Q2 2023 MFA Financial Inc Earnings Call
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Thank you operator, and good morning, everyone. The information discussed on this conference call today may contain or refer to forward looking statements regarding MFA financial Inc, which reflect management's beliefs expectations and assumptions as to Mfa's future performance and operations. When used statements that are not historical in nature, including those containing words such as we.
I'll 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.
Some 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, 2022, 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 2023 financial results. Thank you for your time I would now like to turn this call over to Mfa's CEO and president.
Knutson.
Thank you Hal good morning, everyone and thank you for joining US here today for MFA Financial's second quarter 2023 earnings call also with me today are Steve <unk>, our CFO <unk> Christiansen, Brian Wilson, our co chief investment officers and other members of senior management.
The interest rate environment in the second quarter of 2023 was another volatile one with rates grinding higher for most of the quarter two year treasuries were below 4% early in the second quarter. After rallying in the aftermath of the banking crisis in March however, as the fear of additional banking fallout begin to fade the bond market.
We seem to capitulate and begin to take fed chair Powell is consistent message to heart, we don't hear so much about the false optimism of a rate cut later this year and bond yields, particularly two years moved higher throughout the quarter to reflect this reality.
Two year treasuries ended the quarter, almost 100 basis points higher than the 210 year inversion widened from about 50 basis points at the beginning of the quarter to about 100 basis points at the end of the quarter. This inverted curve together with general interest rate volatility continued to make levered investing in fixed income and in mortgages and <unk>.
Particular, very challenging that said mfa's risk management discipline and strategic initiatives have enabled us to weather. This storm extraordinarily well our net interest rate spread increased by 40 basis points from 174 to $2. One four during the second quarter. Despite this challenging backdrop.
As we have for several quarters now effectively locked in our funding costs through securitization and interest rate swaps.
The yield on our interest earning assets increased by 41 basis points, while our interest expense increased by only one basis point, we added almost $1 billion of new investments in the second quarter as we continue to add assets at progressively higher yields our distributable earnings for the second quarter was <unk> 40.
Which comfortably exceeded our <unk> 35 dividend.
Our book value was up modestly in the second quarter, but this should not be a big surprise as we have consistently communicated that our net portfolio duration gap has been about one this duration exposure led to a book value increase in the first quarter and to a book value decline in the second quarter and we generated a total economic return for the first half.
The year of 2%.
As we illustrate on page 10 of our earnings deck. Our book value was driven overwhelmingly by the higher interest rate impact on the fair value of our loan portfolio, which is marked at a substantial discount to par. Despite the fact that the fair value of these loans is below par the principle that we receive whether through pay offs curtain.
Ailments or simply scheduled monthly principal payments are received at par. We're very pleased with our portfolio credit metrics as we saw loan delinquencies declined during the second quarter in each of our major asset classes.
The substantial seasoning of much of this portfolio and current LTV of 59% provide a solid credit backstop that supports the expectation that this principle will be repaid at par.
Although the future interest rate outlook is far from certain it appears that the fed is at or at least near to the end of the rate tightening cycle and the consensus at this point seems to be that the fed will hold rates steady for at least the next few quarters to give the economy and markets the necessary time to feel the cumulative impact of 500.
25 basis points of tighter monetary policy.
Fortunately, we continue to benefit from the hard work we did in late 2021 in early 'twenty, two which effectively fixed our funding costs. While we now have attractive investment opportunities to add new assets at very accretive yields as we show on page seven of our earnings deck very few of our $3 billion of interest rate swaps mature.
Before the fourth quarter of 2024.
Finally, our wholly owned business purpose loan originator Lima, one continues to shine producing successively higher volume levels of high yielding and high quality assets, we cannot emphasize enough. The inimitable value that this captive originator deliveries to MFA shareholders not only does it provide a steady and.
<unk> source of internally generated assets, but the significance of the integrated nature of this arrangement is evident and loan performance one of the underappreciated benefits of a captive originator versus a more broad and fragmented aggregator strategy that Lima, one underwrites. These loans they service the loans they manage the construction.
Draws and most importantly, they have a relationship with the borrowers now this is not to suggest that loans will not go delinquent. This is always a risk, but we uniquely control our own outcome and there is no conflict of interest between the originator servicer and the investor because we all live under the same roof.
And I'll now turn the call over to <unk> to talk about portfolio activity and Additionally, about Lehman one.
