MFA Financial, Inc. (NYSE:MFA) Q1 2024 Earnings Call Transcript

MFA Financial, Inc. (NYSE:MFA) Q1 2024 Earnings Call Transcript May 6, 2024

MFA Financial, Inc. misses on earnings expectations. Reported EPS is $ EPS, expectations were $0.4. MFA isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the MFA Financial Q1, 2024 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will have a question-and-answer session, and instructions for Q&A will be provided for you at that time. [Operator Instructions] And as a reminder, this conference call is being recorded. I would now like to turn the conference call over to your host, Mr. Hal Schwartz. Please go ahead.

Hal Schwartz: Thank you, operator, and good morning, everyone. 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, should, could, would, 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 those described in MFA’s annual report on Form 10-K for the year end of December 31, 2023, and other reports that it may file from time-to-time with the Securities and Exchange Commission.

These risks, uncertainties, and other factors could cause MFA’s actual results 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 the press release announcing MFA’s first quarter 2024 financial results. Thank you for your time. I would now like to turn the call over to MFA’s CEO and President, Craig Knutson.

Craig Knutson: Thank you, Hal. Good morning, everyone, and thank you for joining us for MFA Financial’s first quarter 2024 earnings call. With me today are Mike Roper, our CFO, Gudmundur Kristjansson, and Bryan Wulfsohn, our Co-Chief Investment Officers, and other members of our senior management team. I’ll begin with a high-level review of the first quarter market environment and MFA’s results, and then touch on some of our first quarter results activities and potential opportunities. Then I’ll turn the call over to Mike to review our financials in more detail, followed by Bryan and Gudmundur, who will review our portfolio, financing, and risk management before we open up the call for questions. The first quarter of 2024 began benignly enough until a blowout January payroll report released in early February, which has been followed by somewhat unexpectedly resilient economic data and persistently stubborn inflation numbers, all of which have sent rates modestly higher.

Two-year treasuries ended the quarter up 37 basis points, and 10-year treasuries ended the quarter up 32 basis points. While a far cry from some of the bond market volatility experienced over the last two years, we are nevertheless reminded that the path of interest rates is still very much uncertain, and the market has crossed out many of the rate cuts that had been expected at the beginning of the year. Agency mortgage spreads have widened somewhat since the beginning of the year, but they’re still considerably tighter about 25 basis points than they were last October. Away from agencies, credit is also tighter versus the October-wide that we saw, with corporates 20 to 25 basis points tighter and high yield over 100 basis points tighter. Non-QM AAAs are 40 to 45 basis points tighter than the October-wides, and the demand for tranches below AAAs is substantially better than it was late last year.

We’ve seen a positive development in the BPL securitization space in the form of a rated RTL securitization in February. This single A DBRS rating has led to materially tighter levels on the senior tranche and is expected to expand the buyer base for the securities sold to finance these assets. Economic data is clearly driving the bond market, and continued strong prints pushed rates higher in April. Friday’s employment report reversed some of this trend, but twos are still 20 basis points and tens of 30 basis points above the yields that we saw at the end of the first quarter. Future Fed actions continue to be very much data dependent, and so far the data has eliminated any sense of urgency for a Fed rate cut. MFA posted a solid first quarter with distributable earnings of $0.35.

We added over $650 million of high-yielding assets, the majority of which came from Lima One, where the average coupon of these originations was 10.4%. Higher interest rates did modestly impact our book value for the first quarter, with GAAP and economic book value down by 1.3% and 1.7% respectively. We continued to execute securitizations with a $193 million RTL deal in early February and a $365 million non-QM deal subsequent to quarter end in April. On the capital front, we issued a very successful senior unsecured bond in January, raising $115 million with a coupon of 8.78 [ph]. We followed this deal with another issuance of $75 million of a similarly structured bond in April, with a coupon of 9%, despite the fact that five-year treasuries were 65 basis points higher than when we issued our 8.78 bond in January.

