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MFA Financial, Inc. (NYSE:MFA)

Q3 2009 Earnings Call

November 4, 2009 10:00 am ET

Executives

Stephanie Coyle - IR

Stewart Zimmerman - CEO

Craig Knutson - EVP

Analysts

Bose George - KBW

Andrew Wessel - JPMorgan

Steve Delaney - JMP Securities

Henry Coffey - Sterne Agee

Douglas Harter - Credit Suisse

Richard Creb - Private Investor

Operator

Ladies and gentlemen, welcome to the third quarter 2009 Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator instructions). As a reminder, the conference is being recorded.

I'd now like to turn the conference over to [Stephanie Coyle]. Please go ahead.

Stephanie Coyle

Good morning. The information discussed in this conference call today may contain or refer to forward-looking statements regarding MFA Financial, Inc. that reflect management's beliefs, expectations and assumptions as to MFA's future performance and operations. When used, statements which are not historical in nature, including those containing words such as believe, expect, anticipate, estimate, plan, continue, intend, should, 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; 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; 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, 2008 and other reports that it may file from time-to-time with the Securities and Exchange Commission, could cause MFA's actual results, performance and achievements 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 MFA's quarterly report on Form 10-Q for the quarter ended September 30, 2009 and/or the press release announcing MFA's third quarter 2009 financial results.

Thank you for your time.

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

Stewart Zimmerman

Good morning, and welcome to MFA's third quarter 2009 earnings call.

With me this morning are Bill Gorin, President and Chief Financial Officer; Ron Freydberg, Executive Vice President; Craig Knutson, Executive Vice President; Tim Korth, General Counsel; Teresa Covello, Senior Vice President and Chief Accounting Officer; Kathleen Hanrahan, Senior Vice President; and Shira Finkel, Vice President.

With my opening remarks, I'd like to go over certain data highlights as they pertain to our third quarter 2009 results and then open the call for a Q&A period.

Net income is $64.8 million or $0.25 per share, dividend $0.25 per share, book value per share is $7.57, return on equity 13.7%, leverage overall debt to equity 3.4 times, our liquidity $815 million in cash, unpledged agency securities and excess collateral.

Our portfolio spread, defined as interest earning assets minus the cost of funds, 248 basis points. Mortgage-backed security net spread, which is our MBS net yield minus the cost of funds, 273 basis points. Our average cost basis of agency securities is 101.3.

Our re-pricing gap, assuming a 15% CPR is 17 months. Our CPR was a little over 20% at 20.2%. MFR LLC at 9/30/09 had assets including the MBS Forwards, was approximately $959 million of non-agency RMBS at an average purchase price as of September 30th of 16.1% at par.

I thank you for your continued interest in MFA Financial and at this time, we'd like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). At this time, we will first go to the line of Bose George with KBW. Please go ahead.

Bose George - KBW

I had a couple of questions. The first was just on the seller-provided repo arrangements that you referred to. I was just wondering, what are the terms, the funding costs and are there any protections in terms of margin calls, things like that?

Craig Knutson

The seller-provided financing is basically a traditional repo, although it's a six-month term. Haircut range from 20% to 25% and the rates are, overall, less than 2%.

Bose George - KBW

Then, just speaking to the non-agency side of the business, what are the unlevered returns in the market right now?

Craig Knutson

It varies according to assumptions, but I'd say the way that we look at it, I'd say right now, in some cases, they've obviously tightened a lot. In some cases, they could be high single-digit, in some cases low-double digits. So call it 8%, 8.5% to 11%.

Bose George - KBW

Then just one last thing on REIT REMICs, I think you had mentioned last time that you guys were thinking about it. I was just wondering what your latest thoughts are on that subject?

Craig Knutson

We continued to look at it. I think that if you all recall that when we were first approached with a REIT REMIC structure as a means to finance the yield at which we would have sold the AAA super senior was 11%. We've said over the last, at least, six months that we continue to look at it. The executions have only improved during that time period. Again it is something that we continue to look at and evaluate. We're certainly poised and ready to take advantage of it, should it make sense.

Operator

Next we will go to the line of Andrew Wessel with JPMorgan. Please go ahead.

Andrew Wessel - JP Morgan

On the non-agency side, obviously you have almost $500 million of cash and you're starting to apply leverage, and given the opportunities you are seeing now, high-single digits/low-double digits, would you imagine that most of your investments going forward would be levered? Are you comfortable putting a big chunk of that cash to work unlevered in the non-agency market at this point?