Thanks, correct second quarter acquisitions increased by approximately 60% compared to the first quarter as we added approximately 1 billion of loans and securities and grew our investment portfolio by 5% to about $8 9 billion.
Business purpose and non QM loans accounted for majority of our acquisitions at approximately $900 million.
These loans had an average coupon of approximately nine 5% and a strong credit profile with average LTV of 68% and average FICO of 734.
We also continued to execute on our agency MBS strategy and added about $100 million of agency MBS in the quarter.
That portfolio now stands at about $400 million and as we discussed last quarter. We believe that agency MBS yields and spreads are attractive here on a standalone basis.
But they also provide risk management benefits store credit focused portfolio by improving portfolio liquidity and having the potential to perform well during periods of economic softness.
Given current financing levels, we expect that return on equity will be around mid teens for the second quarter editions and that continues to be the case for assets that we're adding in the third quarter.
Significantly higher interest rates and wider credit spreads today compared to the late 2022 early 2022 period, providing us with a great opportunity to add attractive assets to our portfolio.
A combination of prudent risk management and strategic decisions have put us in a position to take advantage of this environment.
First our significant interest rate hedging activities in late 2021 in early 2022 combined with active securitization. So for whole loans have helped us maintain substantial liquidity and a strong balance sheet.
Our strategic acquisition of <unk> in 2021 provides us with the capacity to create high quality and high yielding business purpose loans in size.
This combination of liquidity and access to attractive assets Hasnt in the last three quarters allowed us to acquire about $1 9 billion of loans with an average coupon of approximately nine 5%.
As Craig highlighted in his opening remarks, we are seeing the benefits of these acquisitions in our yield on interest, earning assets, which increased 41 basis points compared to the first quarter and is up 135 basis points from a year ago to six 1% in the second quarter.
The increase in asset yields combined with the relative stability of our funding costs increased our portfolio of spreads of 214 basis points in the second quarter of 40 basis points compared to the first quarter and up 70 777 basis points from a year ago.
The economy continues to be resilient and seems to have coped well with the significant market volatility from the regional banking crisis, and a debt ceiling stand up in the second quarter with the first suite in the second quarter GDP coming in above expectations of two 4% in the labor market remains resilient with unemployment.
Right hovering around three 5% the last 15 months.
The housing market is also a surprise many are showing resilience in the face of higher mortgage rates with low element. It has low inventory levels proving to be a strong counterweights to low affordability.
National home prices declined about 3% in the second half of last year, but the housing recession appears to be over for now with national home prices rising about 2% year to date.
These trends combined with inflation steadily trending down and improved the outlook for the economy in the short to medium term and rate the probability that the fed may be close to the end of this hiking cycle, but also that they may keep rates elevated for longer.
This creates a favorable backdrop for credit focused portfolio as delinquencies and loss severities are less likely to deteriorate when the labor market is strong and home prices are rising.
In addition, the current high yielding investment environment.
Last longer if the fed is about to settle in around current fed fund levels for some time and let the lagged effect of monetary policy work its way through the system.
Turning to leave alone.
Lima wanted a really strong quarter and continued to show its importance to our investment strategy.
<unk> originated approximately $584 million of business purpose loans in the second quarter, a 50% increase from the first quarter.
And has originated about $4 3 billion of business purpose loans for our balance sheet since our acquisition two years ago.
Similar to the last few quarters. The majority of origination was focused in the short term transitional loans, which accounted for about 85% of second quarter origination.
Demand for <unk> products and services remains strong with disruptions into private lending space and less competition from regional banks, providing opportunities to grow market share and attract talent in this space.
The third quarter is off to a good start with July origination volume of approximately $215 million and we expect the third and fourth quarters each to have over $600 million of origination.
Credit quality remains fundamental to our BPL strategy and the credit statistics in Lima second quarter origination remains strong with average LTV of 66% and average FICO score of 777 hundred 38 on loans originated.
The 60, plus day delinquency rate on our BPL loans originated by <unk> remained exceptionally low at two 2% in the second quarter.
Lima services all of the loans they originate in house and have a highly experienced construction management team that reviews, all construction budget and as an active hand in loss mitigation activities.
We believe this is a huge advantage in the VPN space, which combined with our investment strategy and credit culture has led to excellent credit performance.
I will now turn the call over to Brian Wilson, who will discuss mfa's securitization activities and portfolio credit performance in more detail.
