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Executives

Stewart Zimmerman - CEO

Bill Gorin - President and CFO

Ron Freydberg - EVP

Craig Knutson - EVP

Tim Korth - SVP and General Counsel

Teresa Covello - SVP and CAO

Kathleen Hanrahan - SVP

Analysts

Steve Delaney - JMP Securities

Bose George - KBW

Douglas Harter - Credit Suisse

Mike Taiano - Sandler O'Neill

Daniel Furtado - Jefferies

Mike Widner - Stifel Nicolaus

Matthew Howlett - Macquarie

Greg Eisen - ICM Asset Management

MFA Mortgage Investments (MFA) Q1 2010 Earnings Call April 29, 2010 12:00 AM ET

Operator

Ladies and gentlemen, good morning and thank you for standing by and welcome to the MFA Mortgage Investments first quarter 2010 earnings conference call. At this time, all lines are in a listen only mode. Later there will be an opportunity for your questions and comments and instructions will be given at that time. (Operator Instructions)

At this time, I'd like to turn the conference over to our first speaker, (Alexandra Giladi). Please go ahead.

Unidentified Company Representative

Good morning. The information discussed on 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, 2009, quarterly report on form 10-Q for the quarter ended March 31, 2010, 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 March 31, 2010 and/or the press release announcing MFA's first quarter 2010 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 Financial's first quarter 2010 earnings call. With me this morning are Bill Gorin, President and CFO; Ron Freydberg, Executive Vice President; Craig Knutson, Executive Vice President; Tim Korth, Senior Vice President and General Counsel; Teresa Covello, Senior Vice President and Chief Accounting Officer and Kathleen Hanrahan, Senior Vice President.

We reported today net income of $80.6 million and $0.29 per share of common stock the first quarter ended March 31, 2010. For the first quarter, core earnings were $66.6 million and $0.24 per share of common stock.

Core earnings for the quarter represents a non-GAAP financial measure, which reflects net income excluding gains or losses on sales of securities. Determination of related repurchase financing and changes in the unrealized net gains and mortgage-backed securities or MBS forwards.

On April 1, 2010, we announced a first quarter 2010 dividend of $0.24 per share, which will be paid on April 30 to stockholders directed as of April 12, 2010. As of March 31, 2010 MFA's Financial's book value per share was $7.67. We're taking advantage of market dislocations by identifying and acquiring Non-Agency residential mortgage-backed securities with superior loss adjusted deals and prices significantly below par.

Our first quarter return on equity was 14.8% and our current core earnings represents Core ROE of 12.2%. With $768.7 million of cash and cash equivalence of $337.5 million of unfledged Agency mortgage-backed securities at quarter end, we remain poised to take advantage of future investment opportunities within the residential mortgage-backed securities market place.

By blending Non-Agency with Agency MBS we seek to generate attractive returns with reduced leverage and reduced sensitivity to prepayments. In the first quarter we grew our Non-Agency MBS portfolio through the purchase of $315.7 million of Non-Agency mortgage-backed securities including $121.9 million of mortgage-backed securities per quarter as MBS forward. At an average cost of 72% of par.

As a result of high premium prices on Agency MBS due in part to the now completed $1.25 trillion Federal Reserve Agency MBS purchase program. And the expectation of increased prepayment rates, we strategically reduced MFA's Agency MBS portfolio during the quarter with the sale $931.9 million of Agency MBS at a weighted average price of 105.1% of par.

With the recent completion of the Federal Reserve Agency MBS purchase program we anticipate acquiring Agency MBS in excess of runoff during the second quarter. We will be acquiring both Agency and Non-Agency assets as we go forward.

In the first quarter both Fannie Mae and Freddie Mac announced delinquent loan buy out operations pursuing to which 120 plus day delinquent loans will be purchased out of existing MBS pools. Due to the fact that Fannie Mae MBS represents approximately 91% of our Agency MBS portfolio, we expect the Fannie Mae's buyout operations will have the greatest impact on our results.

