MFA Financial's CEO Discusses Q4 2012 Results - Earnings Call Transcript

Mar. 6.13 | About: MFA Financial, (MFA)

MFA Financial, Inc. (NYSE:MFA)

Q4 2012 Earnings Call

March 6, 2013 10:00 AM ET

Executives

Danielle Rosatelli - Accounting and Operations Assistant

Stewart Zimmerman - Director, Chairman of the Board and Chief Executive Officer

William Gorin - Director and President

Stephen Yarad - Chief Financial Officer

Ronald Freydberg - Executive Vice President

Craig Knutson - Executive Vice President

Harold Schwartz - Senior Vice President, General Counsel and Assistant Secretary

Kathleen Hanrahan - Senior Vice President and Chief Accounting Officer

Gudmundur Kristjansson - First Vice President

Analysts

Henry Coffey - Sterne, Agee

Chris Donat - Sandler O'Neill

Daniel Furtado - Jefferies

Rick Shane - JPMorgan

Gabe Poggi - FBR

Vlad Rudnytsky - Deutsche Bank

Operator

You may begin.

Danielle Rosatelli

Good morning. The information discussed on this conference call today may contain or refer to forward-looking statements regarding MFA Financial, Inc., which reflects 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, believes, expect, anticipate, estimate, plan, continue, intend, should, could, would, may 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, but not limited to those relating to changes in interest rates and the market value of MFA's investment securities; changes in the prepayment rates on the mortgage loans securing MFA's investment securities; changes in the default rates and management's assumptions regarding default rates on the mortgage loans securing MFA's MBS; MFA's ability to borrow to finance its assets; implementation of or changes in government regulations or programs affecting MFA's business; MFA's ability to maintain its qualification as a real estate investment trust for federal income tax purposes; MFA's ability to maintain its exemption from registration under the Investment Company Act of 1940; MFA's estimates regarding taxable income and the timing and amount of distribution to stockholders; and risks associated with investing in real estate related assets, including changes in business conditions and the general economy.

These and other risks, uncertainties and factors, including those described in MFA's Annual Report on Form 10-K for the year ended December 31, 2011, its quarterly reports on Form 10-Q for the quarters ended March 31, June 30 and September 30, 2012, and other reports that it may file from time-to-time with the Securities and Exchange Commission, 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 2012 financial results. Thank you for your time.

I would now like to turn this call over to Stewart Zimmerman, MFA's Chief Executive Officer.

Stewart Zimmerman

Good morning, and welcome to MFA's fourth quarter 2012 earnings call. Joining me this morning are Bill Gorin, President; Steven Yarad, Chief Financial Officer; Ron Freydberg, Executive Vice President; Craig Knutson, Executive Vice President; Harold Schwartz, Senior Vice President and General Counsel; Kathleen Hanrahan, Chief Accounting Officer; and Gudmundur Kristjansson, First Vice President.

What I'd like to do this morning is just go over some of the highlight of the press release that I hope all of you have had the opportunity to look at. I'm not going to go over the whole thing, but just a number of them that I think are important and then very quickly open the call for Q&A.

So if we're looking at the fourth quarter 2012 highlights, our net income per common share was $0.19 with core earnings per common share of $0.20. Book value per common share grew to $8.99 as of December 31, 2012, compared to $8.80 as of September 30, 2012, and $6.74 at December 31, 2011.

For the year, MFA strategy of investing at both Agency and discounted Non-Agency mortgage-backed securities generated book value share growth of 33%, in addition to quarterly dividend payment. At January 31, 2013, our book value have grown to $9.40, as Non-Agency mortgage-backed security prices have continued to gain additional value.

On March 4, 2013, our Board of Directors declared a special cash dividend of $0.50 per share of common stock. This dividend reflects a portion of the re-taxable income in excess of distribution, previously paid to stockholders for prior period. This dividend will be paid on April 10, 2013, to stockholders of record on March 15, 2013.

A combination of both home price appreciation and mortgage amortization has led to a decrease in loan-to-value ratio for many of the mortgages, underlying our Non-Agency portfolio. Due to this lower LTV, we have reduced estimated future losses within our Non-Agency portfolio.

As a result, in the fourth quarter, we transferred $81 million to accretable discount from credit reserve, and transferred $152.5 million in total for 2012. This increase in accretable discount prospectively increases the yield on Non-Agency mortgage-backed securities and will be realized in income over the life of the assets.