Thanks, good lender.
The story in the securitization markets remain the same in the second quarter.
Great volatility remained elevated which generally leads to spread widening but the counterbalancing force being limited technical supply picture.
We issued one securitization backed by non QM collateral in the second quarter.
In connection with that securitization, we sold $300 million UCB in may prior to the rates back up in June locking in at six 1% cost of debt.
Although we did not issue a securitization backed by transitional loans in the quarter. The two outstanding revolving deals previously issued continued to provide significant benefits as.
As we now have recycled over $300 million in loans into those structures.
Recently, we have seen a tightening in securitization spreads as rate volatility has calmed down and absence of supply continues to provide a tailwind.
Spreads on AAA for recent deals in the market are closing in on the types for the year seen earlier in January .
We expect to come to market again in the third quarter and continue to believe that mortgage securitization will be an important part of our business strategy as it provides for nonrecourse non mark to market financing, which will further insulate the portfolio from volatile markets.
Moving to our credit performance.
You saw improvement over the second quarter across our loan portfolio.
60, plus day delinquencies in our purchase performing loans.
Decreased two 8% from three 1% in the first quarter.
The components of that portfolio being the non QM transitional loan and <unk> portfolios all showing improvement.
60, plus day delinquencies in our legacy Rps NPL portfolio also improved by over three points from the prior quarter down to 27, 4%.
This improvement resulted from a combination liquidating previously delinquent loans as well as revising delinquent loans back to current status through active asset management.
Our asset management team has deep experience working through distressed situations to the benefit of our investors.
We have now successfully worked out over $3 billion in loans, which we believe puts us in a unique position to be able to take advantage of potential opportunities. In addition to limiting losses in times of economic stress.
Prepayment speeds on our purchase performing portfolio increased moderately from the prior quarter.
Our legacy <unk> portfolio, CPR increased almost 3% from the previous quarter and our legacy NPL portfolio had a significant increase over 10% to 14 CPR.
These increases were expected of seasonality impacts from real estate transaction activity tends to push speeds in the spring.
Total paydowns for the quarter were over 400 million, which were reinvested into loans carrying a coupon approximately 250 basis points higher.
Lastly, we continue to take advantage of the strong housing market, reducing our Oreo portfolio, which continues to shrink as fewer properties are entering Oreo status and are being sold out of the portfolio.
Over the quarter, we sold 95 properties for $32 million, resulting in $4 million in gains.
We believe the low LTV of our portfolio combined with prudent credit underwriting of our portfolio well positioned for the current economic environment.
And with that I will turn the call over to the operator for questions.
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And we'll go to the line of Bose George with <unk>.
Okay.
Yes.
The duration gap that you've noted in a year, how do you kind of arrive at that level.
Versus being more youthful.
Hi, yes. Thank.
Thank you yes.
We've kind of been around that level for some time.
We tightened it up a little last year, obviously, as we mentioned when we put on the.
The interest rate swaps and hedges so.
Late 'twenty, one and 'twenty two we did a lot of our hedging as well as for securitization activities.
Way, we've thought about it is.
As rates have risen.
It feels appropriate to have some duration in our portfolio most of our hedges are on the front end of the curve. So we have.
Effectively isolated the impact of rising rates.
Cost of funds and that was really our emphasis to make sure that like we would stabilize the spread in our cost of funds over the long term.
As rates are now probably read seeing.
Close to the end of the hiking cycle for the fed it feels like Youre supposed to respect both sides of the risk here.
Fact that look the fed could go a little bit higher but with inflation trending down.
Probably at the point in time when.
The effects of economic policy.
Facts of fed policy of working its way through the system and so we think having a balanced portfolio, where we have the front end, but then have some duration that could potentially benefit from declining rates is the right approach will keep in mind the duration of one.
<unk> is fairly low in the context of probably the space because keep in mind, our leverage is only about three nine times and so really the impact on equity is always deleverage time situation.
And then the other thing is majority of our returns come from credit and credit exposure and credit spreads are pretty wide.
And so.
In the event that the economy continues to stay resilient. We do think we have a lot of benefits from the credit side of the portfolio.
Not necessarily reflected just in the duration.
Okay, great Yeah that makes a lot of sense. Thanks, and then just switching to just the opportunities.
Arise from some of the turmoil at the banks can you just talk about spots, where you could potentially yes.