We anticipate that the Fannie Mae delinquent loan buyouts will lead to the high prepayment rates for our Agency MBS portfolio over the four month period beginning in April 2010. This temporary surge in prepayments will impact our second quarter earnings due to higher premium amortization expense. A decline in the higher yield in Agency MBS assets and an increase in lower yield in cash investments. As a result, we currently estimate that the second quarter Core EPS will be in the range of $0.18 to $0.20.

We currently anticipate that Core EPS will increase in the third quarter of 2010 as prepayment rates on our Agency MBS return to more normal level, and cash assets are reinvested. At March 31, 2010, MF Residential owned the Non-Agency MBS, including the Non-Agency MBS underlying MBS forwards with a fair value of approximately $1.5 billion. These Non-Agency Securities, which had a cost basis of $1.35 billion at March 31 2010, were acquired at a deeply discounted weighted average price of 64.8% of the face amount of the securities. And at March 31, 2010, had average structural credit enhancement of 9.4%. This structured credit enhancement along with a highly discounted purchase price mitigates MFA's risk of loss on these investments.

Unlike MFA's Agency MBS due to their highly discounted purchase prices, the return on these Assets will increase if the prepayment rates on these securities trends up.

I would like to go over certain additional data highlights as they pertain to our first quarter results and then open a call for a Q&A period. Our leverage overall, in Debt-to-Equity, 2.7 times; our portfolio spread 273 basis points, the MBS net spread 305 basis points, our average points basis of our Agency securities at 101.3% of par. And repricing to add assuming a 15% CPR, 14 months and for the quarter our CPR was 24%.

I thank you for your continued interest in MFA financial and at this time I would like to open the call for questions.

Operator

(Operator Instructions) Our first question comes from the line of Steve Delaney - JMP Securities.

Steve Delaney - JMP Securities

I just wanted to comment or question the Non-Agency purchases. Recently, they have been done mostly in MFR and it looks like they purchased about $300 million or so in the quarter. It looks like you purchased Non-Agency in the MFA unit as well and I just wondered if you could comment on that? It looks like you went up to $423 million, and if I recall you had a couple hundred million previously. Can you comment on why some of the purchases were done in MFA versus MFR?

Stewart Zimmerman

It was absolutely done with MFR.

Bill Gorin

That's the link transaction paragraph, Steve.

Steve DeLaney - JMP Securities

Right, I am reading that. Well, let me ask you this, Bill. I must have misread this; there were no Non-Agency's purchased in MFA?

Bill Gorin

Yes, this link transaction is talking about MFA as a whole including the wholly-owned subsidiary MFR.

Steve DeLaney - JMP Securities

I apologize for that; I read that thing as separate, my bad sorry about that.

Just wondered, when we've talked before, we have seen from some of the fixed income research that prices certainly have been trending higher in this Non-Agency seniors in the last three to four weeks. Fairly significantly, I guess, we are seeing maybe as much as plus four points since the end of March. And in previous conversations, you have suggested that you're buying good quality RMBS and maybe looking for a seven percentish-type yield two turns of leverage to get your return. But with this price move, is 7% still a reasonable yield objective on the bonds? Or would you be looking at something lower now?

Craig Knutson

Steve, i would say that some, first of all your three to four point is correct in the last month or so, but we still think that, this7%, even 8% is a realistic yield bogey. A little harder to buy those assets, but we've been able to continue to buy those assets and we think those are still good yield numbers.

Steve DeLaney - JMP Securities

Okay. And, Craig, could you just give us a little color on the evolving conditions in the Non-Agency repo market, just in terms of availability and terms versus what we were originally seeing say three or four months ago?

Craig Knutson

Yes, Steve I would say it every month that improves, we've more lenders; I think the terms get better, we've seen hair cuts as low as 10% on sort of higher quality assets. But even lower quality asset, we've seen hair cut as low as 20%. So we continue to see more and more counter parties I think we've precise documentation with eight right now, which is up from five at the end of the year. And we've a couple of more that are in process. So it's more available, more plentiful and it's good to see.

Steve DeLaney - JMP Securities

Are you still looking at six-month terms, generally?

Craig Knutson

Six months terms on three months, it really is varied by assets and by counter party.

