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MFA Financial, Inc. (NYSE:MFA)

J.P. Morgan 2014 Securitized Products Research Conference Call

March 6, 2014 2:30 PM ET

Executives

Mike Commaroto – CEO, Apollo Residential Mortgage

David Finkelstein – Head of Agency MBS Trading

Bill Gorin – MFA Financial, Inc.

Jason Marshall – Head of MBS Portfolio Management, Invesco

Bill Roth – CIO, Two Harbors

Analysts

Matt Jozoff – JPMorgan

Matt Jozoff – JPMorgan

All right, great. Thanks everybody. So, just a quick housekeeping note again. As Annie (ph) mentioned earlier, this is close to the press now from this point onwards. So we’d ask the press to respect that please.

And I’d like to do a brief introduction of the panel the full bios are actually in the printed books on page 137, conveniently located. But in alphabetical order, we have Mike Commaroto, the CEO of Apollo Residential Mortgage; David Finkelstein, Head of Agency MBS Trading at Annaly, Bill Gorin, CEO MFA Capital, MFA Financial, I’m sorry, Jason Marshall, the Head of MBF Portfolio Management at Invesco and Bill Roth, CIO of Two Harbors.

So, I think with that, I’d actually like each of the panelist maybe just in that order, alphabetical just to kind of give a quick one-minute summary of your firm. And then we can launch into the discussion.

The other thing is, we’d like to have some Q&A at the end, we’ll leave a decent amount of time for that at the end so please think of some questions and we definitely encourage you to engage our panelist.

Mike Commaroto

Matt, thank you, thanks for having us here today this week, I’m really happy to be here. Michael Commaroto, like Matt said, I run a REIT for Apollo, it’s an agency REIT, it’s a hybrid REIT so it’s a mix of agencies and non-agencies. We were public in 2011 in the summer, we raised $200 million in our IPO and then we did a couple of follow-ons and a preferred offering. So, right now we have about $700 million to $750 million of capital on the management.

The genesis of the REIT was actually a private equity vehicle that we started at Apollo in 2008, that was very focused on credit distressed assets, basically home loans and RMBS. And then as the market evolved, we changed that business from a private equity business to frankly a public equity business in the form of a REIT.

And then, in ‘11 and ‘12, we were very focused on agencies, with still an allocation into non-agencies. And again, as the markets evolved then we’ve changed our allocation from heavy agencies into more heavy credit, still with an overlay of agencies as well. As the market continues to evolve, we hope to turn the business into one that’s not just purchasing credit (inaudible) inventories, but actually originating credit opportunities of our own so again trying to continue to evolve the business with the market as it turns. Thank you.

David Finkelstein

Good afternoon, I’m David Finkelstein and I’m with Annaly Capital Management so, where I’m responsible for agency mortgage trading. Annaly has been in a public company since 1997. We have a little over $12 billion in equity capital. We are predominantly in agency REIT. However, this past year, 2013, we diversified by acquiring CreXus, which is commercial real-estate business.

We now allocate or have the capability to allocate up to 25% of our capital into the commercial real-estate space. And it complements the agency side of the business relatively well. We think that it’s a good diversifier until far as it helps us manage or help us manage interest rate cycles going forward between that barb bell, between agency and commercial real-estate.

Bill Gorin

Thanks. I’m Bill Gorin, I’m with MFA Financial and have been since it’s founded about 17 years ago. I would say, we’re pretty much a pure agency REIT until we when we timed this right, the first quarter of ‘09, where we decided to reallocate a good portion of our capital into the non-agency sector. So, we invest across the residential mortgage back security universe.

So, we don’t want to tie our hand behind our back and say we’re only this, we’re only that. We’ll go where the opportunities are and this only seems to be about 11 trillion of opportunities to pick and choose from. We’re internally advised and our market cap is about $3 billion.

Jason Marshall

Jason Marshall, I’m the Portfolio Manager for Invesco Mortgage Capital. We went public in 2009 we’ve raised roughly $3 billion in book equity since that time. And we too are a hybrid REIT, initially, primarily focused on agencies. We’ve been migrating more towards credit space over the last few years, which includes legacy non-agency MBS and CMBS.

And two markets we’ve really concentrated on really is partnering on new issued hold on deals or we’ll buy the subordinates at IO and sell off the seniors, to consolidate us back up to our balance sheet and also NCRE, as a (inaudible).

Bill Roth

Good afternoon and thanks Matt for including us today. I’m Bill Roth, Chief Investment Officer of Two Harbors. Two Harbors was formed in 2009, we are also a hybrid REIT. We have a market capital, approximately $3.8 billion. We’re externally managed by a subsidiary of Pine River Capital Management.