Stewart Zimmerman

We got a little bit cut off into that. The first part, you are talking about the non-agencies only?

Andrew Wessel - JP Morgan

Yes, just the non-agencies. You haven't bought agency bonds for a while, so just looking out at.

Stewart Zimmerman

Let me answer part of that question, is the fact that, look we have access to a certain amount of repo. The questions that we pose to ourselves and we discuss every day , and again, Craig just mentioned the term was about six months, what's the viability of that?

Right now, everything is feeling pretty, pretty good. Then we also ask our question, in six months, will it feel as good? Will it feel better or not quite as good? So we're trying to be very judicious in terms of the amount of leverage that we do use on the non-agency assets.

Andrew Wessel - JP Morgan

The agency market doesn't look very attractive right now. So, just for modeling purposes looking forward, using up some of that cash in fourth quarter this year and first quarter of next year, I imagine most of that or if not all of that, usage would be to non-agency partners?

Stewart Zimmerman

Look, we continue to monitor both markets. Ron is right on top of the agency market as if we were buying them every day. The problem, the problem that we have, in terms of looking at where is their relative value is, do you want to be in a position to pay 4- and 5-point premium on agencies and wind up with 3% yield, plus or minus? Right now, that doesn't look terribly attractive to us.

So what we'll continue to do is that we've invested the proceeds of our equity raise. We are very comfortable with how we are situated at the moment, and again we will continue to monitor it. Again, I'd say that your analysis is probably pretty good relative to the fact that if agencies continue where they are for the balance of the year, we would probably invest more so in the non-agency side rather than the agency side.

Ron Freydberg

Andrew, one part of your question, so we're clear, is not dissimilar from what JPMorgan itself said. Having the $500 million of cash is not a bad thing. So we are replacing run-off, certainly in the non-agency side and not on the agency side, and incrementally we're investing in the non-agency side. But if we ended the year with $500 million of cash; that would be consistent with our strategies.

Operator

Next we will go to the line of Steve Delaney with JMP Securities. Please go ahead.

Steve Delaney - JMP Securities

You are up to 42% equity allocation and that still gives you plenty of running room on the new strategy, relative to any constraints that the 40 Act compliance would put on you. So given the liquidity in the market for modeling purpose and just, I guess, for general view of where you are positioned right now, should we assume that you are continuing to evaluate and selectively add bonds?

In other words, I think you could probably say that on a minimal basis you've deployed the July capital, but are you still in the market actively looking for bonds to add to the portfolio?

Stewart Zimmerman

Let me answer the question generally, then maybe I'll turn it back to Craig, who can give you some specifics. But the answer to your question is yes. Craig and his group, they look at bonds every day, again, as does Ron on the agency side. Right now the value added for the company is more so on the non-agency side rather than the agency side. So yes, we continue to look at bonds every day. We continue to do our analysis. When it's appropriate, we'll continue to buy securities. But Craig, if you want to just give some detail?

Craig Knutson

Sure. Steve, the non-agency side, the supply is as robust as it has been for the whole year. And, as Stewart said, we look at bonds every day, we bid on bonds every day. So I'd say our hit ratio is probably lower now than it was earlier in the year. But we're still able to find some assets. Sometimes you have to bid $10 to buy one instead of $4 or $5 to buy one, but we are still very active in that market.

Steve Delaney - JMP Securities

And, Craig, that's supply factor, you do see that as a function of year-end approaching and the fact that higher prices flush out the sellers?

Craig Knutson

Yes. The nature of the supply has really shifted during the year. In the early part of the year, the supply was largely forced liquidation or it was cases where you had redemptions in sales or it was cases where the market picked up a little bit, you had accounts that were willing to sell at a loss that wasn't quite as big as the loss was a month before.

The selling that we've seen for the last several months is primarily money managers and hedge funds, and they are (inaudible). So in many cases of bonds that were purchased earlier in the year and they are selling them out at a profit. We also see, when prices do pick up then we will get business, but not all the bonds trade. So in some cases, the case where somebody will pay me $75 for this bond, I'll sell it. But if the best bid I see is $73, I won't.

Steve Delaney - JMP Securities

Just one follow-up on the non-agency repo question that Bose started, dealers that have inventory they want to sell, we can kind of understand why they would be inclined to help you, finance it and help move that inventory and end up with a linked transaction. But are you guys actually seeing any non-dealer type lenders or people that are coming in to basically just seeking back collateral against their cash?