Following a detailed review of tax calculations, initiated my management, we determined that REIT taxable income for certain prior periods exceeded distributions made to stockholders. Consequently, our Board of Directors declared a special cash dividend, totaling approximately $179.4 million.

Approximately $130 million of this distribution will be allocated to the previously undistributed REIT taxable income for 2010 and 2011, with the remainder available to satisfy a portion of 2012 taxable income undistributed to date. Determination of 2012 taxable income will not be finalized until a timely filing of our 2012 tax return, which is expected occur in the third quarter of 2013.

Before filing our 2012 tax return, MFA may elect to apply on an asset-by-asset basis, an alternative methodology for calculating taxable income for non-agency assets acquired in 2012. Application of this alternative methodology may serve to reduce the final determination of 2012 taxable income.

After payment of the special dividend, we currently estimate that under either methodology, taxable income for 2012 is in excess of distributions paid to date in respect of that year. And it expects that our Board of Directors will declare dividends in 2013 to address any undistributed 2012 taxable income.

Having said that, what I would like to do is thank you all for your continued interest in MFA, and open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Henry Coffey of Sterne, Agee.

Henry Coffey - Sterne, Agee

Looking forward, it's fair to assume that there may be some potential additional distribution coming in '13, as you're going to put the final dots on your September tax filing?

Stephen Yarad

So as Stewart pointed out to you, we are yet to finalize our calculations for '12 and what Stewart mentioned is there is two alternative methodologies and we need to compare both methodologies to calculate our 2012 taxable income. But what we have said in writing and in terms of call is the special distribution fully satisfied or under distribution for '10 and '11, and based on our estimate of 12, it's only partially paid out all our distributable income for 2012.

So to make the assumptions, there is yet some more distribution relating to 2012 would be correct, but we haven't finalized '12 and we're not ready forecast '13. So hopefully, that's able to help you with your question.

Henry Coffey - Sterne, Agee

Sort of looking forward, the FHFA put out their plan for 2013, they're talking about doing $30 billion worth of a new PB of risk-based assets. Have you had any dialogue with them and do you have a sense of what kind of opportunity that might create for MFA?

Craig Knutson

Sure. We've looked at this possible risk transfer, which to-date is not really solidified, but we've looked at that trade for months now. It may make sense for us, it may not. It will depend on a lot of things. It will depend on the risk return and what sort of yields we think are available. It will also depend on what form those assets take. So for instance, whether or not, those sales are structured as good assets for REIT for instance.

Henry Coffey - Sterne, Agee

Are there any other alternative asset classes that are, sort of, coming down the pipe that might be interesting for MFA to explore?

Stewart Zimmerman

Andrew, we have looked at various asset classes over the years. We've looked at myriad of myriad of things. So we continue to do that. Having said that, at the moment there is nothing that is pressing to us and we still very much enjoy the continued success that we've had in both the agency and the non-agency markets, and that's where our concentration is. Having said that, we spend a good portion of our time looking at other assets classes and how that might bring value to our shareholders.

Stephen Yarad

And Henry, if I might also add, and sort of our mission statement, I mean, you know for a long-time we've been distributing a good amount of income. But what we've done over the last five years is also benefit, have our assets perform due to improvement in the residential mortgage credit fundamentals.

And I think that positions us well for any new activities that may come up in the next couple of years. There is benefit for the shareholders of improvement from residential mortgage credit fundamentals. It's really shown in the fourth quarter performance and it's something that we hope to benefit from in the future.

Operator

Our next question comes from Chris Donat of Sandler O'Neill.

Chris Donat - Sandler O'Neill

Just one quick question on the excise tax and interest, that's something we haven't seen for a couple of years. Can you remind us exactly what that is?

Stewart Zimmerman

Sure, I'm going to hand it over to Steve Yarad, our CFO, and he is going to explain that to you in some detail.

Stephen Yarad

There's a lot of detail around the rules for the excise tax. I'll try to keep this at relatively high level. But there are two components to the exercise and interest accrual. The interest portion is calculated on the amount of the undistributed dividends for prior periods, and that situation it's primarily 2010 and 2011, and you pay an interest amount based on the short-term AFR, plus 3%. So in our case, it's roughly 3.5% interest paid on that dividend shortfall for that period.

