Q3 2024 MFA Financial Inc Earnings Call

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Speaker Change: Ladies and gentlemen, thank you for standing by. Welcome to the MFA 3rd quarter, 2024, earnings conference call. At this time, all participants are in listen only mode. Later, we've looked into the question and answer session, and instructions will be given at that time.

Speaker Change: If you should require assistance to enter the call, please press star then zero. As a reminder, today's conference is being recorded. I will now let's turn the conference over to our first speaker. Mr. Hal Schwartz, please go ahead.

Hal Schwartz: 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 police expectations and assumptions as to MFA's future performance and operations.

Speaker Change: When used statements that are not historical in nature, including those containing words such as, will believe, expect, anticipate estimate should, could wood or similar expressions, are intended to identify forward-looking statements.

Speaker Change: Off-word-looking statements speak only as of the date on which they are made.

Speaker Change: These types of statements are subject to various known and unknown risks on certain these assumptions and other factors, including those described in MFA's Annual Report on Form 10K for the year ended December 31, 2023, and other reports that it may file from time to time with the Securities and Exchange Commission.

These risks on certainties and other factors could cause MFA's actual results to different materialy from those projected, expressed or implied in any form of looking statements it makes.

Speaker Change: For additional information regarding MFA's use of forward-looking statements, please see the relevant disclosure in the press release announcing MFA's third quarter 2024 financial results. Thank you for your time. I would now like to turn this call over to MFA's CEO Craig Knutson.

Craig Knutson: Thank you, Hal. Good morning, everyone. And thank you for joining us for MFA Financials 3rd Quarter, 2024 earnings call. With me today, our Bryan Wulfsohn, our President and Chief Investment Officer, Mike Roper, our CFO and other members of our CUMANITANTEVENT team.

I'll begin with a high-level review of the third quarter market environment, touch on some of our results, activities, and opportunities, and then I'll turn the call over to Mike to review our financials in more detail, followed by Bryan, who will review the portfolio, financing, Lima One, and risk management, before we open up the call for questions.

Speaker Change: The Federal Reserve Board decreased the federal funds rate target by 50 basis points at their meeting on September 18.

Speaker Change: This rate cut, while more than the 25 basis points expected by many market participants, was most noteworthy as a clear signal that the Fed has now embarked on an easing cycle.

Speaker Change: For levered fixed income investors, this is a welcome development after a very challenging two-and-a-half-year period of restrictive monetary policy and the accompanying inverted yield curve.

Speaker Change: Economic and labor market data has been somewhat mixed over the last few months which suggests that the easing cycle may proceed more slowly than originally anticipated.

Speaker Change: But Chair Powell has been clear that a recalibration is merited and a return to a neutral level of Fed funds is in order, although it remains to be seen how long this easing cycle lasts.

Speaker Change: and how much the Fed ultimately cuts rates, this is a clear and refreshing tailwind for our business.

Speaker Change: During the third quarter, we announced some management changes, naming Bryan Wulfsohn President of MFA, in addition to his role as Chief Investment Officer, and naming Lori Samuels as Chief Loan Operations Officer.

Speaker Change: Both Bryan and Lori joined MFA in 2010 and have played many key roles over the last 15 years. These important promotions are very much deserved and are also a testament to our deep and talented bench of senior executives.

Speaker Change: Thank you. Thank you.

Speaker Change: MFA turned in solid results in the third quarter of 2024 with distributable earnings of 37 cents, book value that was up about 1% and an economic return of 3.3%. We acquired over 550 million of loans with an average coupon of 9.4% and added just shy of 300 million agencies at quite attractive yields.

Speaker Change: We continue to utilize securitizations to fund our assets, closing two deals in the third quarter and two additional deals subsequent to the end of Q3. Our most recent deal, priced just last week, was our first rated deal for residential transition loans originated by Lima One.

Speaker Change: This rated construct materially improves our funding costs for these high-yielding assets.

