Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Stewart Zimmerman – CEO

Bill Gorin – President and CFO

Craig Knutson – EVP

Ron Freydberg – EVP, Chief Investment Officer and Administrative Officer

Analysts

Ryan O'Steen [ph] – KBW

Jason Arnold – RBC Capital Markets

Michael Taiano – Sandler O'Neill

Jasper Birch – Macquarie

Jim Ballan – Lazard Capital Markets

Steven Zakalik [ph]

MFA Financial, Inc. (MFA) Q2 2010 Earnings Call Transcript August 3, 2010 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the MFA Mortgage Investments second quarter 2010 earnings call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded today, Tuesday, August 3rd, 2010.

And now, I would like to turn the conference over to Alexandra Gelardi [ph]. Please go ahead, ma'am.

Unidentified Participant

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 31st, 2009, Quarterly Reports on Form 10-Q for the quarter ended March 31st, 2010 and June 30th, 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 June 30th, 2010 and/or the press release announcing MFA's second quarter 2010 financial results.

Thank you for your time. I would now like to turn this call over to Stewart Zimmerman, MFA's Chief Executive Officer.

Stewart Zimmerman

Good morning, and welcome to MFA Financial's second quarter 2010 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, Senior Vice President and General Counsel; Teresa Covello, Senior Vice President and Chief Accounting Officer; and Kathleen Hanrahan, Senior Vice President.

For the second quarter ended June 30th, 2010, we generated net income available to common stock of $46.3 million or $0.16 per share of common stock. For the second quarter, core earnings were $51.3 million or $0.18 per share of common stock. Core earnings for the quarter represents a non-GAAP financial measure, which reflects net income, excluding impairment losses and changes in the unrealized net gains on MBS Forwards.

On July 1st, 2010, we announced our second quarter 2010 dividend of $0.19 per share of common stock, which was paid on July 30, 2010 to stockholders of record as of July 12, 2010.

We continue to provide stockholders with attractive returns through appropriately leveraged investments in residential mortgage-backed securities. Second quarter 2010 results were negatively impacted by extremely high Agency MBS prepayment rates, due primarily to programs instituted by the GSEs to buy out 120-plus day delinquent loans in their Agency MBS pools. For the second quarter of 2010, our weighted average Agency MBS prepayment rate as measured by CPR was 42.7% compared to 25.6% for the first quarter of 2010.

Prepayments on mortgage-backed securities acquired at a premium reduce earnings as the premium is amortized based on prepayments. With the completion of the initial implementation of the buyout programs, we believe that our Agency MBS prepayment rates will decline in the third quarter. Our goal remains to position MFA to generate double-digit returns on equity over time, and we continue to take advantage of investment opportunities by identifying and acquiring non-Agency mortgage-backed securities with superior loss-adjusted yields at prices significantly below par.

We have substantially reduced our reliance on leverage through repurchase financings. As of June 30th, 2010, our debt-to-equity multiple was 2.8 times versus 4.8 times as of June 30th, 2009. By utilizing less leverage, we believe that future earnings will be less sensitive to changes in interest rates and the yield curve.

I would like to go over some recent financial results and certain additional data highlights as they pertain to our second quarter 2010 results. Second quarter net income per share of $0.16 and core earnings per common share of $0.18. Book value was $7.61 per common share at the end of the second quarter.

In the second quarter, non-Agency residential mortgage-backed securities, including mortgage-backed securities underlying MBS forwards held by our MFResidential Assets I, LLC subsidiary generated, on an unlevered basis, a loss-adjusted yield of 10.3%. Based on MFR LLC non-Agency MBS asset performance exceeding prior expectations, $81 million of the purchase discount on these assets was reallocated in the second quarter from credit reserve into accretable discount.

Together with coupon interest, accretable discount is recognized as interest income over the life of the asset. Therefore, we expect that this $81 million will be reflected in income over the life of these non-Agency mortgage-backed securities.

Agency MBS prepayment rates are expected to decline in the third quarter and it is currently anticipated that core earnings per common share will increase in the third quarter, due to both the expected decline in Agency MBS prepayment rates leading to lower premium amortization expense and continued reinvestment of cash received from MBS principal repayments.