Steve DeLaney - JMP Securities

Right and what's kind of a range of, spread, pricing above LIBOR?

Craig Knutson

I would say probably from LIBOR plus a 100 on the low end and on the high end, probably LIBOR plus 175.

Steve DeLaney - JMP Securities

Okay. Very good. Appreciate it, and thanks for the color on the Non-Agency. I'm going to drop off and give somebody else a chance, but just with a comment, I think maybe the most interesting sentence in your press release was that you anticipate acquiring agencies in excess of runoff during the second quarter. So, I would hope someone will ask you about that because I think that's the first time you've purchased agencies since August of 2008. But thanks for the color.

Operator

Next question comes from the line of Bose George with KBW.

Bose George - KBW

I'll take Steve's cue and ask you about that. And good job selling securities ahead of the buyouts, and you noted you are willing to redeploy capital now to Non-Agency's. I mean into agencies, but obviously agencies are pretty rich, as well. So I'm just curious where you guys are seeing the opportunities and where we could see some of that capital being deployed?

Stewart Zimmerman

I'll give you a target of 25,000 fees then we'll turn it over to Ron, who kind of runs the agency portfolio, but we have continued to see if certain amount opportunity in the Agency sector. So certain areas have continued to be attracted to us.

Ron Freydberg

Sure, thanks Stewart. Bose, we seen some pretty good new activity in the new issued market for the Agency's, we've seen a lot more issuants over the last month than we did see a year ago. We're seeing adjusting for repo and adjusting for swap to change spread in the 225 to 250 basis-point range, depending upon the type of asset. And we're not really having much effect on the overall effective duration on the portfolio. Does that help you?

Bose George - KBW

Yes. And what kind of premiums would it be for those assets?

Ron Freydberg

This new stuff that we have, it's about a 2 point premium, it's slightly higher than what our current average is.

Craig Knutson

One thing and let me give you some numbers. So typically we have a large Fannie May portfolio, we expect high prepayments in this quarter. We expect prepayments in access of $1 billion this quarter. And we'll probably tell you right now, we've more than reinvested and committed to purchase more in that billions that, we've already committed to purchase $1.3 billion this quarter. We are actively buying, so I don't really want Ron to lay out too many of the details.

We're definitely in the buy-mode and part of the rationale is look, we've publicly said we want the Agency portfolio less than $7 billion. We've been saying this for six month. We actually decreased it more than that because it's expected high prepays. So we're building there and we need to replace $1 billion this quarter.

Stewart Zimmerman

But I'd like to just let people understand on the call, having said that and as Steve Delaney had mentioned, we hadn't bought an agency since August of '08. We are being very selective, very careful. And in terms of the duration of the portfolio, we are very, very much aware that we have put on swaps and we do some other matters to kind of hedge that risk. So we are very, very cognizant of that part of the portfolio and the interest rate risk inherit there in.

Stewart Zimmerman

There is two parts. The duration is one. That's the sensitivity of your asset. The other important variable is how you levered that is. Someone might have a duration of one. Someone else might have a duration of one. But if one guy is levered 10 times and one guy is levered four times, you can't just compare the ratio over with the current leverage. And we put up good earnings, good book value growth with very, very low leverage.

Bose George - KBW

Actually that's a great color. Just to confirm, the $1.3 billion is agencies that you have committed to purchase in the second quarter?

Stewart Zimmerman

Yes.

Bose George - KBW

And then just switching back to the non-agencies briefly. This 7% yield that you guys referred to, is there any change in the loss assumption that goes into that 7% yield?

Craig Knutson

No, I would say, Bose, that our methodology and how we analyze the securities has pretty much not changed at all. I think if you'd ask me two months ago, I would've said probably 7% to 9%. And there were certainly plenty that were in the 8%. I think more probably in the 7% now. But no, we really haven't changed the way that we analyze securities.

Stewart Zimmerman

Just to reiterate, we're not chasing assets with the idea that we're going to look at lesser assets, because it's the yield. The yield in fact may be a little bit less. The price may be a little bit higher, but the methodology hasn't changed one iota since we started this.