Over the four and half years that we’ve been publicly delivered a little over 100% total return to our shareholders, and another – actually the thing we’re proud of is that we’ve had a positive return every year that we’ve been public.

Our business is comprised of two primary strategies, of REIT strategy which most recently was about 57% of allocated capital. And that includes agency assets of all shapes and forms including derivatives, mortgage servicing rights or MSR, as well as any associated hedges.

And then our credit strategy, which is about 43% of our capital is comprised primarily of legacy distressed RMBS non-agency style loans as well as a conduit business to generate new credit investments for us going forward. Thank you.

Matt Jozoff – JPMorgan

All right, thanks. So, I’ve got a set of questions here kind of covering the assets that REITs are looking at, what looks attractive, hedging and then some of the broader industry questions. So we’ll see how many we get through before the Q&A. But I guess on the asset side, this morning I’d sort of laid out our view on where we think Agency MBS spreads are going and the REITs have been a big player in the market obviously having gotten as big as $400 billion at the peak. So I would turn it back to you guys, as we head into 2014, what do you think of the agency MBS asset at this point? Feel free to jump in, yes, go ahead.

Mike Commaroto

We were pretty constructive on Agency MBS through I would say early 2013. And then we evolved our book and we went from about $5 billion in agencies in our balance sheet down to closer to really $2 billion to $2.5 billion. And it was obviously a function of the back-up in REITs. And we haven’t really reloaded on the agency side. We’re much more focused on reloading on the credit side.

I think right now, it feels like a lot of the pain has been experienced in the agency space. So to a certain degree it’s little bit safer to get back in water now than it was 100 basis points ago on the tenure note. But on the other hand, I do think later on in the year you could see some pressure on spreads and there could be a little more spread widening.

We tend to continue to stay in the 30-year sector we think on a fully hedged basis we have the best rate of return for investors there. But we definitely try to keep our duration gap as close to zero as possible because we’re concerned about the volatility and the REIT market.

David Finkelstein

I would say we’re relatively optimistic on the MBS basis but that being said we’re always cautious. In the current environment, we obviously have the Fed stepping away ultimately towards the latter part of this year. We do feel that the technicals over the near term are relatively supportive of MBS.

And we also believe that even beyond the Fed’s departure from being a apart from adding to their portfolio, we think that the landscape will still be favorable to MBS due to a relatively low volatility, the fact that we will not have a significant portion of the MBS market actively hedging their portfolio, which should reduce volatility day to day.

And we feel like at current spread levels, they’re reasonably attractive in terms of growth as Matt was alluding to. I think that most people think that equity issuance may not materialize much this year but we specifically, we spent the last couple of years reducing leverage year-over-year.

And we’re at a point now we’re at our historic low, historically low leverage levels at around five times at the end of the year. So, we’re actually comfortable in a very opportunistic fashion over the course of the next couple of quarters, we actually add leverage and increase our exposure to MBS methodically and opportunistically but to the extent the opportunity to materialize we will add MBS.

Bill Gorin

Nothing newsworthy here from MFA, we came into the year owning zero 30-year agency paper. And therefore we had to manage on zero, into paper which we’re happy with. When you’re competing with a non-economic, non-profit maximizing competitor in the space, I don’t mean the other people in the panel, I mean, they are the Federal Reserve.

We’ve decided not to be in that space, so we continue to focus on the lower duration portion of Agency universe. We were not direct competitor of that.

Jason Marshall

We too have kind of diversifying away from 30 years base especially. But that being said we only think valuations, we do look kind of okay here, we’ve been in a trading range, we kind of view that we’ll continue to be in a trading range although we do have to get through the tapering.

So, well, I do think agency RMBS look relatively okay here, I think the margin will probably continue that credit assets. So, it’s a way to continue to diversify our portfolio. Yes, I would guess overall, barring another sharp re-pricing in REITs I think, you’re certainly not going to have a year like last year where REITs were seller of $70 billion to $80 billion of MBS.

I think if anything, I think REITs will not be (inaudible) MBS as here. Maybe even marginally adding MBS and that’s all.

Bill Roth

So, I think we’re a mix of what everybody has said. But we’re not fans in the agency basis if you look at our holdings which we have a presentation on the website. From our Analyst Day you’ll see that we’re actually net short 30-year current coupons through TVAs, we’re substantially constraint in higher coupon 30 years. But we’re also basically short duration.