There has been quite a lot of discussion over the last few days regarding government-sponsored refinancing of Agency mortgage-backed securities. Overall, we are of the belief that the risks and costs of trying to implement such a refi program mostly outweigh the potential benefits. Not to mention that there are limited resources to effect such as refi program and such a program would likely hurt the housing recovery rather than help it.

In particular, we believe that one, the potential impact of such a refi program would have a negative effect on banks, insurance companies, and all other investors and, Agency mortgage-backed securities; two, the GSEs would likely be negatively impacted with a result of the continued negative earnings; three, a potential significant increase in mortgage rates is also likely; and lastly, additionally, there is a limited origination of servicing capacity available for such a potential refinancing.

As previously mentioned, our MFA MFR portfolio consists of both Agency and non-Agency mortgage-backed securities and as a result, even if such a refi program were instituted, we strongly believe that MFA's strategy of blending Agency and non-Agency mortgage-backed securities would work to mitigate the negative impact of any such program. The end result is that it's unlikely that a government-sponsored refinancing will occur. However, if such a refi program were to occur, we believe that our investment strategy will be much less impacted than other companies in our space.

I thank you for your continued interest in MFA Financial. And at this time, I would like to open the floor for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). One moment please for our first question. And our first question comes from Bose George with KBW. Please go ahead.

Ryan O'Steen – KBW

Hi, good morning, guys. This is actually Ryan O'Steen [ph] on for Bose George.

Stewart Zimmerman

Okay.

Ryan O'Steen – KBW

So it's good to see the $81 million reallocated to the accretable discount. Can you kind of talk about what goes into the decision to do that? And then also, is it likely we are going to see that again in the future?

Stewart Zimmerman

Craig, you want to handle that?

Craig Knutson

Sure. As far as what goes into that decision, it's really – it's a process that we go through all the time of reevaluating all those assets and the actual performance versus the assumptions that we book those assets on. So as we get more and more historical data, it would – it becomes a little easier to say, "Well, gee, we think our assumptions were a little bit harsh here or we think our assumptions were a little bit lenient." At the end of the day, it's really loss severity, default, and prepayment that govern the performance of these securities. So it's a combination of those things and it varies by security.

Ryan O'Steen – KBW

Okay.

Craig Knutson

Again, the fact that in many of these cases and in most of these bonds where we did this reallocation, there are purchases from 2008 and 2009 where we do have some more substantial pay histories. As far as do we anticipate this in the future, it remains to be seen. Most of the bonds that we adjusted were 2009 and prior. Bonds that we purchased in 2010, you – at most, we have six months of data, which is not really all that conclusive. So we will continue to monitor it. We do that at least quarterly and to the extent that the evidence is compelling that we do need to change those, we will.

Stewart Zimmerman

Just to add to that, our surveillance process is all encompassing and when Craig and his team, they look at these – they look at each of these securities certainly on a monthly basis after the remittance reports come in on or about the 25th of the month. So again, it is continually revisited.

Ryan O'Steen – KBW

Great. Thank you. And then just a couple of quick ones. One, what kind of unlevered returns are you getting right now on your non-Agency portfolio? And two, do you have the duration gap for the end of the quarter?

Craig Knutson

The non-Agency assets that we continue to purchase, that – it was a little over $300 million that we purchased in the second quarter. They vary by asset type and class, but I would say generally obviously those yields loss-adjusted unlevered range from about 7.5% to 9%.

Ryan O'Steen – KBW

Great. And did you have the duration gap?

Craig Knutson

For the overall portfolio?

Ryan O'Steen – KBW

Yes, yes. At the end of the quarter.

Bill Gorin

You want the duration or the – the effective duration for the whole portfolio was 0.49 at the end of the quarter. That includes a negative (inaudible) of 0.75.

Ryan O'Steen – KBW

Okay. Thank you.

Stewart Zimmerman

Thank you.

Operator

Thank you. And our next question comes from the line of Jason Arnold with RBC Capital Markets. Please go ahead.

Jason Arnold – RBC Capital Markets

Hi. Good morning, guys. Thanks for the color on the refi thought there. That was helpful. I was just curious if you could talk a little bit about the purchases made in the quarter on the Agency book. You mentioned some purchases of 15-year MBS, but perhaps you could offer a little bit more color there on what you found attractive in the quarter?