Speaker Change: At Lima One, now led by new CEO Josh Woodward, some recent management changes, together with a refocus away from multifamily originations and some sales channel consolidation, have had a not unexpected impact on origination volume as we funded $329 million of business purpose loans in the third quarter.

Speaker Change: Non-QM acquisitions in Q3 were relatively flat to Q2, but we added more agencies in Q3, and it turns out that our total asset acquisitions for the third quarter were almost identical to the second quarter.

Speaker Change: The management team at Lima One is working hard to fill some personnel vacancies, including sales positions.

Speaker Change: and MFA's asset management team is actively engaged with Lima's servicing group to work through some of the delinquent loans, evaluate underwriting guidelines and institute process improvements to strengthen the platform for the future.

Speaker Change: As we have said repeatedly, Lima One is an important differentiator for MFA as it provides us with the ability to organically create our own high-yielding assets in the business purpose space.

Speaker Change: Lima One underwrites our loans and borrowers, services the loans, and manages construction draws on transitional loans. This is another important differentiator because we are not reliant on third parties to resolve loans that go delinquent.

Speaker Change: And finally, we have a unique and instant feedback loop with Loan Originations at Lima One. Because we are intimately involved with the securitization markets, and more recently a few loan sales to third parties, we were able to adjust loan pricing in real time to reflect market developments.

Speaker Change: In this welcome new period of lower rates and a steepening yield curve, we are optimistic about our business model and excited about the opportunities it will generate for Lima 1 and MFA. And I'll now turn the call over to Mike Roper to discuss our financial results. Thanks, Craig.

mike roper: September 30th, Gap book value was $13.77 per common share, and economic book value was $14.46 per common share, an increase of approximately 1% from $14.34 at the end of June.

mike roper: We declared dividends of $0.35 per common share and delivered a quarterly total economic return of approximately 3.3%.

mike roper: For the third quarter, MFA generated gap earnings of $48.2 million, or $0.38 per basic common share, up from $41.9 million, or $0.32 per basic common share in the second quarter.

Speaker Change: Our GAP earnings included net unrealized gains on our residential whole loan portfolio of approximately $140 million.

Speaker Change: These gains were concentrated primarily in our non-QM and SFR loan portfolios and were partially offset by a slight increase in credit-related unreliable losses on our multifamily transitional loans.

Speaker Change: During the quarter, we sold single-family rental loans with an unpaid principal balance of approximately $236 million. As Bryan will detail further in his later remarks, these sales included $74 million UPP of recently-originated SFR loans that were sold to third parties by LimaOne.

Speaker Change: These cells represent the first of what we expect to be a new and growing distribution channel for lemurs' origination in the quarters and years ahead.

Speaker Change: We believe that third-party sales provide strategic diversification away from securitization markets, enhance Lima's relationships with other capital market participants, and improve our returns.

Speaker Change: We report gains derived from loans sold to third parties within three months of their origination as a component of Lima One's mortgage banking income, which is included in our distributable earnings.

Speaker Change: Sales of recently originated loans contributed $3.5 million to Lima One's mortgage banking income this quarter, driving the increase from the second quarter despite lower origination volumes.

Speaker Change: Thank you. Thank you. Thank you.

Speaker Change: During the quarter, MFA again generated DE in excess of our common dividend.

Speaker Change: D.E. for the quarter was $38.6 million, or $0.37 per basic common share, a decrease from $0.45 in the second quarter. The decrease in our D.E. was driven primarily by $0.07 of realized credit losses during the quarter, primarily on our transitional loans at fair value, an increase from $0.01 of realized credit losses on fair value loans in the second quarter.

Speaker Change: As we explained in our last call, expected credit losses on our fair value loans are recorded in our GAAP results and in both our GAAP and Economic Book Values as mark-to-market adjustments over the life of the underlying loans, but only impact DE when the losses are realized, generally at the completion of foreclosure proceedings.

Speaker Change: Our third quarter G&A expenses and our DE were also impacted by non-recurring separation, severance and retirement related charges of approximately $3.3 million.