We have a substantial holding in Ginnie Mae HECM, which are short duration assets as well some arms. So, we’re trying to stay out of the sector that we think will widen the most, going through the end of the year. And the bottom line is the ROEs that we see hedging out the risk and we’re not a company that takes a lot of leverage or duration risk, in fact, very little of any REIT risk. It’s hard for us to make money for our shareholders right now in the sector that the Feds playing in. So, that’s kind of where we stand.

Mike Commaroto

Great, thanks. But the right answer is, I’m just kidding. So, I guess, and I think Bill Gorin actually kind of hinted this a little bit the duration of mortgages and sort of one of the themes I talked about this morning. And the fact that mortgages were so long, it’s becoming a problem I think for banks and to REITs to a certain extent.

So, my question is, again on the asset side, do you see yourselves maybe moving into some of the negative duration assets whether it’s servicing or IOS or excess or any of the products like that.

Bill Gorin

Yes, I would say all of the above to the extent we could. Right now we’ve added more IO as a hedge as a negative duration asset to just help hedge the 30-year federation we have in our pass-throughs. I think I do like the MSR trade, we spent a lot of time looking at that.

There are a lot of barriers to entry with respect to that trade, regarding licensing and approvals of the counterparty. We’ve looked at more on a joint venture basis with an entity that would necessarily be part of the Apollo family and that’s what makes it tough.

So, I think we’ll continue to look at that as a potential way to add more negative duration assets or excess servicing or MSRs. But right now we’ve definitely used IOs as a way to just help add negative duration to the book.

Jason Marshall

First of all, to Billy’s point about the carry on lower coupon and the lower coupon MBS and the fact that it is a time that’s attractive short vehicle. We agree with that discount 30 years or when you look at the duration of adjusted carry that is an area that is far inferior to higher up the coupon stacks. So most of our 30-year exposure and new purchases are tend to be in the higher coupon is 4s and 4.5s, so we absolutely agree with what Billy said.

As far as IO MSRs, we’ve been a player in the IO market for quite some time. We look at MSRs very regularly, to Mike’s point in terms of barriers to entry that’s certainly the case. And also to get that ideal negative duration positive yielding exposure, IOs do offer an attractive substitute.

The difference between IOs and MSRs are two-fold. Number one is, with MSRs, you’re servicer, you have the liability and the obligation to go along with that – which is a complex business. And number two is liquidity, IOs and excess IO do tend to be relatively better, more liquid than in instrument or an asset like an MSR. So we do realize that the yield on MSRs can be a little bit higher, but when you consider the qualities associated with IO and excess IO, that’s a favorable attribute that we tend to value.

That being said, again, we do look at MSRs on a regular basis. We have the infrastructure and the capability to go into that sector. We just have not as of yet found an appropriate entry point.

Bill Roth

So, for the last number of years, we’ve been saying G, we’ve built a real good shop, focusing on credit. And I think it’s a little easier to predict credit because we do credit for next three years, oil prices should trend up somewhat, loan to values should trend down and the credit should look good.

If you’re buying IOs or mortgage servicing rights, while there are great strategic partnerships involved ways, we capture prepays. You need to, you probably need to have a good model about, I want the assets to be there and that’s particularly prepayments over one year, two year, three years, which we find a little more difficult to predict in credit.

So, we haven’t owned any of those assets yet, and we try to control our hedges by the interest rate risk we take on with buyer assets.

Mike Commaroto

Yes, I’ll say somewhat similar and we do hedge most of our book through our swap and swap option book. We do have a small structured agency IO book and we also own some 2.0 non-agency IO. We haven’t pursued getting set up to be a servicer. It’s something we look at and always keep in mind.

In the interim, we’ve kind of focused on trying to buy we’re not negative duration, trying to originate floating rate, mezzanine, commercial real-estate assets and participating in some of the GSA we’re sharing. So, we really haven’t taken that step yet. But into the MSRs but we do periodically buy ion. And we’ve been looking at the margin to uploading REIT assets.

Bill Roth

So, my comments on this would be a little different. At Two Harbors, we actually own a servicer, we don’t actually service loans directly. We subcontract that out. We have a couple of very strong partnerships, one with Flag Star and we purchased about 40 billion some odd notional last year, and one with PHH where we have a two-year flow agreement. So we’re very active in the MSR space. And that’s a business that we’re looking to expand.

We think the asset is a perfect fit for our book. And so, we’re comfortable managing the interest rate risk and the prepayment risk as we have that expertise in terms of managing prepays, IOs, duration, etcetera, just from our natural business. So, that’s a business we’re very active and we’re looking to grow.