Stewart Zimmerman

I'm going to turn it over to Ron just in a moment to answer that. Again, as you know, we've been basically a non-buyer, but we saw some real value in the 15-year, so we kind of dipped our toe in that pool and it turned out to be, I think, a very, very good decision. But Ron, why don't you give some detail?

Ron Freydberg

Sure. For the most part, we were about $1.5 billion of Agency mortgages in the quarter. And that includes $205 million of 15-year; those were 4% coupons and we bought those at the beginning or to the middle of May when we saw much better yields and – than what we've seen in the hybrids, especially when you compare it with the effective duration that you are getting. So we viewed it as a much better risk-reward than we were seeing on the hybrids. The rest of the portfolio we purchased were essentially 5/1 hybrids, 3.5% coupons on average. So that – those are the two main categories that we did purchase, but at the 15-year, we were looking at the 4s and 4.5s.

Jason Arnold – RBC Capital Markets

Okay. Perfect. And then I was just curious also if you could offer a little bit of color on what you are seeing in the non-Agency repo availability end of things, haircuts, rates, et cetera.

Craig Knutson

Sure. The non-Agency repo was a little bit up from what it was in March, but – I think March was $902 million, it was $929 million at June 30, so up a little bit, but relatively unchanged. We continue to see repo availability in that market. Haircuts on the better-quality assets are typically as low as 10%; haircuts on lower-rated assets are generally 30%, maybe in some cases 35% or 40%. In terms of rates, I would say that the tight end of rates is probably LIBOR plus 100 and LIBOR plus 175 is probably sort of the wide end of where rates are.

Jason Arnold – RBC Capital Markets

Terrific. Do you guys anticipate taking advantage of utilizing a little bit more repo leverage in the portfolio going forward? Are you kind of comfortable with where you are at, at this point?

Craig Knutson

On the Agency or the non-Agency?

Jason Arnold – RBC Capital Markets

Non-Agency, please?

Craig Knutson

Certainly to the extent it's available, we look at that. I think we have also looked at the re-securitization market as well. So I think we said at the beginning of the year that on the non-Agency side that a lot of the task [ph] this year was to optimize the capital structure. So at this point, I think repo has obviously served us very well. It's more available than it was three months ago, than it was six months ago and at very cheap levels. But at the same time, the re-securitization market has improved, at least the execution on a super-senior bond that would represent permanent financing.

Jason Arnold – RBC Capital Markets

Okay. Terrific. Thank you very much for the color.

Stewart Zimmerman

Thank you, Jason.

Operator

Thank you. And our next question comes from the line of Michael Taiano with Sandler O'Neill. Please go ahead.

Michael Taiano – Sandler O'Neill

Hi, good morning. I just wanted to see if I could dig down a little bit further into the $81 million reallocation. Is there – can you be a little bit more specific in terms of what you are seeing on those securities? Is it more severity is coming in better than you expected or are there certain geographies that are performing better than you thought? Can you maybe give us a little more color there?

Craig Knutson

Sure. Well, the analysis that we do is really by security, not by geographical regions. So it's – every security sort of stands on its own against its analysis. I would say, of the three things I mentioned, loss severity, prepayment speed, and default, that loss severity and prepayment speed are probably the two most of significant, right, because higher prepayments which come back at par obviously decrease our amortized costs; and lower severities are typically a little bit more meaningful than lower default rate. But it really is security-by-security.

Now, there were some securities where we may have had some very significant paydowns and the loss assumptions were more or less accurate, but remember that those loss assumptions, that default rate, we use a percentage number. So it's a percentage default rate. So if we get a very large prepayment, that percentage is now applied to a much smaller base number, which means the dollar amount of defaults would be lower. Does that help?

Michael Taiano – Sandler O'Neill

Yes, that's helpful. And in terms of that flowing through the earnings, do you have a rough estimate as to what sort of period we are looking at in terms of how long that would take to flow through with current prepayment speeds?

Craig Knutson

Yes. I would say that – again, on average – but remember there are 200 odd securities here on average, that the average life of the non-Agency MFR portfolio is probably somewhere around seven years. Again, these numbers are not linear, but as an estimate – there are a lot estimates involved here, I would say that the annual impact of this change is probably about $7 million.