These two issuances were very timely, enabling us to raise $190 million with a weighted average coupon below 9%, setting us up comfortably to pay off the remaining $169.7 million of our convertible bond that’s due in June. Both bonds have five-year maturities, but we retain valuable optionality as they’re callable at par after two years, should we find ourselves in a more favorable rate environment in a couple of years. We also have considerable optionality in our liabilities, with a total of 30 securitizations outstanding. Page 19 of our earnings deck lists all of our outstanding securitizations, together with relevant details of each deal, including the call date in the last column. Although many of these bonds carry low coupons, the weighted average coupons of outstanding bonds will increase over time as senior bonds pay off.

In some cases, it can make sense to call a deal and re-lever the underlying loans in a new securitization. Even if the cost of debt is marginally higher than in an existing deal, a call and re-lever could unlock significant additional liquidity, which we can redeploy at attractive ROEs. These call rights provide an often underappreciated option that we have to optimize our liability framework in the years ahead. I’ll now turn the call over to Mike Roper to discuss our financial results.

Mike Roper: Thanks, Craig. As Craig highlighted in his opening remarks, during the quarter, MSA again delivered strong financial results, generating distributable earnings that covered the quarterly dividend and achieving book value stability in challenging market conditions. At March 31st, GAAP book value was $13.80 per common share and economic book value was $14.32 per common share, representing decreases from December 31st of 1.3% and 1.7% respectively. Given our net duration of approximately one, our book value was negatively impacted by higher rates across the yield curve, but benefited from credit spreads tightening during the quarter. We declared dividends of $0.35 per common share and delivered a total economic return of 0.7% for the quarter.

MSA generated GAAP earnings of $15 million or $0.14 per common share and distributable earnings of $36.1 million or $0.35 per common share. DE decreased by $0.14 versus last quarter and increased by $0.05 from the first quarter of 2023. The decrease versus last quarter was primarily driven by non-recurring items totaling $0.11 per share that benefited our fourth quarter results. Additionally, mortgage banking income at Lima One declined by $0.03 per share as a result of lower origination volumes in the first quarter. Net interest income for the first quarter was $47.8 million, an increase from $46.5 million in the fourth quarter. As a reminder our GAAP net interest income did not include the benefit of deposit of the positive carry on our interest rate swaps.

Net interest income, inclusive of swap carry, was approximately $77 million for the first quarter, unchanged from last quarter, and an increase of approximately $15.7 million from the first quarter of 2023. During the quarter, our board of directors authorized a $200 million share repurchase program, and we filed a $300 million at the market program, enabling us to issue shares from time-to-time in the open market. We have not utilized either of these programs to date, but believe they offer us the flexibility to act efficiently, should market conditions warrant in the future. Finally, subsequent to quarter end, we estimate that our economic book value has declined by approximately 1% as a result of higher market interest rates. I’d now like to turn the call over to Gudmundur, who will speak to our portfolio highlights and the performance of Lima One.

Gudmundur Kristjansson: Thanks, Mike. We continue to see attractive investment opportunities in the first quarter, and added about $650 million of loans with an average coupon of approximately 10% in the quarter. Lima One originated BPLs accounted for 70% of our acquisitions, while non-QM loans accounted for the remaining 30%. Credit characteristics were strong with an average LTV of 64%, and average FICO score of 744 on loans acquired in the quarter. Portfolio runoff was roughly unchanged, quarter-over-quarter at $422 million. The average coupon and paid off loans was about 8.7%. As rates declined sharply late in the fourth quarter and early in the first quarter, we took advantage of improved pricing on some of our seasoned lower coupon non-QM and SFR loans, and sold about $150 million of loans at a $2 million gain compared to year-end marks.

All of these activities resulted in our portfolio remaining relatively unchanged at $10 billion, while our portfolio asset yield increased by 12 basis points to 6.58% in the quarter. We see expected returns on equity in the mid-teens area for first quarter additions and continue to see similar returns available in the current environment. The labor market remained strong in the first quarter with non-farm payroll growth accelerating, and the unemployment rate remaining close to historical lows at under 4%. Home prices also remained resilient, and after rising by about 6% last year, continued to trend higher in the first quarter as low supply of homes continues to outweigh low affordability. These macro trends of housing and labor market resilience provide ongoing support to our credit portfolio.

