity, it could have a profound impact on the price of that bond. So it's really just a constant strategy of calling the portfolio. If a bond trades in the marketplace in a round lot and we have an odd lot, we can maybe tack that on and get a round lot execution. So it's a variety of things, but it's -- the numbers that come out, the realized gains, are really -- are a function of the fact that we bought them all at low dollar prices. So any time we sell anything, we typically have a big gain.

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

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That's really helpful color. Maybe I can just press you guys a little bit for your assumptions or just some color around the Non-QM strategy. I mean, what's the cumulative default rate that you expect on some of those -- the pipeline of originations there?

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Bryan Wulfsohn, MFA Financial, Inc. - Co-CIO [13]

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So, again, QM defaults, you're looking at somewhere in the order of 100 to 200 basis points and the losses are really low. I mean, if you look at the portfolio, the weighted average LTV is 65%. So we're talking about a lot of protection, again, to any movement in home prices if loans were to go back.

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

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Yes, that makes sense. Okay, great. Then an accounting question, just kind of bigger picture stuff. How was CECL -- how should we think about CECL and the impact that, that could have on some of the accounting behind the loans that, I guess, you would hold at carrying value, would be maybe the ones that are affected there? Can you just give us some color as to how you're thinking about CECL and the impact there when it takes effect, I guess, in about a year?

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Stephen D. Yarad, MFA Financial, Inc. - CFO [15]

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Yes. Sure Doug, thanks. This is Steve. We are currently looking at CECL and implementing for that new standard. As you noted, it becomes live in 2020. And you're right. The impact that it will likely have on our portfolio is with some of our loan product, because really on those carrying value loans, as Bryan has mentioned, the way those loans that we really have acquired them now, low LTVs, we don't -- we see some default risk, but severity to protect will be low and those loans are very well protected. So right now, we don't really have much in the way of loan loss reserves on those loans. Under CECL, you have to look at those on a life of loan basis rather than what's incurred today under the current accounting. So we're looking at that. We're looking at implementing a methodology to cancel loan losses for those loans under CECL. Still going through that in the early stages. But we would expect possibly some additional loan loss reserves under CECL than what we would cancel today under the current accounting standards, but too little to know until we sort of quantify that because we're just not far enough into it at this stage.

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Eric J. Hagen, Keefe, Bruyette, & Woods, Inc., Research Division - Analyst [16]

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Got it. But I think it's fair to say that the LTV in your portfolio is still low that, that provision that you're talking about taking would really be fairly modest at the end...

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Stephen D. Yarad, MFA Financial, Inc. - CFO [17]

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That's right. That's what we would expect at this stage.

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Operator [18]

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(Operator Instructions) Our next question will come from 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 [19]

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Craig, you talked about the relationships that you've developed with strategic partners, primarily on the origination side, but I know on the special servicing side a little bit too. I'm just curious if you've made any equity investments, small investments, but try to help solidify those relationships or support the growth of any of those platforms? And if you haven't, is that something that you would consider doing in the future?

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

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Sure, Steve. Thanks for the question. The short answer is yes. We have made minority equity and/or preferred stock investments. However, I think, as you point out, investment amounts are not material to our financial statements. So we've not provided specific detail about them. And also for competitive reasons, we prefer to discuss our origination partners in general rather than specifically. Different originators have diverse needs and objectives, and we think we've been able to consider various arrangements that address these unique desires. Our objective is not really to develop a conduit here, but to -- rather to form meaningful partnerships with a finite group of originators that we can assist in growing their franchise, volume and profitability.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [21]

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That's helpful. And I certainly understand the need for confidentiality there and the fact that you have something to offer them in terms of a much lower cost of capital than they would have stand-alone. So my second point, obviously, a quarter that had noise in it for everyone. I guess, what I'm thinking when I hear your comments about the more straightforward accounting for interest income on the various whole loan portfolios and thinking about where we might be in a year or so versus where we've come from when there was a lot of more complex accounting with respect to discounts and credit on the legacy RMBS. What I'm really getting at is, as that mix changes, would you consider adding some new disclosure in terms of your earnings, which would lead us to something akin to a core EPS disclosure, and so you'd be able to take the fair value noise out of your reported earnings?

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Stephen D. Yarad, MFA Financial, Inc. - CFO [22]

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Steve, thanks for the question. It's Steve Yarad. I think you should bring that up because it is something that we do talk about here internally regularly. We're probably one of the few mortgage REITs who don't have a, sort of, core income concept in their reporting. And it's true that our GAAP earnings, which we've sort of used exclusively reported on now for a number of years, does suffer a little bit from quarter-to-quarter with some noise on some of the accounting elections we've made in the past. So that's something that we have thought about and potentially would think about making some changes depending on how our portfolio continues to evolve in the future.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [23]

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So Steve, it's a timely question. As Steve said, we have started to talk about that. You probably remember, we actually did have a core concept many years ago around linked transactions on Legacy Non-Agencies.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [24]

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Yes.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [25]

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But yes, it's -- suffice to say it's under consideration.