Stewart Zimmerman

I think one of the most important things that comes out of this is the fact that the prices that we have been able to buy, the quality of securities that Craig and his team have been able to purchase, right, and the type of surveillance that they do, the end result is there will be a better result than we had anticipated with some very realistic or even maybe some severe – of severe assumptions. So it's all – it's good news and again, the portfolio is acting even better than we had anticipated.

Michael Taiano – Sandler O'Neill

All right. And then just finally in terms of the sort of the mix you have – obviously, you had a lot of run-off on the Agency side last quarter that you had to replace. And just where do you stand in terms of relative attractiveness of the two strategies, Agency versus non-Agency, given the run-off especially in Agency MBS prices?

Bill Gorin

Sure. I think we continue to prefer the non-Agency. We think that's real value-added, the loss adjusted, unlevered yield on total non-Agency portfolio, so in excess of $10 billion. There are assets available in this marketplace with yields of 7.5% to 9%. We must refer that to an Agency yield of 3%, albeit with a higher levered basis.

So we continue – we think we are creating more value for the shareholders and for ourselves and for you by incrementally growing the non-Agency. And probably keeping Agency portfolio about where it is, which is – originally, we had a portfolio of excess of $10 billion and now we are mid $6 million and I think for now, that's probably replacing run-off unless the opportunities increase, staying where we are in the Agency.

Stewart Zimmerman

But having said that, the – I mean, the Agency product is still a product that we enjoy, that we look at, and we continue to see where there is value. And again, Ron had looked at through opportunities in the 15-year as an example and we dipped our toe in that pool. So again, I would agree with what Bill said. The non-Agencies are very effective, but we still enjoy the Agency product.

Michael Taiano – Sandler O'Neill

Great. Thanks very much.

Operator

Thank you. And our next question comes from the line of Jasper Birch with Macquarie. Please go ahead.

Jasper Birch – Macquarie

Hi. Good morning, gentlemen. Thank you for taking my question. I find your comments on the – on potential refinancing pretty interesting. Just historically, you guys have been pretty defensive, putting on high-dollar price MBS. I was wondering – I mean, I guess first of all, does your outlook on there not being a refinancing wave change that, what dollar pricing are you putting on, and were you comfortable taking both your equity allocation and leverage on the Agency book?

Stewart Zimmerman

Well, our Agency exposure in terms of dollar price to premium is about 1.5%. So I would – again, maybe I understood part of what you said, we have never really been a large player in buying securities at very, very significant premiums. Having said that, the Agency – the Agency market again is still attractive to us, although, as we said a moment ago, the non-Agency is a little more aggressive. But having said that, we see – we have seen some opportunities and the – we have paid a little bit higher premium for certain assets. But again, we have gone from, I think it was 101.3% in the quarter previous to about 101.5%.

Jasper Birch – Macquarie

Okay. And we should probably – and you said that you are pretty much just replacing run-off on that book?

Bill Gorin

Yes. It's going to stay close to $6.5 billion.

Jasper Birch – Macquarie

Okay. In terms of your outlook on there not really being many more refinancings, I thought it was really interesting that you said you expect the yield curve to steepen with Agency MBS. Is that really what's driving your outlook on that front or is it more a lack of credit availability for borrowers?

Stewart Zimmerman

I don't think I said that.

Jasper Birch – Macquarie

Oh, you didn't? I'm sorry; I thought I heard it in your opening remarks that you expected mortgage rates to go up.

Stewart Zimmerman

No (Multiple Speakers) – the potential of the government kind of waving a magic wand and doing a refi across the board and basically, looking at the some of the data and looking at the – what the relative availability of the – of what's available to mortgage – to the mortgage banking industry, there is less opportunity rather than more. So we feel that there – the chances of them doing that across that board just aren't as readily available.

Jasper Birch – Macquarie

Okay. That makes a lot of sense. Thank you for the clarity on that. And then just one last question. If I remember correctly, you guys run your Agency premium amortization on a lifetime CPR.

Bill Gorin

No, we do based on – we correct each quarter based on actual.