Mike Commaroto

Okay. And I would just add one more comment. There is a couple of comments into that barriers to entry. They’re extraordinarily high. And in fact, even if you get into the game, every transaction has to be approved by Fannie, Freddie or Ginnie as well. So, just because you’re in doesn’t necessarily mean that you get to do trades or transaction. So, it’s very complicated. It’s takes a substantial infrastructure to process that.

Matt Jozoff – JPMorgan

So, I guess also on the asset side, maybe on the credit dimension, I had a slide this morning that kind of compared the repo haircuts for let’s say REITs or hedge funds on various assets relative to the bank capital requirements. And basically the sort of the conclusion was that the high credit quality asset should be going to, banks that’s where the capital is less than haircut. But when it comes to credit, it goes the other way. And in particular when you look at something like Stacker or any other risk transfer deals, it seems like the banks really are not going to be competitive.

So, my question to you guys is kind of two part. In general, how do you see your allocation shifting between agency and credit or non-agency? And then secondly, in terms of risk transfer, what are you – how does that asset look to you in terms of Stacker etcetera?

Jason Marshall

Sure. I think as I mentioned before, we already moved fair amount of our capital out of agencies into credit in June of last year as we saw rates backing up. So, we saw that and we still subscribe to that, we’re much more constructive on credit non-housing than really trying to figure out the path of interest rates here. And then, even with the spreads and agency given the Fed is in this paper mould.

So, I think our mix and again my sense of where the industry is, is definitely shifting more from credit, from REITs into credit. And then, with respect to Stacker, I mean, we’ve participated in the risk transference trades. These spreads have been a lot on those from the first one or two but still they’re attractive.

And in haircuts, are definitely a bit more attractive to REITs since bank couple of charges are to banks or assets like Stacker or even in lot of the bonds that we traffic. And on the credit side we tend to traffic in a lot of season sub-prime, both ‘06 and ‘07 vintage, but even lot of stuff that’s probably earlier than that. So, we have our books probably early vintage but a lot of it is non-investment grade. Some of it, some new pieces even are non-investment grade.

So the haircuts we get on that and this is something new to me that I had heard but it’s not quite clear to me that I think, U.S. banks or (inaudible) maybe has come down and said they have that certain haircut of 25%. And maybe that’s a case. I don’t think all the banks necessarily follow that rule. I don’t know, I think JPMorgan might be on the other side of 25%, might be my sense of it.

But then a lot of the farm banks are inside that. And to sense they’re inside of that things like Stacker and things like season sub-prime or season on agency, then I think REITs definitely have an advantage versus banks.

But the important thing to mention to is, we’re not after the cowboys, we’re not using leverage to try and choose returns especially in something that is somewhat less liquid in terms of credit bonds and our agency bonds, private label securities. So we still try to have our maximum leverage in that side of the business between two and three terms of leverage.

Bill Gorin

First of all, with respect to credit risk sharing, because the cash flows from those instruments do not come directly from the real-estate asset. We actually do not view them as good REIT assets, which would mean that we, in our view, we can allocate up to 5% of our assets towards that sector. And when you have a narrow slice to which you could invest in, we think there is, better opportunities in credit. For example as I was saying earlier, commercial real-estate is the area in which we’re gravitating more into.

Our asset base right now is approximately or at year-end was about $1.6 billion in commercial real-estate. And that’s currently unlevered although we do have the opportunity if we choose to do so to lever that through borrowing or for through securitizations.

Matt Jozoff – JPMorgan

So, Dave, explain something which is always complex but these deals, these risk sharing deals are not qualifying real-estate assets. So there is a natural limit for companies such as our own to be major players.

On the other hand, probably the majority of the people in this room were major players in those risk sharing transactions. So, I don’t think it’s very high value added for us to say this is a big part of our strategy. And it’s okay, I think we all agree LIBOR plus 450 sounds good. But there is, other niches that we tend to focus on?

David Finkelstein

We’ve participated in I think almost all of the deals and anyone has looked at it, the management is spectacular for on the deals so it’s hard to get a lot of allocations on them. But we have participated and I think we will continue to, and just given the credit book profile of the polls that have come, the floating REIT nature of the asset. It just – it’s attracted to as of course subject to REIT rules, as imagine there is a limit as to how much you can do. But we continue to participate in that market. And I think we’ll continue to do so, and in doing issues with them.

Mike Commaroto

Yes. We have a substantial position in mortgage credit we have over $3 billion market value as of the end of the year, which is about 43% of our capital allocation. The bulk of that is in season non-agency primarily sub-prime paper, typically a 3A 4M one bonds. And we think that the optionality from faster pre-pays or better borrowed performance is still compelling.

