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MFA Financial, Inc. (NYSE:MFA)

Q3 2011 Earnings Call

November 07, 2011, 10:00 a.m. ET

Executives

Alexandra Giladi - Executive Assistant

Stewart Zimmerman - Chairman and CEO

Bill Gorin - President

Stephen Yarad - CFO

Ron Freydberg - EVP

Craig Knutson - EVP

Hal Schwartz - SVP & General Counsel

Kathleen Hanrahan - SVP and CAO

Shira Finkel - SVP

Goodmunder Christiansen - EVP

Analysts

Steve DeLaney - JMP Securities

Bose George - KBW

Mike Taiano - Sandler O'Neill

Jason Weaver - Stern, Agee & Leach

Douglas Harter - Credit Suisse

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the MFA Financial, Inc. Third Quarter 2011 Earnings Conference Call. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session, instructions will be given at that time. (Operator Instructions) As a reminder this conference is being recorded.

I’d now like to turn the conference over to Alexandra Giladi. Please go ahead.

Alexandra Giladi

Good morning. The information discussed on this conference call today may contain or refer to forward-looking statements regarding MFA Financial, Inc. which reflect management’s beliefs, expectations, and assumptions as to MFA’s future performance and operations.

When used, statements that are not historical in nature, including those containing words such as, will, believe, expect, anticipate, estimate, plan, continue, intend, should, could, would, may or similar expressions, are intended to identify forward-looking statements. All forward-looking statements speak only as of the date on which they are made.

These types of statements are subject to various known and unknown risks, uncertainties, assumptions, and other factors including, but not limited to, those relating to changes in interest rates and the market value of MFA’s investment securities; changes in the prepayment rates on the mortgage loans securing MFA’s investment securities; 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, 2010 and other reports that it may file from time-to-time with the Securities and Exchange Commission could cause MFA’s actual results to differ materially from those projected, expressed or implied in any forward-looking statements they make. For additional information regarding MFA’s use of forward-looking statements please see the relevant disclosure in press release announcing MFA’s third quarter 2011 financial results.

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

Stewart Zimmerman

Good morning, and welcome to MFA’s third quarter 2011 earnings call. With me this morning are Bill Gorin, President; Stephen Yarad, Chief Financial Officer; Ron Freydberg; Executive Vice President; Craig Knutson, Executive Vice President; Hal Schwartz, Senior Vice President & General Counsel; Kathleen Hanrahan, Senior Vice President and Chief Accounting Officer; and Shira Finkel, Senior Vice President.

Today we announced financial results for the third quarter ended September 30th, 2011. Recent financial results and other significant highlights for MFA includes the following; third quarter net income per common share $0.23 of core earnings per common share in $0.24.

On October 31, 2011, we paid our third quarter 2011 dividend of $0.25 per share of common stock to shareholders of record as of October 11, 2011. Book value per common share was $7.16 at the end of the third quarter versus $7.48 at June 30, 2011 due primarily to price weakness within the Non-Agency mortgage backed security sector. This is after the $0.25 dividend deducted.

For the third quarter ended September 30, 2011 we generated net income allocable to common stockholders of $81.2 million or $0.23 per share of common stock. Core earnings for the third quarter were $84.7 million or $0.24 per share of common stock. We continue to provide stockholders good attractive returns to appropriate leverage investments in our Agency and Non-Agency residential mortgage backed securities.

Our Agency portfolio had an average amortized cost basis of 102.6% of par as of September 30, 2011, and generated a 3.37% yield in the third quarter. Our Non-Agency portfolio had an average amortized cost of 73.2% of par as of September 30, 2011. And generated a loss adjusted yield of 7.29% in the third quarter. In the third quarter we continue to selectively find value in the Agency hybrid MBS market. In addition, we continue to implement our strategy of identifying and acquiring Non-Agency mortgage backed security with what we consider to be superior loss adjusted yields of prices well below par. Our goal remains to continue positioning MFA to generate double-digits returns on equity overtime.

In the third quarter, the Non-Agency mortgage backed security market like other credit set is a good market became less listed. All this made prices more volatile and also has given longer term investors such as MFA. The opportunity to acquire assets with attractive long-term cash flows. Due to underlying borrower characteristics and structural features, our Non-Agency portfolio was less impacted by price movements, declining an average of 2.4 points.

I’d like to go over other certain additional data highlights as they pertain to our third quarter 2011 results. Fair market value of Non-Agency mortgage backed securities $4.14 billion; face amount of Non-Agency mortgage backed securities $5.65 billion; amortized cost of Non-Agency mortgage backed securities $4.1 billion; net purchase discount of Non-Agency MBS $1.58 billion.

Average structured credit enhancement of Non-Agency mortgage backed securities 5.7%; interest earning asset portfolio net yield of 4.53; cost of funds of 1.7% and our portfolio spread as defined by the interest earning assets minus the cost of funds of 2.83%; and the portfolio spread as defined of interest earning asset minus the cost of funds, but this includes our mortgage backed securities underlying linked transactions of 2.9%.