Bose George - KBW

And then just one last thing. What was the duration gap at the end of the quarter?

Stewart Zimmerman

Give us one second. I believe it was about 0.65.

Operator

And next we will go to the line of Douglas Harter from Credit Suisse.

Douglas Harter - Credit Suisse

I was just wondering if you could talk about the willingness to add new non-agency repo while you are sitting on a lot of cash and sort of how you balance that.

Why would you be adding the repo while sitting on the cash? Why not deploy the cash first and then add the repo later? And how do you balance that?

Bill Gorin

Two things. I think one as we've opened new lines on the non-agency side, there has been certainly a desire to put some assets on those lines. There's then a lot of interest on the lending side. But I think the third thing is based on what we said about Fannie Mae prepayments, those prepayments will generate a fairly large principal receivable.

Craig Knutson

If the credit department of the bank gives you the repo, they want you to use it. They don't want you sitting on those unused lines. It doesn't do them any good. If they allocate to potentially going to use it, they want to make the money. So when they give you the line, you want to use it.

Stewart Zimmerman

And again, we look at the Fannie Mae being a three or four-month situation, not going on forever. So we felt there was a prudent way to handle cash positions and to be able to address the repo of the non-agencies, which again became available to us.

Douglas Harter - Credit Suisse

So I guess as we get into the back half of the year post the GSE buyout, then you would expect those cash balances to decline?

Stewart Zimmerman

Right. As we just said, we've already committed to buy a $1.3 billion during the quarter and we'll probably look to some more during the quarter. So you could look for that. But again, it's very important to be very prudent. Again, when you look at the Fannie Mae program and what they started to do, again, they started in March with coupon 6.5 and higher; April, 6 and higher; May, 5-plus; and June, 5-plus.

So when you look at that and when you look at our portfolio, we want to make sure we have enough cash to meet our obligations. And we certainly have that.

Operator

And our next question comes from the line of Mike Taiano with Sandler O'Neill.

Mike Taiano - Sandler O'Neill

Just to hit on the agency MBS purchases question, is it fair to say that the reason for the change is not because the prices have gotten all that much better, it's more just because you're getting a lot of cash flow from the Fannie Mae buyouts and you have to basically redeploy that?

Stewart Zimmerman

That's part of it. I mean the (inaudible) do it, that's certainly part of the reason. But we also like the value that we se in that. But having said that, we also are being very selective. We're being very careful on the other sides, because, again, you might say where the interest rate is going to be over the next two or three years. And generally, they're not going to be lower than they are today; they're going to be higher. We recognize that. We're going into this blind. We recognize it. We've put on some edges on the other side to address most of those problems.

And again, I think to reiterate what Bill said a moment ago, we aren't 10 times levered. So when you look at our leverage, and you look at what we've purchased and look at the existing portfolio, when you put it all together, I think we're very well situated going forward.

Bill Gorin

We took the number below where we want to go, just because if we could sell assets of of 105 and we thought 25% of them were going away the next month at par, that was the good trade to make. But we publicly said we want to be closer to 7. And part of the reason we are comfortable buying these assets here, as you mentioned the prices have not pulled back, it is the swap rate that's so attractive.

Mike Taiano - Sandler O'Neill

And the amount of leverage you anticipate on the agency MBS purchase, is it somewhere in the 6 to 7 times sort of range?

Stewart Zimmerman

There isn't a bogey. Again, our leverage is relatively low right now. As Roger mentioned, we're committed to purchase quite a number of securities. So I would look for that leverage number to go up, but I'm really not prepared to give you a precise level at this moment.

Bill Gorin

Remember we said we expect about $1 billion more to run off. So purchasing $1.3 million growth relative to the capital in excess of $2 billion. So it's not a big change in leverage strategy.

Mike Taiano - Sandler O'Neill

Okay. And then just a question on the non-agency. So I'm just curious to get your view on, I guess, the more recent changes to the (han) program and talking about principal reductions and sort of how you view that. Is that a good thing for MFA? How would that be a principal reduction? How does that flow through the securities? Does it come through as a prepayment or how does that work exactly?