I think the points about qualifying REIT assets, actually strikes at the heart of GSE reform and private label securitization. If you think about how much the government would like to reduce their footprint and then these end up in private label securities, those do not quality as to meet the whole pool test or the whole mortgage interest test.

So, distributing this kind of the volumes that might come out, we’re an ideal holders for credit but we get capped out on how much capital can be allocated. So, that’s something that we’re hoping that folks down in DC make some headway on to allow, not only ourselves but other panelists and other companies allocate more to mortgage credit going forward. Because I think Matt, as you pointed out, we’re good holders of this risk. But we do need a little help to be able to commit the kind of capital that would be meaningful.

Matt Jozoff – JPMorgan

Okay. So, switching gears a little bit and talking about maybe the business model and hedging, the hedging side of things. I mean, over the last seven to eight years, we’ve seen the overall leverage of REITs drop from let’s say 12 times to five or six times, a big drop in leverage.

But over the long-term we’ve seen in certain cases, extension in the duration gap. And so those are kind of two dimensions that REITs can take in terms of risk to generate net interest margins. So, how do you think about the leverage versus duration gap trade off and where do you stand in that? And I think David kind of addressed this a little bit earlier but?

Mike Commaroto

Yes, I would say in ‘11 and ‘12 we had more on the duration gap than we have now. And we probably had a little bit more leverage again just because of mix of our book with more agencies and non-agencies.

I think we view the market presently in a more defensive manner. So, we’ve actually taken our duration gap back pretty close to zero, it’s between half year and year end. And the same thing with respect to our leverage, I think their rule book is down from five turns of leverage to close to four turns of leverage again a function going from agencies to credit, with capital allocation.

I’ve seen the research that we’ve done I think it’s a pretty nice research actually. And it shows that to me the way I look at it, if you try and chase returns by adding duration gap versus adding leverage, you tend to have I think a lot more risk as you tend to add duration to the portfolio, again just given the nature of the fact that it’s a levered portfolio.

You don’t need a lot of moves and REITs really start to drive returns. And if they move against, it can get pretty painful. So I think the prudent way if you want to try and add returns, if we try to add more return at this point, we’ll probably be to add more leverage rather than to, but not again, incredible amounts of leverage, risk go well below where we’ve been historically. But rather we’d add it with leverage than adding it through duration gap.

So, how we view it, we take a look at the three major components of risk in a portfolio particularly a leverage portfolio. Interest rate risk, basis risk and convexity risk. We think of interest rate risk as determining our willingness to take increase our duration gap obviously. And with respect to leverage, basis risk is well responding risk, but basis risk informs that.

And convexity, actually overlays both of those. First taking a look at convexity, the more negatively convex, the market of our portfolio the less tolerance for both interest rate risk and leverage risk we’re willing to take because that can magnify performance based on – or underperformance based on adverse markets.

So, we overlaid convexity to the decision of how we feel about interest rates, which informs our duration gap. And then we also overlay convexity onto our appetite for the basis.

If we’re optimistic on the basis, we’ll increase leverage. If we’re optimistic on the level of interest rates, we’ll take on more duration gap.

With respect to convexity again, if we’re in a very – or a better convexity environment like right now, given the fact that the vast majority of the mortgage universe is out of the money in terms of refinance-ability, we think that the reduction in the amount of convexity risk, in the market and in the portfolio, enables us to look to those two other pockets of risk in return and gives us a little more opportunity to increase either duration or leverage.

In the current environment, where rates are still at relatively historic low levels, in spite of the fact that we’re 100 basis points higher than we were a year ago, we’re cautious on the level of interest rates. So, we keep our duration gap relatively low. However, with respect to leverage, we are as I said, before at the low end of our leverage range. And we think that spreads are reasonable here. So, we’re little more comfortable adding leverage.

David Finkelstein

So, Matt, we take the Fed every word and everything they say. It actually works, that actually works out, it simplifies your life. So, where interest rates are going to go based on Fed Actions or data driven – data dependent and that is true. So they don’t sell no, the voting numbers don’t know where REITs are going to be at the next meeting. So I certainly don’t.

We mentioned we started the year with 0% exposure in 30 years and are still there. We started the year with leverage of three times and again we’re still there. Your question was how do you look at duration relative to leverage. And it’s a simple formula of duration times your leverage is how much equity you have at risk. And our equity exposure remains fairly constant throughout the year.

Fortunately, because we have a large credit exposure and we think these assets are lot less dependent on movements of interest rate and a lot more dependent on credit, we’ve been able to maintain a constant duration and a constant leverage while still generating good ROE. So, that’s how we look at the both two trade-offs.