The excise tax comes into play to the extent that you've distributed less than 85% of your taxable income in the calendar year. And if you're in that situation, you pay an excise tax that's roughly 4% of the difference between the amount you distributed and 85% of your taxable income. And in our financial statements for 2012, we've recorded an accrual for $7.5 million covering both excise tax and interest for the current year and all prior periods.

Chris Donat - Sandler O'Neill

Then just to make sure I understand this. In the filing you put out earlier this week, it states that no material impact to previously issued financial statements from the material weaknesses here and also no expected impact to REIT status. I didn't see that language in the press release, but just want to make sure that that is still the case, nothing has changed in two days, right?

Stewart Zimmerman

Sure, Chris, absolutely. When you see our 10-K, which will be filed later this morning, you will see some disclosure around that in our controls and procedures section and what you said is absolutely correct. There is no restatement of prior period financials and there is no material impact on our current period financials relative to this matter as well and as you said as well, no impact on our REIT status whatsoever.

Stewart Zimmerman

Is it also just fair to say also just to follow-up nothing changed in the last two days?

Stephen Yarad

Absolutely. No change in last two days.

Stewart Zimmerman

Well, I just wanted to be more precise relative to your question.

Chris Donat - Sandler O'Neill

Finally from me, the $81 million that was transferred from the credit reserve to accretable discount, just ballpark when I think about the timing of that flowing into income. How does that work?

Craig Knutson

So it flows in over the remaining life of those assets. So basically, we take $80 million and it goes into accretable discount. So it will translate to a higher yield on those assets going forward. If you look at the total, which was I think $152 million that we transferred from credit reserve to accretable discount during the calendar year 2012, to sort of frame it for you, if I just isolate that one change, but forget forward curve, forget assets that pay down, it probably increases the yield on the Non-Agency portfolio by between 20 and 25 basis points.

Operator

Our next question comes from Daniel Furtado of Jefferies.

Daniel Furtado - Jefferies

Craig, I missed some tail-end of that response. Are you saying that $81 million or $152 million for the full year is 20 to 25 basis points?

Craig Knutson

The $152 million. For the whole year, if you look at those assets as of the end of the year, it increases the yield between 20 and 25 basis points.

Daniel Furtado - Jefferies

And then another kind of methodological question. You're saying that your credit reserve is approximately twice the underlying 60+ DQs. Is it simply, as simple as if you assume that you're not going to get two extra 60s and say all the 60s go bad but nothing else rolls into that bucket, that that would you could theoretically transfer from credit reserve into accretable discount, is about half of your current credit reserve or is it not linear like that?

Craig Knutson

Well, I think what we say is, we don't say our credit reserve is twice our 60. I think what we say is in our GAAP assumptions that our estimated defaults on the portfolio are equal to approximately two-times the current 60 plus days delinquent.

Daniel Furtado - Jefferies

And where do you believe the market is today in that assumption when competitors or just the market is out buying bonds. I mean, is it still at that two times your 60 paradigm when you're pricing bonds or has the market tightened? In that sense, how much more conservative versus the market do you believe you are?

Craig Knutson

I can't really speak to how much more conservative or less conservative we are versus the market. But what I will tell you is that as we see increased performance in the underlying assets and that can be because LTVs are improving, which could be due to the fact that loans are now amortizing in many cases, and in addition we've seen some home price appreciation.

So as those underlying LTVs get better and borrowers are less underwater or perhaps not underwater at all, our assumptions on future defaults will come down. So I think, overtime if credit reserve changes continue along the same thing, what that will mean is that that the ultimate default assumptions will not be twice the 60 plus at some point.

Daniel Furtado - Jefferies

And then if I may just squeak one last one in, do you have any material swap maturities this year? And if so what's the fixed pay on those they are rolling off?

Stephen Yarad

Let me give you an update and this will be laid out in the K, which will come out today. But in the first quarter of this year a very small amount of swaps run-off. It's about $50 million and the average cost there is about 390, so we glad to have those swaps go away. And then you really don't see much high cost swaps running off until the second half of the year in which time we have about $400 million of swaps with a fixed pay rate of 4% run off. So we are continuing to see improvement, funding costs coming down as these swaps run-off. But most of the improvement will occur later in the year.

Operator

Our next question comes from Rick Shane of JPMorgan.