Bill Gorin

Our understanding is that most principal reductions in the first mortgages will come through the credit waterfall as a loss. So you could say on one hand that that's a bad thing, because it increases losses. On the other hand, we model losses into our assumptions when we purchase securities, and we lay out a table in the Q where we show what are our credit discount is.

And overall, the whole portfolio is about 28 points. But I can tell you that in general, the loss severities that we assume to get those numbers are typically on the low end, probably 40%, 45% and on the high end as high as 70% or 75%.

Nobody really knows, but I guess the way that we look at it is if you had principal reduction and let's say that the mark-to-market LTV on the loan was 150%, which is pretty high, and let's say that they could give the principal down to 100, that's basically a 33% loss severity.

So if that modification works, that is if the borrower does not re-default, then we probably used default numbers that were too high to begin with, but more importantly, the severities that we assumed were too high.

Mike Taiano - Sandler O'Neill

And so would that loan note stay on your books or would that loan be effectively replaced by a new loan?

Bill Gorin

Well, unlike agencies where any modification causes the prepayment, in non-agencies the loan would stay in the pool. There would just be a loss associated with that mortgage. So the loss would flow through the deal. But whatever was left, in that case if there was 150 and they modeled it down to 100, the 100 would stay in the pool.

Mike Taiano - Sandler O'Neill

So you're not getting the principal back. You would then just start to collect the coupon on the new loan?

Bill Gorin

That's right. There is no recovery like there would be on a liquidation, but it's just the loss.

Operator

We will go to Daniel Furtado's line with Jefferies.

Daniel Furtado - Jefferies

A quick question. On this $900 million-and-change in sales, did these occur before or after the GSEs announced the buyout?

Craig Knutson

Well, some people like to point out how pressured they are. We sold in the fourth quarter. So clearly, that was (inaudible). But honestly, most of these sales were done after the February tax announcement.

Daniel Furtado - Jefferies

Okay. And then how about the thoughts from new non-agency RMBS issuance? And I'm not necessarily talking about the deal that was out in the space. But to the extent that that market comes back, is new issuance something that you would look to invest in? Or are you guys strictly vintage securities from a non-agency perspective?

Stewart Zimmerman

I think what we did say is that we're going to look at both. We'd like to see the history. I think it makes Craig's job a little bit easier. He can make some very good educated guesses, if you will. But again, to rule out new originations doesn't make a heck of lot of sense. So we will look. But right now, we are very comfortable with looking where we can see a little bit of history, and we get a much better feeling about the value of the security.

Daniel Furtado - Jefferies

And then the decision to reenter the agency market, is there anything technical from a REIT rules standpoint or anything that's causing this philosophy shift? Or is this just a philosophical shift on your part?

Stewart Zimmerman

I can't answer the question exactly the way you asked it. So I will do my best to give you some color. As you know, we have no whole pools. And it's got about what's called the 55% test. We don't get close to it, because I have to sleep at night. However, having said that, when you look at the amount of Fannie Mae delinquencies and when you look at this buyout program, you want to be sure. So as Bill had mentioned a moment ago, we anticipated maybe $1 billion in buyouts for this quarter. And that's fine. But again, which particular pools are going to be bought out. Everything we have are whole pools. So you need to be careful, and we are extremely careful with that.

Daniel Furtado - Jefferies

Okay. I definitely like your philosophy that you were employing before that if price isn't too high, we don't like them. Now you are back in the market despite the fact that prices have ground higher. Assuming that pricing stays exactly the same, do you think that this is like a 2Q event where you replenish the portfolio and then kind of wait for pricing to get more sane, or do you continue to look for value in that agency market 3Q and beyond?

Stewart Zimmerman

Look at the philosophy of the company. What do we buy? Well, we own a very nice portion of non-agencies that are doing very well for us. We are very pleased with the philosophy.

So again, we could look at either/or. So we're not fixed on the agency; we're not fixed on the non-agency. It's a blend which is exactly what the press release says. And it says where is the value. And again with that value on the non-agency side, we'll certainly continue to be active in that market.