Bill Gorin

I mean, we’re going to be somewhere there, I mean, we’re running historically at our end of duration gap and leverage and basically we take MBS spread, duration, residential and commercial spread risk and that’s how we earned money for our investors. And right now we just view the spread risk and credit, and residential and commercial creditors as more attractive a risk as the duration or MBS spread risk.

So, we’re going to continue to run our GAAP, probably one, or inside of one on a model basis. And hope that empirically that we get some benefit from the correlations between those assets and rising – and a gradually rising rate environment, we would expect credit to do well. So, empirically we think that GAAP is probably closer to zero.

Mike Commaroto

Yes, we think of the world in terms of equity value at risk. So, I think getting back to duration and leverage, we typically have had the philosophy of taking a very, very low level of risk in those regards. We view ourselves as extractors of relative value in the mortgage space, not someone is going to take a bunch of leverage or REIT risk to drive a certain return.

So, if you look back historically, we’ve typically run very close to no interest rate risk. And additionally, our leverage has historically been on the very low end of the range. So, more recently it’s in the low 3s on an aggregate basis. So, I guess, you’ve put us in the low risk camp.

Matt Jozoff – JPMorgan

Great. Maybe I’ll just throw out one more question before we open it to the audience. I guess, just very bigger picture, in terms of the industry, what do you think are the biggest threats to growth for the REITs right now, is it – do you see any regulatory pressures coming up, do you – how big of an issue is price to book ratio is right now, kind of where do you see the industry going?

Mike Commaroto

I think probably the biggest risk is more than anything market risk in terms of trying to grow. I don’t think we’ve really seen a lot of regulatory risk, I do think some of our bigger peers in the industry have potentially been looked as they are CVs or not, systemically important financial institutions. And I think that they came away than they’re not.

So, I mean, right now, the industry is relatively unregulated. There was some noise three years ago from the SEC around amounts of leverage and the application of 40 Company Act. So, I think that I don’t really view regulation as a big overhang for us. I think regulation has overhang for the mortgage industry, definitely has repercussions on our business. Things like securitization 2.0 what’s going to happen with the footprint of Fannie & Freddie and then risk transference and from rep and warrant and how does that kind of play itself out in the next round of securitizations.

So I think that the mortgage industry is frankly overly regulated. And since we’ve aligned the mortgage industry for our asset base, and for our returns and regulation does impact us but more of a second order event I think with respect to us.

And I think with respect to price to book, I mean, it’s a function of market. So, right now, I think that REIT is definitely a cyclical industry. We’re at the point in the cycle where a lot of guys touch lows are included of 80% in terms of price to book. We’ve come back to kind of mid-90s I think most of the peer group is in the mid-90s. So, it’s going to just a function of how the market thinks about the sector, the business model and forward path of REITs and obviously spreads.

And I think that that will always put, I won’t say pressure on the business but it would just makes it cyclical in terms of when can you raise capital. But it’s an industry that to raise capital to grow, because the capital that you earn has to be distributed to your shareholders.

David Finkelstein

Let’s say, I certainly agree with Mike. And so far as the work that’s being done by the Fed, FSOC, etcetera has been ongoing. It’s been a number of years. And we face the same set of discussion points that other participants in the mortgage industry as well as in financial markets in general face. So there is always the possibility of regulatory changes, but we do feel like we’ve been through a lot of the discussion thus far.

And in spite of the work being continuing, we do feel like we’re in a better place in terms of being able to explain our industry. The fact that the capital is private equity capital, the role we play in housing finance in terms of our positive impact in helping borrowers achieve loans etcetera.

So, we feel like we’ve made a good statement to the people who evaluate this industry. And we continue to have those discussions, it’s one of the larger participants in the REIT sector, we’re often in a position to provide insight to people in DC etcetera.

So, we do feel like we’ve gotten through a lot of the work. And there is always the possibility of some regulatory changes. But we’re not as concerned about it as maybe at times in the past.

With respect to GSE reform etcetera. One of the things that we do think about as a very large agency player, we do have in upwards of $80 billion in agency MBS assets. One of the concerns long-term with respect to possible changes in housing finance is the availability of securities for us to invest in. We are concerned about liquidity, the functioning of a TBA market and things like that. So, we do attempt to inform policymakers as much as possible to reach back to the importance to that TBA mechanism and a fundable market that creates strong liquidity.

Bill Gorin

So, I don’t know what will come tomorrow but as we’ve mentioned, this is private capital. We do face regulations. But probably a lot less so than banks and insurance companies. So to some extent the regulatory environment is a competitive advantage.