Rick Shane - JPMorgan

Just wanted to talk a little bit about capital allocation and particularly given what we've seen in the market this quarter. You've obviously seen strong continued appreciation on the non-agency paper and during the fourth quarter, your allocation there increased slightly. Given we've seen agency spreads widened out a little bit and potentially rich pricing on the non-agency stuff, are you thinking about shifting back a little bit more?

Stewart Zimmerman

Let me start the answer and then we can give you some detail. As I've said, I don't know how many times on other calls, we continue to see value in both sides of it, in terms of the agencies and non-agencies. And you're right. When you look at the appreciation on the non-agency side, it is fairly some dramatic. But we've also seen opportunity. I'm going to turn over to Gudmundur Kristjansson in a moment just to give you some color on the agency side, where we have also continued to see some value.

Gudmundur Kristjansson

Well, you're absolutely right. I mean, in the first quarter of 2013, yields have gone up and spreads have widened on agency securities. So they are incrementally more attractive in the first quarter of 2013 relative to what they were in the fourth quarter of 2012. Yields on the assets that we're acquiring, we're seeing them about 185 basis points and with spreads including funding costs that is about 125 basis points.

Stephen Yarad

So incrementally, we're investing in the same way, but an important point, some of run-off doesn't need to be invested because some of that run-off is being used for the special dividend.

Rick Shane - JPMorgan

Given the opportunities that you're seeing, the stability we've seen in the capital base over the last couple of years, do you feel like you have the right amount of capital right now for market opportunity that you see?

Stewart Zimmerman

The answer is generally, yes. There are always exceptions, but again, as you know, as we've had discussions before, I think we've been very disciplined in raising equity. We will continue to be very disciplined if we see those opportunities and the opportunity to raise equity is there, we will certainly approach that, but we are very comfortable about how we sit today.

Stephen Yarad

Rick, as you know, we are internally managed and our incentives and shareholder incentives are the same. So we have been still happy with the performance of the assets that we have. We really didn't want to share it much with too many shareholders. So we continue to work for the benefit of existing shareholders.

Operator

Our next question comes from Gabe Poggi of FBR.

Gabe Poggi - FBR

I just had a quick question on the agency side of things. Your speed has declined in the fourth quarter from the third quarter, any color kind of year-to-date you can provide? And then as you're getting those prepays, were you guys allocating capital in the agency bucket that'd be helpful?

Craig Knutson

Yes, on the agency side, I mean the speed in the first quarter should be in line with what we've seen over the last couple of quarters. January and February were about 20 CPR, so I guess that gets you two-thirds there. In terms of what we're looking at and what we're finding most attractive, I mean we have been focused and we continue to favor that with the hybrids. And I don't see that change going forward.

Operator

Our next question comes from Stephen Laws of Deutsche Bank.

Vlad Rudnytsky - Deutsche Bank

This is actually Vlad Rudnytsky dialing in for Steven. I just had a quick question, kind of, just looking ahead and given Bernanke's comments last week. I guess, if you just have any thoughts on just as Bernanke said that he might just let the securities run-off upon the QE exit. And what is that Fed decides to kind of put some of these Agency MBS out on repo? And what the impact would be on the funding costs?

Stephen Yarad

Sure. So ever since the QE started and ever since the Fed has been buying assets, the natural question will be, how do you get out? And he's been answering it the same way since it started, either, we could sell the assets, we could borrow against the assets or we just let the assets payoff. This answer has been the same for years, so no news there.

Those are the only three ways out. Remember, if his goal is not to increase liquidity, but to decrease liquidity, the sale or borrowing against it, it's going to achieve the same thing. You've been pulling liquidity out of the market. So it's the standard answer, it remains the same. No new news there.

Vlad Rudnytsky - Deutsche Bank

I guess, I'm just wondering about the impact on the actual funding costs if the Fed was to put these out on repo?

Stephen Yarad

Again, it's the same. If you have a new competitor, it incrementally would impact funding costs going up. We've answered this question for many years on these phone calls. Yes, incrementally if the Fed became a competitor for repo funding, then it would have an impact on agency repo funding costs.

Operator

I show no further questions in queue at this time. Sir, you may continue.

Stewart Zimmerman

So at this point, I would like to thank you for your continued interest in MFA and we look forward to speak with you next quarter.

Operator

Thank you, ladies and gentlemen for attending today's conference. This concludes the program. You may now disconnect. Good day.

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MFA Financial (MFA): Q4 EPS of $0.20 in-line. (PR)