An uptick inflation and surprisingly strong economic data in the first quarter led to a modest increase in interest rates as market participants reduced their expectations for rate cuts in 2024. Rates have risen further in the second quarter, largely reversing the decline in rates we experienced at the end of 2023, and the market now expects that about one to two rate cuts this year versus six at the beginning of the year. Our interest rate risk management approach continues to emphasize protecting the portfolio and our cost of funds from interest rate volatility. To that end, we’ve maintained a relatively short net duration and prioritize stability of funding costs through securitization issuance and swap patches that mostly cover our floating rate liabilities.

With over $3 billion of swaps and about $4.8 billion of fixed rate securitized debt outstanding, we entered the quarter with a net duration of about 90 basis points, which contributed to the modest book value decline we experienced in the quarter. Turning to Lima One. Our Lima One strategy continues to deliver organically created high quality and high yielding credit investments for our portfolio. Since our acquisition in the middle of 2021, Lima One has originated over $6 billion of business purpose loans for a balance sheet, and has been a key part in driving up our asset yields over the last couple of years. In the first quarter, Lima One originated about $430 million in line with our expectations at the end of 2023. Short-term transitional loans accounted for 80% of origination and longer-term DSCR rental loans made up the remaining 20%.

Credit profile remains strong with an average LTV of 65% and average FICO score of 749 on loans originated in the quarter. We expect the origination volume to be roughly unchanged in the second quarter in the mid $400 million range. The 60-plus days in frequency rate on our BPL loans originated by Lima One, increased modesty in the quarter to 4.7%, but remains low and in line with our modeling expectations. The increase was primarily concentrated in the shorter-term transitional loans while the longer-term rental loans decreased modesty. Credit monitoring and asset management remains important parts of our BPL strategy. The servicing done in-house by Lima One and MFA’s extensive asset management experience, we believe you’re uniquely set up to manage delinquencies effectively and efficiently.

Finally, we expanded our RTL financing capacity in the quarter as we price our fourth unrated revolving RTL securitization. We now have over $800 million of RTL security stations outstanding and have financed over $1.4 billion of loans through these revolving structures. I will now turn the call over to Bryan Wulfsohn who will discuss MFA’s credit performance and securitization activities in more detail.

Bryan Wulfsohn: Thanks, Gudmundur. The market appetite for securitized bonds continued to show improvement in the first quarter following the trend leading into year end. Capitalizing in this demand, we issued our fourth unrated revolving securitization in February of transitional loans originated by Lima One. We sold $160 million of bonds collateralized by $193 million of loans. The bonds sold carry a coupon of slightly over 7% and the loans securitized carry a coupon approaching 11%. In April, we issued another non-QM securitization selling $330 million of bonds backed by $365 million of loans. Bonds sold have coupon of 6.7% and the loans underlying the transaction had a weighted average coupon of 8.4%. We have now issued securitizations backed by over $9.5 billion in loans since 2020.

And the percentage of our loan portfolio financed by securitizations increased to approximately 70%. On slide 19 of our presentation, you can see that many of our securitizations are currently callable and others will become callable in the coming quarters and years. As Craig previously mentioned, those call features provide the potential to relever our collateral unlocking substantial non-dilutive capital that can be redeployed at mid-teens ROE. Our strategy is not dependent on lower rates but should we find ourselves again in a lower interest rate environment, the call features also provide optionality to reduce our borrowing costs. We believe that mortgage securitization will continue to be a significant piece of our loan financing strategy since it is non-recourse, non-mark to market funding and further insulates the portfolio from volatile markets.

Moving to our credit performance. Coming off the past two years of record low delinquencies, we have seen a normalization in our loan portfolio. 60 plus day delinquencies in our purchase performing portfolio increased to 4.3% from 3.8% at the end of the year. The increase came from both our RTL and non-QM portfolios. 60 plus day delinquencies in our legacy RTL and PL portfolio remain stable at 24% as our in-house asset management team works through delinquent loans achieving positive outcomes, both through modifications and property related resolutions. The team has extensive experience working through billions of defaulted loans and continues to work closely with our servicers to improve outcomes on defaulted loans, including generating gains on our legacy RTLs and MPLs and mitigating potential losses on our newly originated loans.