Michael’s statement when he spoke, he made a point that we sort of our central pieces, the government took on all the residential mortgage credit risk. I think he paid enough to do it. So, we know they don’t want to take as much risk and if they do, they want to get paid more. So I think people like ourselves are permanent capital will get paid more to absorb the residential mortgage credit risk. That residential mortgage credit risk always exists and it’s turning to dollars.

Now, if the industry doesn’t grow because there is no premium to book for years, so what will make, we’ll make a lot of money on the way. The key was to get, you got to get to a critical size so you’re important to your counterparties so that you’re not too small for opportunities. But once you’re there, whether you grow incrementally or not, if you just payout your earnings and stay in a place, it’s a fine time.

And I’m actually very comfortable because what lot of institutions, do get concerned about changes in interest rates, maybe there is less incremental buyers of mortgage REITs to the extent we did show our share basis in the industry as a whole, maybe we’re in good supply-demand equilibrium now. So I’m pretty happy where we are.

Jason Marshall

And I would agree, there is, additional regulation is always there, but right now it is an advantage for REIT entities. And I think they’ll be dynamic and it would be a part of housing finance reform. However, that ends up looking, I think Matt said at intro 1.8, REIT’s on $400 billion of agency MBS which is 10% of the universe. It’s a significant amount. So I think we as an industry we’ll play an important role in housing finance evolves.

And of course, the more you grow I guess the more regulation could become a threat. But as for now, I think it is an advantage that we have relative to some of the others in the markets.

Mike Commaroto

Yes, I’m going to try not to be repetitive, there have been a lot of good comments made. I just have a couple of points. First of all, the fact that the REITs have owned a lot less mortgage, agency mortgages today is actually I think a testament to the folks sitting up here as well, some of our other peers. Because when your stock is trading at a substantial discount, the book value and you can sell your agency mortgages at where they’re marked. That’s a very good trade for our shareholders.

So, we bought stock back last year I know a number of companies here did. And I think that that’s a very good discipline for the market when that opportunity exists.

The other thing I would say is in terms of raising new capital, we’ve been fortunate to be able to raise capital numerous times since 2009. And in every case we have something really good to do with the money.

And to think about equity investors, they’re actually pretty smart crowd. If you have something really good to do with the money that they think will make their money, they’re willing to give you the capital to do it. So, I think as the winds blow back and forth and opportunities present themselves to REIT industry, I think we’ll have no problem raising capital when those opportunities are there.

Matt Jozoff – JPMorgan

Right, great. Thanks. So, with that, I think with the time we’ve got left, why don’t we open up to audience if there are any questions.

Question-and-Answer Session

Matt Jozoff – JPMorgan

There is one down here, we have a mic coming.

Unidentified Analyst

Hello. This is going to sound like a little bit of a smart online question, it’s really not meant to be that way. I work at a big money manager on the securitized side. And often times our equity guys come down to my office and they try to figure out what you guys do and how your business works. And obviously they look to me to try to explain it to our men.

If you look over the past year with your equity returns being negative anywhere from 13% to 27%, with the S&P up 22% and at the same time the Fed’s getting out of the agency mortgage business and the non-agency CMBS credit market, reasonable people could disagree but it’s probably in the 6th or 7th inning as far as tightening goes.

And meanwhile you guys seem to be looking to do different things instead of agency going into CMBS or non-agency, I struggle with telling our equity guys why I think your business model makes a lot of sense unless you want to just time it bide at the bottom of the cycle and hold your nose and hope it does well.

So, I’m not trying to justify your – have you guys just for your existence, I just want how you would look at it, given where we are in the cycle right now, Bill said that if things look good, then equity guys would give you a lot of capital. Do things look that good for you right now and do you think it makes sense for the equity market to be giving you capital?

Bill Gorin

I think I’m the Bill you’re referring to.

Unidentified Analyst

That’s right.

Bill Gorin

So, yes, so we’ve said publicly in the past and say again today that ROEs out there in the market that we see are not that interesting. Certainly in the agency space and if you’re involved in that space, I’m sure you’ve read some of the research that shows you the same thing. I mean, you’re all looking at the same numbers.

You go back a couple of years and expect that ROEs were in the mid-teens plus or minus. And so, we’re well below 10%. So, it’s very hard for us to raise our hand and say hey Mr. Equity guy, this is a good time.

And in fact, as I mentioned, we not only we net short current coupons, but our basis exposure overall is probably as low as it’s ever been. So, we’re happy to wait until spreads normalize and depending on whose research, JPMorgan obviously has some great write-ups on that about where they might go. We’ll be the first to say that that’s the way we see it.