Having said that, there are certain strengths relative to being a REIT where you have to have a certain amount of agencies. The answer is yes. But having said that, we like the agency market. We always have and we continue to. So that's not the absolute reason. It's a reason.

Operator

And next we'll go to Mike Widner's line with Stifel Nicolaus.

Mike Widner - Stifel Nicolaus

So I'm assuming the 10-Q will be out sometime this morning, as you guys customarily do.

Stewart Zimmerman

It will be up before the end of the day.

Mike Widner - Stifel Nicolaus

So let me just see if I can get you guys to give us a little more clarity on how you think about the relative attractiveness of the two halves of the business today. And I don't know how you want to express it. But maybe in terms of what kinds of ROEs you'd expect, the type of leverage you're running on the agency versus the non-agency and how you might see your relative allocation or expect your relative allocation of equity to go across those two pieces of the business.

Craig Knutson

And this sort of ties in with the last question. So the point brought up was you need to have majority of your assets in whole pool agencies, and we've said this before. I know you guys all know that. And we are easily there. But as Stewart pointed out, if you lose $1 billion, you don't know which (inaudible) the agencies is going to prepay. So you need to build in that cushion. So I think we communicated that.

The other thing is we have added some credit risk, which because of the credit enhancement and because of the prices we pay and because of the credit reserves we build in we are very comfortable with. But a company like ours also gets paid to take some form of interest rate risk. And some companies take a lot more and some take a lot less. And we tend to be on the lot less, but we have to have some.

And Ron pointed out the duration was 0.7, and our leverage is probably at the bottom of the level with everyone else. And compared with the environment, we do have to accept some form of interest rate risk. We are not going to substantially remain in their place to run off. So to the extent that we are buying versus selling, that is different, because it's not like you were taking up multiples of leverage here. So it's not a big change. Did that help you, Mike?

Mike Widner - Stifel Nicolaus

I mean a little bit. Maybe if I throw out some numbers, you can respond. If I look at the non-agency part of your portfolio over the prior couple of quarters, and I haven't really crunched all of the numbers for this quarter, but you're kind of in the 10%, 11% ROE range in the non-agency part of the business. And I was just wondering if that's kind of the range you're shooting for if you're hoping for things to be better?

And we all know prices on that side have appreciated nicely and that's worked in favor of your book values. But with asset prices being a little higher, how do you think about that part of the business and the relative trade-offs of having to put more leverage on to get better returns? And just generally, where do you expect that directionally to be heading?

Bill Gorin

Well, on the non-agency side, that number is correct, but that's been after yield. That's not in ROE. So unlevered it's 10% to 11%. So add leverage obviously and that number can increase. And then we've also discussed the current state of the non-agency market and where loss adjusted yields are. And those are probably in the 7% to 8% range.

And as we both have said, there's obviously leverage available on the non-agency side. Fair cuts have been as low as 10% and on the high end probably 30% or 35%.

Mike Widner - Stifel Nicolaus

I'm just really mostly looking for the indication of how you view the relative trade-off between the two right now, because obviously you are in a position where you have a lot of capital and you could overweight one part of the business relative to the other going forward.

And just all else being equal, current prices, current assets, current things that you see out there, current expectations for the fed, do you have a slight bias one way or the other, or should we look for the mix of equity allocation across the two parts to stay roughly the same?

Stewart Zimmerman

I think you'll see it roughly the same. I don't see a large differentiation one way or the other.

Operator

Our next question comes from the line of Matthew Howlett with Macquarie.

Matthew Howlett - Macquarie

Thanks for taking my question. Just a follow-up on the hybrid business model. Longer term out, maybe next year in 2011, 2012, can you eventually see spinning out MFR? Given really the trade of the non-agency side, you guys came in at the right time, and that appears to be going where you need to keep on adding more and more leverage to generate the double-digit ROE. Do you feel like this is a business you're going to stick with over the longer haul or do you feel like at some point you're just going to go directly to the agency side?