Yes areas to deploy capital.
Sure.
And you have heard a lot about bank capital rule changes recently, and how that could open investment opportunities for mortgage Reits and this is certainly possible, but I think some of that optimism is probably a little bit premature.
We see the portfolios that are described as for sale, but in many cases in many cases, the sellers of prime jumbo loans with low interest rates are not willing or able to sell these pools at market prices and.
In addition, and most of these cases would be bank sellers, they really want to maintain their relationship with the borrower. So their preference would be to retain the servicing even if they sell the loans and this can also create challenges for a buyer such as ourselves who would want to use securitization as a financing strategy because many of these.
Banks are not setup to properly service to a securitization so now pricing expectations could lineup with reality in the future and obviously the operational friction can be overcome but this will likely take some time.
And finally I'll point out that.
But as we focused on primarily non QM loans and business purpose loans for the last five years and I think that.
That came from our belief that these loan classes offered superior risk adjusted investment returns, but we also identified a very strategic component of this investment strategy and namely that was because there was very little competition for banks for these loans. So I don't I don't think it's by accident that those are the loans that we focused on there could be there could be some.
Opportunities going forward, but at least thus far I think there were some real challenges to banks.
Banks selling loans at market prices.
I would just add in terms of the Lima, one and then kind of the BPL origination side.
We are feeling some benefits on the margin.
Lack of competition from regional banks.
Those banks definitely would compete in some of the transitional loans fixed and flip construction loans and so to the extent that their balance sheet is constrained.
As well as potentially higher capital requirements on them.
We are definitely feeling some benefits on that I mean, it's not a transformational thing, but on the margin it's definitely making.
Lima.
Life easier to attract borrowers.
Okay, great. Thanks, a lot.
Thank you. Our next question will come from the line of Steve Delaney of JMP Securities.
Good morning, everyone and congrats on the strong distributable EPS figure of 40.
Reading in the deck I was I was curious about the economic book value decline of about 5% to 6%, but I see you're in the deck youre attributing that to just higher.
Higher interest rates.
Compared to where we were in the second quarter, which.
Where the bonds are today better better than I, but on average, we're probably up 50 basis points I'm curious if you've put any additional interest rate swaps on your on your.
Portfolio.
And the last couple of months to try to protect book value.
Sure. Thanks for the question Steve So in answer to your question no. We have not added additional interest rate swaps, but if we look at where the price changes were in the second quarter I think they are exactly where you'd expect them to be the majority of loan prices that led to that book value decline were non QM loans, which were.
We down a point in three quarters, or so and single family rental loans, which were probably down about two points or so so again I don't think its a big surprise.
As <unk> said, we do see that.
The overall interest rate risk being a little more balanced than we certainly did a year ago.
And just to add to that we performed a securitization of non QM loans in may and we didn't take off any hedges when we execute on that securitization so and the majority of the assets that we added were much shorter in nature being the BPL loans. So we didn't really think.
It made a ton of sense to add a bunch of hedges in the quarter, but we obviously reevaluate that on a day to day basis.
Yes, that's a good plans.
It was 85% of the <unk>.
<unk> origination was in the shorter term transitional loans.
Yes, and those trying to external lines do you actually float the rate or is it just the short term nature of the loans that you might have a fixed coupon, but its short duration.
Yes. It is the short term nature of them. So they are off a fixed rate coupon. So it is a short term nature of them unless you've seen if you look through our deck. The coupon is becoming up every single quarter substantially and leg as you look at our pipeline currently we say the coupon and the pipeline is above 10%, but thats a blended coupon. So if you just look at the transitional loans.
They are probably closer to 10, 5%.
10, 5% to 75, something like that in terms of coupon. So that's what's coming on on the books and those are short assets and we continue to see paydowns in that book.
You said like the CPR is about 42 to three months CPR on the transitional loans, but the paydown.
As a substantial pay down in terms of principal received and Thats as Brian pointed out the Paydown was about 7% coupon it came off.
Got it okay.
Do you have a handy.
Distributable return on equity figure for the second quarter that you've calculated.
I'm sorry.
Do you have a distributable return earnings return on equity using distributable earnings for the second quarter.
So I guess.
We can calculate it.
Annualized.
So annualized it's probably kind of 11% on book value that's close enough.
That will give us a good target to kind of.
Just have in mind, as we're updating model and such and Okay well look.