Speaker Change: We expect that the personnel changes that gave rise to these charges will result in a modest reduction in our quarterly GNA and a benefit to our DE beginning in the first quarter of 2025.

Speaker Change: Finally, subsequent to quarter end, we estimate that our economic book value has decreased by approximately 3-4% as a result of higher market interest rates.

Speaker Change: I'd now like to turn the call over to Bryan, who will discuss our portfolio highlights and the performance of Lima One.

Bryan Wulfsohn: Thank you, Mike.

Bryan Wulfsohn: We grew our investment portfolios during the quarter by adding $565 million of new loans and $294 million of agency securities. NEMA I originations and draws accounted for $329 million of the additions.

Bryan Wulfsohn: Non-QM purchases sourced from both bulk and flow channels total $236 million with an average coupon of 8.2% and an LTV of 64%.

Bryan Wulfsohn: We grew our agency MBS portfolio to approximately $1 billion during the quarter since we believe spreads and carry continue to be attractive.

Bryan Wulfsohn: Our purchases have been focused on low pay-up pools, which provide some prepay protection without sacrificing yield.

Bryan Wulfsohn: We believe these investments currently offer ROEs in the mid-teens and are complementary to our credit portfolio.

Bryan Wulfsohn: In addition to the runoff, we sold $241 million of loans from our single-family rental loan portfolio in the quarter. All of those loans we sold were made by LimaOne, and $77 million of them were newly originated.

Bryan Wulfsohn: We expect to sell more loans moving forward as the bid for rental loans remains strong, particularly from insurance accounts looking to add duration to their investment portfolios.

Speaker Change: As Craig touched on, we have been successful in the securitization markets across our loan strategies.

Bryan Wulfsohn: The market has been supportive of residential securitized credit, absorbing almost double the issuance year-to-date as compared to last year.

Bryan Wulfsohn: We issued a rated RPL transaction in July, selling $259 million of bonds at a cost of debt of approximately 5.8%.

Bryan Wulfsohn: In September, we issued our 15th non-QM securitization, selling 321 million bonds with a coupon just under 5.4%.

Speaker Change: In post-quarter end, we issued a non-rated deal, compromise of NPLs from our legacy RPL-NPL portfolio.

Speaker Change: And last week, we were excited to close our first rated RTL securitization, issuing over $200 million of bonds at a coupon just under 6%.

Speaker Change: The rated nature of the transaction allowed us to lower our cost of funds significantly from the last non-rated RTL deal. The senior tranche in our rated deal traded 75 basis points tighter than our senior tranche of our last non-rated transaction.

Speaker Change: We have now securitized over $10 billion in loans since 2020, and the percentage of our loan portfolio financed by securitizations was 70% at the end of the quarter.

Speaker Change: Many of these securitizations are callable, or will become callable, in the coming quarters and years. These call options give us the ability to refinance at lower rates if borrowing costs come down, as well as the opportunity to re-lever our collateral and redeploy capital as bonds pay down.

Speaker Change: Our estimated duration rose modestly in the third quarter to 1.16 from 1.12 a quarter ago.

Speaker Change: As a reminder, we hedge our interest rate exposure by issuing fixed rate securitizations of which we have $5.5 billion of bonds sold outstanding, and with interest rate swaps of which we had $3.5 billion notional at the quarter end.

Speaker Change: One billion of these swaps will be rolling off in the next two quarters, and as we continue to add agencies to our portfolio, expect to see additional swap activity and incremental usage of longer-dated swaps to balance out the portfolio. Moving to Lima One.

Speaker Change: We originated $312 million of loans in the third quarter, which was down from just over $400 million in the prior quarter. 75% of Q3 origination was in short-term transitional loans and 25% in longer-term rental loans.

Speaker Change: As previously mentioned, we have begun to programmatically sell rental loans as a way to generate additional income and enhance Lima One's franchise value.