Stewart Zimmerman

First, we're not a hybrid breed. All due respect, we are a real estate investment trust. And we like residential; we invest in residential mortgage-backed securities. So whatever that's, I think there was extension. We liked the idea that we've done it under the umbrella of MFA as a wholly-owned sub. All of it makes sense.

Looking to the future, a lot of different things could happen. So when I rule it out 100%, now I can never rule out something 100%, but the formation of MFResidential under the MFA umbrella, looking in hindsight, is exactly the way it should have been. And I'm very, very glad it's exactly what we did.

Bill Gorin

Advertisements for the company being run as one, the non-agency assets that are yielding in excess of 10% unlevered have very little sensitivity to interest rates. So we decrease our interest rate risk by running that portion of the portfolio. The other interesting thing, that's a coincidence, in this quarter the premium amortization on our agencies and the discount accretion on non-agencies were equal. So you had no impact on EPS. So we great synergy between the two. But the focus is residential mortgage-backed securities, agency and non-agency.

Matthew Howlett - Macquarie

It's certainly been an excellent trade. I guess the question would be as the non-agency side continues to rally as the economy improves, do you have to use more and more leverage on that side or maybe even deep down more and more credit analysis? I don't know if you are taking down below senior pieces, you know, maybe part of the new issue market if that ever comes back. We're starting to see it come back a little bit.

Do you feel comfortable really diving down into the credit side at some point and taking really the credit risk that's going to go with that business over the long run?

Stewart Zimmerman

We will continue to be very, very selective in terms of securities. I don't know how many Craig looks at before he determines that he's going to make a purchase. So that philosophy is not going to change.

Craig Knutson

Between January and June of last year, the consensus was we're too early. And starting in July, the consensus was we're too late. So we don't think it's too late. We think yield in excess of 7% loss-adjusted unlevered was still incredibly attractive in a zero interest rate world.

Matthew Howlett - Macquarie

And then, just on the forward purchases on the agency side, any more color? I know you said it was roughly 102% you are buying stuff at. Any color on the coupon, the yield? In certain analyses, it looks like new issue stuff. Any more color on that point would be great.

Stewart Zimmerman

I just don't want to give out everything in terms of what our particular selection process might be, but, Ron at 25,000 fee, you can give some color.

Ron Freydberg

We're seeing splits north of 200 basis points on a adjusted-per swap basis. As I said before, the premium from what we've learned so far is slightly higher than our average 101.3 a little over 102. But again we're seeing very good spreads especially in any a very low interest rate environment and we're able to do very well on the swap market.

Matthew Howlett - Macquarie

Is that, on that spread analysis at, I mean, is the asset a little more focused on the asset yield side, are you seeing stuff yielding over north of 320, sort of that area, when you run them against your curves?

Ron Freydberg

We're seeing in the 300 to 320 range.

Operator

And next we'll go to the line of Greg Eisen with ICM Asset Management.

Greg Eisen - ICM Asset Management

Regarding the Agency's that you are going to be buying in this quarter, will they be of the similar character of the Agency book that you already have? Specifically meaning focused on, I guess, the hybrid type loans as opposed to fixed rate loans or anything else?

Stewart Zimmerman

We've always looked at the hybrid side of it and we continue to look at all sectors of the market, we're not limited of what we can look at. So I would continue to say that we certainly understand and appreciate the hybrid market and we continue to look at other parts of the market as well.

Greg Eisen - ICM Asset Management

Okay, the second question and I stepped away from the phone for just a second so I don't know if you may have answered this when I was away from it. But you mentioned the adjusted yield spreads that you could earn on the new Agency's, adjusted for swaps. And I think you implied that you are putting swaps on the books along with the new Agency's. Is that correct?

Ron Freydberg

Yes.

Greg Eisen - ICM Asset Management

Okay. Because I was kind of modeling out that you're just going to let your swaps run off for the rest of this year. Because it looked like you had, from the beginning of the year around $800 million of swaps to run off which, by my figuring, it was added to earnings in a pretty nice way since you're paying over 4% fixed and receiving next to nothing on the adjustable side. Could you tell us what kind of fixed base swap rates you are faced with now in the market?