Our mortgage backed security portfolio CPR which includes that mortgage backed securities underlying linked transactions to 17.8%, our Agency MBS CPR 19.2%, and for those of you who have an interest, I think most everybody on this call are CPR as just recorded on Friday was approximately 19.6%. Our Agency MBS CPR was 14.5% and our leverage which is overall debt-to-equity was 3.5 times.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the line of Steve DeLaney from JMP Securities. Please go ahead.

Steve DeLaney - JMP Securities

Just wanted if you can give us little more color on what you guys were thinking about as you were watching this volatile market in the third quarter and kind of how it affected your portfolio decisions. Specifically, Stewart, I mean you started buying Non-Agency RMBS I believe in the fourth quarter of 2009.

Stewart Zimmerman

It was 2008, Steve.

Steve DeLaney - JMP Securities

Time flies.

Stewart Zimmerman

We were having fun.

Steve DeLaney - JMP Securities

Yes, we are, almost three years now. But this I think is the first quarter that I can recall since then where sequentially the Non-Agency portfolio, the average cost basis didn’t go up. So, I mean overall you were roughly flat, you grew the Agency book a little bit. Maybe just big picture what’s your thought were looking at relative value between say new Non-Agency versus season hybrids on the Agency side, because it looks like in terms of any commitment to higher leverage seem to go to the Agency book in this quarter. I’m looking at it right? Thanks.

Stewart Zimmerman

Steve, let me give this at a 25,000 feet and I think Bill will probably like to give you some detail, but as you know wherever we see value it's where we continue to buy the assets and again we did see some value on the Agency side, and as you know there has been quite a bit of volatility on the Non-Agency side. There are number of folks who would say well in a situation like that maybe you would back away from the Non-Agency, but again we don’t necessarily do that, because those are all the opportunities. And as you know your book value is a snapshot in time. So, yes there were certainly some volatility on the Non-Agency side, as I said in the opening remarks and as you can find in our press release it was down about 2.4 points on the non agencies, but as far as I’m concerned that’s another opportunity for us. Bill?

Bill Gorin

Yes, we were excited about the opportunity in the non agencies and Goodmunder has found some good opportunities on the Agency side. So, pretty much a relationship between the two asset classes being changed over the course of the quarter. I think actually the second quarter was probably the first quarter where Non-Agency marks trended down and that continued in the third quarter. We selectively found buying opportunities, as you know we focused on senior most tranches of better quality assets and despite what you might read in the Popular Press, there has not actually been a large amount of selling of these types of assets, but when those assets are available we pick through, we are probably a little more choosy, because we are now looking to grow a large amount probably until we do another resecuritization. So, we found optimism both sides and we invested throughout the quarter.

Steve DeLaney - JMP Securities

Just one quick follow-up Bill. You sold some MBS during the quarter, I assume that was Agency, will you just trying to get out of the way of Harper, trying to protect yourself from a standpoint of prepaid picking up.

Bill Gorin

Yes, it was a small amount and it was from higher coupon assets. I think actually a good amount in those or non (inaudible).

Stewart Zimmerman

But Steve, that’s something we know we always do from time-to-time, we really commented calling out the portfolio in terms of particular security that maybe was negatively invested. Those might be securities you better off selling rather than keeping. But again it's such a small amount.

Operator

Thank you. And our next question comes from the line of Bose George of KBW. Please go ahead.

Bose George - KBW

Just in terms of follow-up on that, in terms of the yields on the new Non-Agency, I was just wondering where they are relative to last quarter, and just the same on the Agency side or spreads rather.

Stewart Zimmerman

So, on the Non-Agency side, Bose, I’d say as Bill said that the opportunity to buy product has not quite been the same in the last month or two. So, there weren’t as many bumps for sale, but I’d say those yields right now are probably 7 to 8% type range.

Bose George - KBW

Fair to say a little bit higher than what you guys have had on the portfolio the average for the third quarter?

Stewart Zimmerman

Yes, there is backup in price has obviously raised yield and so I’d say we probably told you, I’m guessing on the second quarter call that yields were in the 6.5 to mid 7 type range. I’d say they are now yield 7 to 8%.

Bose George - KBW

Okay. Great. And then just similar on the agencies like word incremental spreads.

Goodmunder Christiansen

Hi Bose, this Goodmunder. So, on the Agency side, the yields are about 2.25, and the spread including appropriate hedges is about 175 basis points, so 1.25.

Bose George - KBW

Okay, great. And then just share (inaudible). On the last call you guys discussed the 2 billion of non agencies that are resetting and your yield assumptions and corporate, so there is no impact on the returns. I just wanted to make sure, I understood the mechanics, so it just on the early year's there is more cash and then there is more accretion later year's after the reset occurs.