Speaker Change: We attribute the decline in origination volume to restructuring of Lima sales organizations since our shift away from multifamily lending. We have been adding talent to our production team and improving borrower outreach with marketing and technology initiatives that should start to pay dividends with higher volume beginning in 2025.

Speaker Change: Moving to our credit performance.

Speaker Change: 60-plus day delinquencies for our entire portfolio increased to 6.7% from 6.5% a quarter ago. The rise was primarily from our non-QM and multifamily loan portfolios.

Speaker Change: As it relates to non-QM, given our low portfolio LTV, when a borrower falls behind on payments, they usually just sell the home and pay us off in full to protect their equity.

Speaker Change: Multifamily delinquencies increased by 7 million over the quarter to 61 million. In post-quarter end, that figure rose by an additional 33 million.

Speaker Change: As a reminder, our asset management team has worked through billions of dollars of defaulted loans over the past decade to the benefit of our borrowers and shareholders.

Speaker Change: We have and will continue to leverage that team to improve outcomes across our entire loan portfolio including working through delinquent transitional loans with our servicing group down at Lima One.

Speaker Change: We believe the combined expertise and experience of these teams puts MFA in a strong position to deliver for our investors.

Speaker Change: And with that, we'll turn the call over to the operator for questions.

Speaker Change: and many more. Thank you. Thank you.

Speaker Change: And ladies and gentlemen, if you wish to ask a question, please press 1 then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1 then 0 command.

Speaker Change: If using a speakerphone, please pick up your handset before pressing the numbers.

Speaker Change: Once again, if you have a question, please press 1, then 0 at this time.

Speaker Change: Our first question today comes from the line of Doug Carter. Please go ahead.

Doug Carter: Thank you.

Doug Carter: Thanks. Just first, hoping you could clarify the book value comments you made. Just

Speaker Change: Craig Knutson, Michael Roper, Craig Knutson, Harold Schwartz, Bryan Wulfsohn, Harold Schwartz,

Speaker Change: Thanks for the question. So that 3-4% is probably as of earlier this morning and it's a bit of a moving target with some spread volatility and rate volatility, but that would be net of the dividend accrual.

Speaker Change: and Michael Roper. Thank you. Thank you.

Speaker Change: Great, appreciate that.

Speaker Change: How are you thinking about the earnings power of the portfolio and the sensitivity to lower short-term rates as you factor in the swaps you have and swap expirations?

Speaker Change: Again, thanks for the question. This is something we spend a good amount of time looking at. I think when we think about the earnings power of the portfolio, we try to look at what those assets and liabilities and hedges would be if we were to effectively restrike those yields today. And effectively, over the long term, whether that's reported as interest income, interest expense, or mark-to-market, that is what the earnings power of the portfolio is going forward.

Speaker Change: So, you know, given where things are marked at $9.30 and obviously returns have increased since quarter end with the sell-off and rates, you know, I think we feel really good about, you know, where the dividend is set and what that earning power is of the portfolio in the context of the dividend.

Speaker Change: As for your question about the swaps, yes, we have some swaps rolling off at the beginning of the fourth quarter, or really at the end of the fourth quarter, and again in Q1. But again, we've benefited for a long time from those swaps, with really below-market pay rates.

Speaker Change: But as we sort of re-strike those yields, again, we feel really good about the earnings power of the portfolio going forward.

Speaker Change: Thank you. Thank you.

Speaker Change: I appreciate that. Thank you.

Speaker Change: Thanks, Doug.

Speaker Change: And if there are any additional questions at this time, please press 1, followed by the 0 on your touchtone phone.

Speaker Change: Thank you very much.

Speaker Change: Once again, if there are any additional questions, please press 1 followed by the 0. And our next question comes from the line of Eric Hagen. Please go ahead.

Eric Hagen: Hey thanks, good morning. Can you talk about how much loan warehouse capacity Lima 1 has to retain loans on the balance sheet in a scenario where the securitization pipeline maybe doesn't turn over as quickly and spreads worldwide?