We’re spending a lot of time developing our MSR platform, which we think provides very attractive returns for us. As well as the conduit business to generate RMBS 2.0 credit bonds and IOs etcetera. And we think that look, the market is going to have opportunities from time to time, today as you point out, spreads are not nearly what they were.

But at the same time, the question is, and I don’t know what the REIT index average yield is, but I know it’s over 10%. The question is, is that an adequate return given, assuming guys are well hedged and at low leverage, is that an adequate return. Some folks will say yes and some will say no.

Mike Commaroto

Could I just add to what Billy mentioned, I think to your point about being in the 6th or 7th inning of tightening, I would disagree with given the fact that the Fed is actually still easing to the tune of $60 billion a month roughly and that will continue through the fall at which point they’ll remain neutral for some period of time while they reinvest the run-off to their portfolio. And it’s likely 18 months away from actual tightening to occur. So, when we look at the shape of the curve, the cost of funding, etcetera over the near term, it’s certainly still in reasonably good carrying by the MBS basis.

Bill Gorin

Yes, just one thing I’ll add to that on more time we have. But I think to David’s point, I think you can definitely get paid to wait if you look at the ROEs or the dividend yields on the guys up here as well as the rest of the peer group.

And I think you’ve also heard from the team up here as well that everybody here to a certain degree has a hybrid trade on someway shape or form right between credit and rate. And then everybody has evolved as markets evolve, we’ve evolved. So just, from our experience, I mean, rating credit but heavily weighted towards REIT. And then we were now more heavily weighted towards credit.

But again opportunities that we buy in the market, in the secondary market primarily. And now as we look where the market is going, we’re trying to evolve one more time to an entity that not just buys credit but manufactures its own credit, to certain degree along the lines of some of the stuff Bill Roth had said.

We’re looking at it from a slightly different perspective rather than just a jumbo conduit or a kind of a current coupon conduit but looking at more ways to originate credit sensitive lines. And that could be a big market of you talk to some people and another people could say it’s not a very big market.

So, I was at a conference that again one of your competitors through a couple of weeks ago, and the team of people that were up there were talking about the jumbo market which, were essentially bank originators. Their view was that the credit sense in the loan market in terms of a new issue market won’t be very big at all. But then some of the guys who are on the REIT panel which are – I think Bill is on that panel.

And I think that those guys had a view that that market should be very big on a go-forward basis. So, you’re right, some of these markets are in the 6th, 7th, 8th, maybe the 9th inning but then there are other markets that they’re not even kind of doing warm-ups yet.

And ideally we can turn our business into a business that takes advantage of that and at the same time, given the business model, because it can be hybrid and you can get paid to wait to a certain degree.

Matt Jozoff – JPMorgan

All right. Let’s take maybe one more question if there are any. I think there is one over there, raise your hand? There you go. Over there.

Unidentified Analyst

Dr. Stegman this morning talked about the private label securities market is being critical to the next round of residential finances country. To date that hasn’t really taken hold to a large degree, what do you guys think is really holding that back today?

Mike Commaroto

Bill, do you want to go.

Bill Gorin

I think it’s primarily – there is a lot of rep and warrant issues but mainly the larger generators are all banks. And right now that’s a very attractive portfolio asset for them. So, and I think it will be for several years. So, until you get banks – an active bulk home loan market, where banks are willing to sell those assets, it’s going to be tough.

There are a lot, of conduit and smaller origination programs but you do have kind of the rep and warrant issues when you look at those securitizations. I mean, they are getting done but it’s in a rather anemic base. But I do think the main thing holding that back is just an attractive organic asset for the banks right now.

Mike Commaroto

Yes, I’ll just add. We’re in that business and we’ve – we have a long list of hurdles or impediments. What Jason said is probably one of the biggest ones. Lack of supply of deals, creates a lack of demand. It’s very hard for large investors to care when there is no volume.

At the same time there are a whole host of other issues, rep and warrant is one, sunset, existence of second leans, I mean, the list kind of goes on and on. I will tell you that some of the industry groups are – have formed groups to work on. There needs to be consensus and sort of certainty to see large buyers of the Triple A come back. And until we get that I think it’s going to be – I think it’s going to be slow.

Matt Jozoff – JPMorgan

Okay. Well, I think we’re out of time. But thanks so much panelists. Mike, David, Bill, Jason and Bill, thanks for participating and sharing your thoughts. And I’ll encourage the audience if you have more questions you can approach them afterwards. Thanks. Thank you, guys.

Question-and-Answer Session

[No formal Q&A for this event]

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