Good dividend coverage 40 over 35, it sounds like the portfolio is only improving in terms of yields so.
Keep it in the middle of the road guys.
You are in a good place.
Thank you Steve.
Sure.
Thank you we'll go next to the line of Doug Harter with credit Suisse.
Thanks.
Looking at slide 10, which shows the potential upside to economic book value.
Can you talk about where most of the assets.
Discount.
And.
Kind of how should we think about the duration of those assets or the time that it might take to recover that.
Yes.
So I would just say.
The top of my head that the majority of that is going to be in non QM loans and single family rental loans.
And.
What do you think in terms of average life for yes, I mean, the average life.
Four to five years kind of for the portfolio as a whole and as Craig pointed out most of the discount is probably in the non QM single family rental as well as some of that.
PCT loans as well because those that are longer duration assets would have declined the most in value as rates rose and you think about the portfolio.
Slide was probably five years on these longer assets for the entire portfolio is around four years.
Got it.
Does that any of that discount kind of get accreted back into distributable earnings or kind of as those loans pay off.
So open book value.
For the for the carrying value assets, we are going to accrete.
So the discount to the save a one counter distributor gets backed out right.
As the carrying value loans, increasing value that probably gets gets reflected in the yield if we get additional payoffs or additional.
It returns or cash flows on those loans.
Ryan can payoffs would definitely be reflected in the book value because we're getting principal back at par that is.
To the extent, we acquired assets at a discount and they pay off that would be reflected in a higher yield to so those are the two components.
But do things that are fair value as Steve was pointing out.
That goes to the income statement, just as rates go up or down and get that GAAP earnings, but not in distributable.
Okay.
I appreciate that thank you very much.
Thanks.
Thank you and we'll go next to the line of Eric Hagen with BTG.
Hey, Thanks, Good morning, actually first in the conversation out maybe just a little bit more like what would be the impact in marketing the securitized debt to market if rates were to drop in that duration.
Or to shorten on the non QM portfolio like what would that look like is there any are there any kind of is there any optionality in the on the on the liability side that would.
We should think about when rates drop.
Okay.
Also we show we show them that page 10, we show there is a.
The Gray bar, that's the discount for the securitized debt the discount for park, because we have to net that against the assets because obviously the.
<unk>.
Our point is that we're going to pay back all that securitized debt at par so even though some of those AAA bonds that we sold at less than 1% yields might be worth in the low eighties.
Those are going to get repaid at par.
Do you feel like there could be an opportunity to call on re securitize any of the non QM deals that you did like the one that shortly after the pandemic if spreads come in a lot more from here.
I mean, there certainly are opportunities.
Call them.
I think generally it's probably a three year.
I'll call period.
But again, we'll have to balance the outstanding cost of outstanding Securities versus where we could reissue.
Right.
Another one here on <unk> I mean, do you have the unfunded commitment blum of one portfolio and over what kind of timeframe that gets <unk>.
Distributed.
Yes, I think we show the portfolio.
Look at face.
<unk>, if you show the <unk> and the maximum loan amount and so the difference of the two would be the <unk>.
This commitment so it's about $480 million or so.
$580 million.
And the way that that really works its just kind of in the normal course of business.
Draws happened.
It's akin to quote buying a new loan.
And so we find that on our warehouse lines.
Transitional loan securitization in the normal course of business as Brian pointed out for example, in our revolving securitization $400 million, but that's why we funded on day, one and then subsequently we've done $330 million additional has rolled through that deal because stuff pays off for new things in the new things. We're funding are both new <unk>.
<unk> as well as draws on those loans.
And then the other thing is the draw rate on our portfolio is equivalent to about 30, CPR, but the paydown is equivalent to about 42 CPR so effectively.
This is organically funded.
It is through our paydowns on the on the transitional loan portfolio as well as through our warehouse lines and the Securitizations in the securitized loan self funded within the securitization that's right.
Right yes.
Yes.
On the RTL securitization can you remind us how much time is left on the revolving period.
Do you have.
Yes. So the first one we did that in May of last year. So we have another year left on that roughly and then we did one in February of this year, which was.
So that leaves another year and a half and then.
Uh-huh.
Great. Thanks for the comments guys Thats helpful.
Thank you thanks, Eric.
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Alright. Thank you everyone for your interest in MFA financial enjoy the rest of your summer and we look forward to our next update when we announced third quarter results in November .
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