Speaker Change: So, we have ample capacity and several RTL revolving securitizations outstanding.

Speaker Change: So, you know, there's really, combined between MFA and Lima One, you know, we have over a billion dollars of potential borrowing, you know, on those assets, away from securitization. So, you know, really, there's plenty of room.

Speaker Change: and Bryan Wulfsohn.

Speaker Change: Thank you.

Speaker Change: What would you say are some of the considerations or constraints, if you will, to taking the agency portfolio back up again and increasing leverage there?

Speaker Change: I mean, really, we just look at what spreads are available in the market and versus our other assets.

Speaker Change: So we do think it's a complementary asset to our credit portfolio. You know, we grew it to a billion.

Speaker Change: If you were to look out, if spreads remain where they are and the shape of the curve continues to steepen out, we could see that growing to maybe a billion and a half to two billion in the coming quarters.

Speaker Change: Got you. All right, that's actually really helpful. Thank you.

Speaker Change: Thank you.

Speaker Change: Thanks Eric.

Speaker Change: And our next question comes from the line of Bryan Zialino. Please go ahead.

Bryan Zialino: Great. Thanks for taking my question. Just was hoping to get some more detail on the programmatic loan sale outlook. I guess how big could that distribution channel get over time and is it only SFR or could we see some transitional loan sales as well?

Speaker Change: So, Bryan, I'll take that as Craig. So, you know, I think it could be a significant part of, particularly on the rental side. As Bryan said, the, you know, the demand is pretty significant there.

Speaker Change: You know, it's still an asset that we like and that we also have in our portfolio, but I think

Speaker Change: You know, these third-party sales, they validate pricing, they validate marks, they open an additional distribution channel. Right now, I think our rental loans were about 25% of the origination in the quarter.

Speaker Change: in a lower rate environment, you know, that could grow over time. So, you know, I think it's, you know, it's another arrow in the quiver. It's not what we'll do with all rental loans.

Speaker Change: But, you know, it's a good outlet to have. You know, if you fast forward and...

Speaker Change: and imagine Lima One's origination volume, you know, growing significantly over the next couple of years, you know, it may be a more necessary outlet at some point. But for now, I think, you know, we're really just developing another distribution channel.

Speaker Change: Thank you.

Speaker Change: Okay, great. Thank you very much. That's it for me.

Speaker Change: Thanks.

Speaker Change: And our next question comes from the line of Boz George. Please go ahead.

Boz George: Good morning. Actually, can you talk about how much was the credit mark on the you know the multifamily piece of the BPL and then just can you remind us just how much exposure you have left there?

Speaker Change: Thank you very much.

Speaker Change: Yeah, so during the quarter, it was about $15 million, and we now carry that portfolio at, I think it's a four-point discount to the total UPB. The total UPB at 9.30 was right around a billion, through the exact number.

Speaker Change: $1.1 billion as of 9.30

Speaker Change: Can you talk about the competitive side of the BPL business, the demand side seems very strong but are you seeing incumbents trying to grow or can you characterize how that's developing?

Speaker Change: Thank you very much.

Speaker Change: Yeah, it's definitely competitive. But, you know, as we mentioned, you know, volume was down slightly. We're sort of out in the market trying to attract talent. And really, the way the way that we believe you grow, there's sort of three ways, right? It's having a good sales force, and then there's, you know, marketing and sort of technology improvement.

Speaker Change: We think we're sort of getting to, you know, improving out all three of those fronts. And, you know, we're aware that it's competitive, but we think there's, you know, there's enough room for us to get back that volume that we sort of had lost over the past quarter.

Speaker Change: Okay, great. Thanks.

Speaker Change: Thanks, both.

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Speaker Change: Thank you, Operator. Thanks everyone for your interest in MFA Financials. We look forward to speaking with you again in February when we announce fourth quarter results.

Speaker Change: Thank you.

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Speaker Change: [inaudible]