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Steven Cole Delaney, JMP Securities LLC, Research Division - MD, Director of Specialty Finance Research and Senior Research Analyst [26]

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Okay, great. And then, Craig, I can't not ask this just because of the amount of activity. I think through this week, we've had 12 follow-on offerings from mortgage REITs, and all but 1 was from a residential-focused company. Just curious on your view of the capital markets. And what we hear from these companies is almost all this new equity is being targeted to Agency MBS. That clearly isn't your focus. So I guess, I'm thinking, as you look at the market opportunities, is that agency opportunity attractive enough that it would -- you guys -- lead you guys to consider another capital markets transaction following up on your offering last summer? That's my last one.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [27]

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Sure, Steve. So obviously, we've seen the many follow-on equity issuances since the beginning of the year. I think because MFA is internally managed, our rationale for issuing additional equity is perhaps more simple than for externally managed entities. Future capital structure decisions are motivated by what's in the best interest of the company, the shareholders and we're all shareholders. I would just say, in general, we would consider issuing additional equity if we felt that we could do so at attractive levels and if we felt that we had compelling investment opportunities in which to deploy the new capital. As we stated a few times during our prepared remarks, we expect we'll be able to fund near-term expected portfolio growth through modestly increased leverage, whether in the form of repo or securitization. But obviously, to the extent that circumstances change, we'll reevaluate our options at that time. I think, yes, agencies are wider, and you saw that reflected in book value numbers. I'm not sure they're so pound the table cheap that we would sort of alter our strategy and issue equity just to buy agencies at this time.

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Operator [28]

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Our next question will come from Stephen Laws with Raymond James.

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Stephen Albert Laws, Raymond James & Associates, Inc., Research Division - Research Analyst [29]

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Like to follow-up on Doug and Steve's questions on the Non-QM and business purpose. And I understand the competitive reasons for not disclosing your partners. But can you provide a little color on the competition? There is a lot of your peers that are targeting these assets as well. How do you see the competition framing up for this? Is it pricing driven? Is it really more you guys are willing to provide underwriting standards and take down significant volume? But can you maybe talk about how you're protecting your pipeline versus others that are looking to become more active in this asset class?

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Bryan Wulfsohn, MFA Financial, Inc. - Co-CIO [30]

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Yes, Steve. While we do see there are more market participants that are evaluating the asset class and would like to get involved, what we are also seeing is significant growth to the amount of loan origination volume relating to Non-QM. So there's really a lot of room for people to get involved where it won't be so competitive, at least we believe, to push pricing to uneconomic levels. So that's sort of how we feel about that. I mean, in terms of our existing relationships, they -- we've had them for a period of time now. And the way that we're able to source loans, either through flow or sometimes limited, very limited comp, we think that we'll have the ability to continue that, and we're really -- we're happy to see more people interested in the asset class.

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [31]

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And Stephen, I think, one other point is whole loan trades are different than securities trades, right. Securities trades it's a CUSIP. It's pretty easy to figure out what the highest number is, and you sell it to that guy with the highest bid. When you trade whole loans, it's really a different thing, because there's underwriting and there's sometimes kickouts or repricings. And so, I think, with a lot of our origination partners, what they've discovered is that we're good counterparty. We work really well together with them. There have been cases where we haven't been the high bid and we win the trade anyway because they know they have that certainty of closing with us. So there's a lot that goes into it. And it's not all about money. A lot of it's about relationship and just this sort of true partnership of working together with them. But it's a lot of work. It's a lot more work to do that than to buy CUSIPs, for sure.

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Stephen Albert Laws, Raymond James & Associates, Inc., Research Division - Research Analyst [32]

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Right. And on the financing side, again. This is a follow-up question. Can you talk about -- I think one of -- at least one of your competitors is in Non-QM securitization in Q4. Can you talk about what the opportunities are in the securitization market now, kind of, given the dislocation? Have things normalized? Or that's something you think you could look at, as the market is not stabilized enough yet? And then on the -- similarly on the fix and flip, given the short duration, do you think there's securitization options of CLO or some type of option where there is a manageable period or a replenishment period where you can do the short duration assets into a longer duration financing? Can you maybe talk about the options and opportunities you see there?

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

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Sure. As it relates to Non-QM, the market for the sale of senior bonds did widen out going into the end of the year and sort of had stabilized, and we're seeing some momentum. Part of that is just adoption of the asset class, knowing that there's going to be enough supply to get the attention of the larger money managers to participate. When there's only a few billion of bonds for sale and people get called upon to take a look at new investment, they may get the reaction, is it worth my time? Now that we're seeing the increase in issuance, right, the money managers are finding okay, it is going to be worth my time. And we do see the potential for -- at least we see stability in spreads and the potential for the spreads to narrow over time.

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Gudmundur Kristjansson, MFA Financial, Inc. - Co-CIO [34]

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And so, as it relates to the fix and flip loans, there have been a few public and private securitization or securitization-like structures that have been put together. But there's also a viable weaker financing market. And so, from our point of view, our intention is to utilize leverage on that asset class over time. And we would simply look at the best option or the best execution from our point of view. Some of the issue with the business purpose loan securitization is the fact that you have to assemble enough size, and there's fixed cost involved. And the structure can become somewhat complicated because you have a lot of new ones in the underlying collateral. So in some sense, it can be more efficient to simply work with a bank or a repo provider and do that without the noise of having to basically show the market what's going on and convince people of the quality of the underlying collateral, even though it's quite solid. So we evaluate both options and our intention is to use leverage over time.

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

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And Stephen, I'd just add one thing on the fix and flip side. There have been a few deals, not many, just a handful of deals. And most recently, there were 1 or 2 deals that had this collateral concept where you could top up the collateral. But they're pretty new and the spreads are pretty wide. And I think probably the best indication of what we felt about that is -- leverage is, we were actually a buyer of the senior bond in size of one of those deals. So I think we view is at least the current pricing, we'd probably rather buy that asset than use that as a liability. But as Gudmundur said, obviously, the expectation is over time that will probably change.

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Operator [36]

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

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Craig L. Knutson, MFA Financial, Inc. - President, CEO & Director [37]

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All right. Thanks, everyone. We look forward to speaking with you next quarter.

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Operator [38]

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