Jasper Birch – Macquarie

Based on actual? Okay, great. Thank you very much. That's all I have.

Stewart Zimmerman

Thank you.

Operator

Thank you. (Operator Instructions). And we have a question coming from the line of Jim Ballan with Lazard Capital Markets. Please go ahead.

Jim Ballan – Lazard Capital Markets

I wanted to ask about the drop in the average yield on your assets, just sequentially in the quarter. Can you talk about how much of that was maybe due to the greater amount of premium amortization because of the buyouts? Maybe the premium amortization exceeding the accretion of the discount; how much of it was related to that as opposed to just reinvestment at lower rates?

Bill Gorin

Yes. I would – look, there is three things that impacted us. One, obviously, the higher prepays led to more premium amortization. Two, you are right, the Fannie and Freddie buyouts of the 120-plus day delinquencies were tiered by coupons, so they went after the higher coupon first as you know. And the third point would be we are still running with above-average cash balances because of this heavy prepay.

So to the extent the higher coupon – to the extent that assets that yielded us 5% went away and is replaced by a 3%, that's a permanent change on our yield. To the extent that prepays have spiked and are going to go back down, that will increase the yield. I can't quantify exactly – let's say, the – if the yields in the first quarter on our Agency – and this is mainly the Agency, so if the Agencies were yielding 4.64% in the first quarter and now it's down to 3.6% in the second quarter – we will see how much of that's expected to come back – I would say – I would capture back – it's hard to say, it's about half and half.

Jim Ballan – Lazard Capital Markets

Okay.

Bill Gorin

So basically we are saying the yield on the Agencies will go back up to some extent as the premium amortization slows down. But it's not going to go back to where it was because higher-coupon assets were called away and replaced with lower-coupon assets.

Jim Ballan – Lazard Capital Markets

So maybe something a little bit above 4% is a – just for modeling purposes?

Bill Gorin

I don't want to say an exact number.

Jim Ballan – Lazard Capital Markets

Okay. All right, great. That's helpful. Just one other thing if I can. The book value was – it was – didn't really change much, but I'm sure there is a lot of moving parts in that. Could you talk a little bit about the components of the changes in book value, just Agency, non-Agency, and swap book? Maybe the –?

Bill Gorin

It's actually – it's actually a very simple explanation. We got it very right in terms of our hedges. So basically, we had an increase in value in both our Agencies and non-Agencies, equal to the diminished value in swap. The reason for the difference in book value from quarter-end of the first quarter to the second was solely based on the difference in earnings. So to the extent that the earnings were less and basically we pay out – we declare the dividend after the quarter, it was just that differential in earnings per share explains the whole difference in book value.

Operator

Thank you. And our next question comes from the line of Steven Zakalik [ph] with – he is a private investor. Please go ahead.

Steven Zakalik

Thank you. With increases in strategic defaults when doing your due diligence on non-Agency securities, how do you relatively weigh FICO scores versus collateral values and are you modeling in further declines in housing values?

Craig Knutson

We do model in further declines in housing value. As far as FICO scores and LTVs, I would say the predominant consideration is that mark-to-market LTVs on the loans underlying these pools. Well, we do have the ability to get some updated credit, FICO or other borrower-type credit information. It's – generally, the information available on FICO scores in credit is as of origination. So it's not as helpful obviously three, four, five years after the fact. So it's really primarily based on what we believe the true mark-to-market loan-to-value ratios are now.

Steven Zakalik

Okay, thank you. And if you were to issue preferred stock today, what rate would it sell for and how important you view preferred in your capital structure?

Bill Gorin

Well, since we already have an existing preferred stock, which has an 8.5% coupon and is trading near par, I would near 8.5%.

Steven Zakalik

Okay. Thank you.

Stewart Zimmerman

Thank you.

Operator

Thank you. And there is no further questions. I'll turn it back to management for any closing statements.

Stewart Zimmerman

I just want to thank everybody for your continued interest in MFA Financial. We look forward to speaking with you next quarter.

Operator

Thank you. Ladies and gentlemen, this does conclude our conference call for today. Thank you for your participation and you may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: MFA Financial, Inc. Q2 2010 Earnings Call Transcript
This Transcript
All Transcripts