Craig Knutson

We haven't done any trades other than with dealers that we've purchased bonds through, at this point. But we have had some discussions and there is some possibility of other financing. So it's developed fairly quickly in the last couple of months or so and this situation continues to improve. We have several people that we're in the process of documentation with but that situation continues to improve.

As Stewart said, when we see in six months where all this repo rolls over, and if there are more plans to the market, we'll probably be more comfortable with it at this point. But we are approaching it somewhat cautiously.

Operator

Next we will go to the line of Henry Coffey with Sterne Agee. Please go ahead.

Henry Coffey - Sterne Agee

Craig, I'm intrigued with the seller finance program, are these assets that you're being able to leverage characteristically different than the other assets you're buying without leverage? Is this sort of a different pocket of investing? Obviously, we can do the reverse math and get a sense of what the effective yields are, but is this sort of another growth track? Or is it just, you happened to get lucky and you found someone who would provide seller finance on the assets?

Stewart Zimmerman

I wouldn't call it seller finance. I'd say it very differently. What Craig and his group has done, they've been able to find particular assets that are very attractive that they wanted to purchase. They've had a number of those same sellers that subsequently are willing to finance it. I think there is a nuance there, but it's an important nuance that you understand.

In addition to that as Craig said a moment ago, we are now starting to find a couple again, not dozens, but a couple of other potential counterparties who have an interest in financing non-agency securities.

So I think that's an important distinction, but Craig why don't you answer the detail of it.

Craig Knutson

The other thing that I'll note, and you bring up a good point is, are the assets any different? They are arguably slightly different in most cases, not all, but in most cases. The repo financing is predicated on an investment grade rating. So these are bonds that were born as triple As. They may or may not, most of them had experienced some downgrades, but they are still investment grade rated in some cases by at least one agency or in some cases by both agencies.

So that being said, it maybe 2005 type vintage, 2004. So a little bit higher on the quality spectrum. The yield is a little bit lower on those assets than it would be on say, '06, '07 generic, Alt-A or prime paper.

Henry Coffey - Sterne Agee

I appreciate you pointing that out, Stewart, but I am assuming, as you get more and more independent financed, your accounting will go back to more of a "normal" look. But I do appreciate the extra information here. But is that correct, that ultimately as you get independent financed against this you can report at kind of on a gross basis?

Stewart Zimmerman

The answer is yes.

Henry Coffey - Sterne Agee

But I do appreciate the additional disclosure, so thank you.

Operator

Next we will go to the line of Douglas Harter with Credit Suisse. Please go ahead.

Douglas Harter - Credit Suisse

Thanks. My questions have been asked.

Operator

(Operator Instructions) We do have a question from the line of [Richard Creb], a private investor. Please go ahead.

Richard Creb - Private Investor

I had a question about the earnings reports and the expectations of the earnings throughout this prior quarter. Generally speaking, they were looking for $0.29 and I understand the press release that you folks put out indicating that you weren't able, because of being careful to purchase good-quality mortgages that you weren't able to get all of the money put to work as quickly as possible so that you did pull back and suggest that the earnings were going to be $0.25 to $0.26.

My question is with the ability you've had at this point to put the money to work, is it reasonable to expect the earnings might grow during the fourth quarter? Or is that something you can't respond to?

Stewart Zimmerman

I can't respond to that. I appreciate your positive remarks relative to the company and management, thank you for that. Again, we can't forecast where we will be for the fourth quarter or going into 2010. Again the only thing I can tell you from a more general perspective is that we did put out, as you referenced, a press release that showed that we would be at $0.25 to $0.26. As you can see now, we came in right there at the $0.25 number. We continue to try and position the company in a very positive way and we'll continue to do that.

Again, whether that's called being conservative, prudent, call it what you will, I don't care what adjective you use but that's the direction we'll continue to go.

Richard Creb - Private Investor

Those adjectives are good in my book. Thank you very much for a good quarter.

Operator

There are no further questions at this time. Please go ahead.

Stewart Zimmerman

Well, I'd like to thank everybody for taking the time, being part of our quarter three 2009 earnings call. We look forward to speaking with you next quarter. Thank you and bye, bye.

Operator

Thank you. Ladies and gentlemen, this conference will be made available for replay after noon Eastern Time today until November 11, 2009, at midnight. You may access the AT&T executive playback service at any time by dialing 1-800-475-6701 and entering the access code 122246. International participants may dial 1-320-365-3844.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.

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