Goodmunder Christiansen

Well, I guess, yes in practice you would get more accretion in later years if the coupon goes down. But the yield assumption in corporate assumptions of future coupons on the security. So, as the forward curve changes the assumptions about future coupons will likely also change.

Operator

Thank you. Our next question comes from the line of Mike Taiano from Sandler O’Neill. Please go ahead.

Mike Taiano - Sandler O'Neill

Just curious on, I think you guys have said that the activity on the Non-Agency CMBS side is slowed. And just wondering does that affect how you mark your portfolio, in other words you have to rely more on our mark to model as oppose to mark to actual trades that are happening at this point.

Bill Gorin

No. The answer is we don’t mark, mark to a model, we outside we have models and we have anticipations on what those yields might or might not be and how sensitive are those cash flow to the banker region in the market. But again we continue to go out and we get marks from various counter parties in addition to the pricing services.

Stewart Zimmerman

Mike, you will see in our 10-Q which we will be filed later today that we still have everything classified as level II in our disclosures for FAS 157.

Mike Taiano - Sandler O'Neill

Okay, great. And just curious as to what you have seen in price movement specifically on the Non-Agency side to the end of this quarter.

Craig Knutson

Mike, it's Craig, I’d say places have still been soft since the end of the quarter which is somewhat surprising given the rally in most other risk assets. But if I had to guess across the sector places since September 30, are probably down about a point for so.

Operator

(Operator Instructions) And our next question comes from the line of Jason Weaver from Stern, Agee. Please go ahead.

Jason Weaver - Stern, Agee & Leach

First, can you talk about a little bit about the effect of taking some of your gains from the Non-Agency prepayments and using those to increase the credit reserves discount and how we should think about that going forward?

Stewart Zimmerman

Thanks for the question. So, I think what I’d like to explain is that we use what we think are conservative assumptions about future losses. Now the losses occur in the future as we showed in this press release, the CPR for non agencies was close to 15%, that higher than what we project in our yield estimates. So, when the extra cash comes in and it does, it actually, prepays the cash actually comes in, what it does is it lowers your amortized cost and I think that might address your question Jason?

Jason Weaver - Stern, Agee & Leach

Exactly. So, going forward, that’s really just going to be a function of how prepayments come in versus your estimates, is that why I’m here?

Stewart Zimmerman

Yes, because the repayments, look they are performing better than we projected when we bought the assets, when that actual cash comes in, what it does is, it's going to pull down somewhat our amortized cost, which should help you yield overtime.

Jason Weaver - Stern, Agee & Leach

Fair enough. And just one more. What are you seeing right now as far as the state of the resecuritization market goes whether this becomes an ongoing part of your strategy?

Stewart Zimmerman

Well, we had three resuritizations, which in the last year cleared up capital for us to invest at good yield. Some of the drawbacks now are the rating agencies have made it more difficult to get ratings, not a good rating, get any ratings of resecuritization but it's something where we are working on.

Operator

Thank you. And our next question comes from the line of Douglas Harter from Credit Suisse. Please go ahead.

Douglas Harter - Credit Suisse

Just the follow-up on that last question. Is the non rated market also open and is there something that you guys consider in light of the rating agencies?

Stewart Zimmerman

Yes, (inaudible) is open and it's been open. But because we are buying higher quality assets and the execution is more expensive on the non rated re-REMIC. It's something we have in doing. We looked at it, because we are buying better assets, that don’t yielding seven, you are not excited on the execution on the non-rated re-REMIC.

Bill Gorin

It's much more efficient if you will relative to the marketplace when we look at a rating situation rather than non rated.

Stewart Zimmerman

The other thing I’d add is, the issue with the non rated resecuritization and obviously those have become more prevalent in the last two quarters or so. The issue with those is really if the big liquidity give up. So, if were to purchase the senior piece of non rated re-REMIC, it's more difficult to find answers to private placement based on a dealer shelf. So, there really going to be maybe one place to finance that, and also more importantly you can never resecuritize again in the future. So, we view it as a liquidity give up.

Bill Gorin

I think Doug was asking being an issuer not investor, is that right, Doug?

Douglas Harter - Credit Suisse

I was talking about the issuer but that color is all helpful.

Operator

Thank you. And this time we have no further people in the queue. Do you have any further remarks at this time?

Stewart Zimmerman

No. Just like to say thank you. We look forward to speaking with you on our next earnings call.

Operator

Ladies and gentlemen, this conference will be available for replay after 12 pm Eastern time today through November 14, you may access the AT&T teleconference replay system at any time by dialing 1800-475-6701, and entering the access code of 223913; international participants dial 320-365-3844. Those numbers again are 1800-475-6701 and 320-365-3844 with the access code of 223913. This does conclude our conference for today. Thank you for your participation and for using the AT&T executive teleconference. You may now disconnect.

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