Ron Freydberg

Historically, we hedged it about 40%. So that made good approximation for you to the extent adding new assets right about 40%, but it shouldn't mess up your calculations. You do have the old assets going away, just the way those old swaps going the way you've mentioned out $800 million this year. And the new swaps, you can look that up yourself, what's a swap curve for three year swap and five year swaps?

Greg Eisen - ICM Asset Management

So you are buying on a three to five-year side. That answers that question. And I guess my final question is kind of a hypothetical. If we just at the moment assume the continued strength in the economy and the market returned to some level of normality and the (9HZ) bonds that you hold continuing to price up in the direction of par, but not getting to par, yet at the same time the Agency world somehow fixing itself even though Fannie and Freddie are wards of the government, and you're able to buy reasonably priced Agency's back in the 101 range and yet your Non-Agency book moves back up to 85%, 90% of par. Could you see, on the other hand, selling off Non-Agency bonds to take the capital gain and redeploying back into a more leveraged Agency portfolio to change the whole character of the portfolio again as the environment changes that way?

Stewart Zimmerman

I guess I should be a wise guy and ask you to repeat the question. Look, it's kind of a question that was asked before relative to MF residential, would we ever spit it out. And again, the best way I can answer your question and the question that was asked previously, was that we really like the idea of having one asset class complementary to the other.

Again, the prepay go up generally across the housing sector. One side of us, we're going to pick up close 30 points and the other side of us, we're going to premium amortization. So one is a terrific buttress against the other. So we really enjoy that. Having said that, you can never say never. Again, using your thesis, if all of a sudden all the bonds Craig had purchased were at an average price of anywhere from 65 to 70 became par, sure we would sit down and take a real good hard look at that and say, "Hey, does this make some sense when we take those gains?"

So we only look at that but with a hypothetically, which is how your question was posed. Hypothetically we would look at it. But right now I will tell you we're very comfortable with the strategy that we've engaged now over the last couple of years.

Bill Gorin

The one thing I'd add on the Non-Agency side, we do look at the entire portfolio when all the bonds, very frequently, we have a pretty regular surveillance process and you'll see in the Q, we actually did sell on Non-Agency bond in the first quarter. Basically the reason for that was we saw the bond craze in the market. It was a bond that we owned. We looked at our assumptions that we used to purchase the bond and felt that we were still very comfortable with those assumptions and at that implied market pricing; the bond was about 2% yield at least in our mind.

So that made sense to sell. It's generally not what we would do, but we look at that. So in your scenario, where the market improves and the prices climb significantly higher is that just because the prices went higher or is that because the underlying technicals or the underlying fundamentals have improved because if that's the case then the yield on those bonds still may be very attractive.

Operator

And our next question comes from Bose George a follow-up with KBW.

Bose George - KBW

I just wanted to ask about the possibility of doing a re-remic transaction or is that kind of on the back burner given the strong re-available with the repo in Non-Agency market?

Stewart Zimmerman

Bose, we continue to look at it. I actually pulled up some numbers because we get asked about this all the earnings call and when this re-remic or re-securitization market first came about which is just about a year ago was in March of '09, the yield on the AAA bonds was 12%, by June it was about 8.5%, in September it was about 7.5% and in December it was 6% may be a little bit inside of 6%.

So as we've said before, the market for those bonds continues to improve, there've been some innovative structures that have seen very, very attractive levels, so we continue to look at it. With the repo market, there's not the same sense of urgency may be that there would be, if the repo market were not as robust as it is, but suffice to say we're very much on top of that.

I think it's probably safe to assume that the repo market for financing is sort of short to intermediate term strategy and the re-securitization strategy would be a longer term solution.

Operator

And, Mr. Zimmerman, there are no other questions at this time.

Stewart Zimmerman

Well, I'd like to thank everybody for being a part of the call this morning. We look forward to speaking with you next quarter, thank you and good bye.

Operator

And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using the AT&T Executive Teleconference service. You may now disconnect.

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Source: MFA Mortgage Investments Q1 2010 Earnings Call Transcript
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