We’re proud of our asset management capabilities since they give us comfort growing our purchase performing portfolio and provide optionality should distress loan opportunities arise in the future. Pre-payment speeds in our portfolio were relatively stable over the quarter across our loan types. Non-QM, SFR, and legacy RPL/NPL maintain CPRs in the mid to high single digits. The transitional loan portfolio had an annualized repayment rate 33%. We had another quarter of paydowns totaling over $400 million in addition to the loan sale previously mentioned, which are reinvested into higher yielding assets. Lastly, we continue to sell our REO properties out of our portfolio. Over the quarter, we sold 73 properties for $24.2 million, resulting in $2 million in gains.

And with that, turn the call over to the operator for questions.

Operator: [Operator Instructions] Our first question comes from Stephen Laws with Raymond James. Go ahead, please.

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Q&A Session

Stephen Laws: Hi, good morning. I appreciate the comments in the report. I just wanted to follow up — I guess first on the credit performance, you mentioned normalization here as we’ve moved off of the rate lows, but 4.3%. I don’t think that’ll peak or plateau and talk about the timeline of resolution process, once something gets to 60-day, kind of how do you — how’s the timeline go as you resolve those loans?

Craig Knutson: So Steve, it really depends on the loan type, because we have some of the legacy re-performing, non-performing loans, that’s say that’s one timeline, which is probably been pretty lengthy, in terms of newly originated loans, it really varies by product type. We can maybe split it out into non-QM and BPL, if that would be helpful for you and maybe talk a little bit about the two of those.

Stephen Laws: Yes, that’d be great.

Craig Knutson: Sure. As it relates to non-QM and really both, a lot depends on the geography and the foreclosure of timelines depending on the state, whether it’s judicial or non-judicial. But a lot of times we see out of our non-QM portfolio are because of the equity position and that the borrower has in the home, right? Nine times out of 10, they’re just going to sell the property. So those resolutions can happen relatively quickly inside a year. If you get a prolonged battle, that could take one to three years, depending on how long the judicial process takes.

Gudmundur Kristjansson: Yes, and then just look, I mean, from a macro perspective as Bryan touched on in the opening remarks, all delinquencies were probably abnormally low coming out of COVID, with the incredible amount of stimulus that came from the government and monetary policy. So when you look at our delinquencies, they trended down into late ’22 and early ’23. But for some perspective, I mean, the 60 plus on the transition loan portfolio right now is similar to what it was in the middle of ’22. And so it feels to us, and when you look across the broader consumer sectors and you look at delinquency trends across credit products, there is a normalization process going on, and that seems to — and it makes sense, give it amount of tightening in terms of monetary policy rates are up 500 basis points, I think, for the nature.

And the same thing as Brian said, applies to the transition loan portfolio in terms of resolution. It really depends on state versus judicial versus non-judicial, and the ability to get to the property. But importantly, on the transitional side, there’s multiple ways we approach that. It depends on the state of the project. We try to work closely with the borrower, and if it is a viable project, we can make sure that he is in a position to complete it. To the extent we need to pursue foreclosure, we’ll, of course, do that, and then rely on our asset management capabilities, as well as the underwriting, of course, at origination to make sure we can have acceptable solutions.

Stephen Laws: Right. And as a follow-up, I just want to touch on kind of your thoughts around dividend sustainability, the triple earnings right on top of the dividend level. As you look out, you mentioned your repair remarks, attractive mid-team returns on new investments, the ability to kind of call and relever some details, which frees up additional capital for new investments. On the other side, looks like you’ve got some swaps that kind of mature late this year, early next year. In this, higher for longer rate outlook, how do you view those two things and the benefits versus the higher costs after the swaps mature with the ability to maintain the current dividend level? Thank you.

Mike Roper: So Steve, without, obviously forecasting our dividend, I think we’ve handily covered the dividend for the last year or more. And I think given the portfolio and the net interest income that’s solid or increasing, I think we feel pretty good about our earnings capability going forward.

Stephen Laws: Great. Appreciate the comments this morning.

Mike Roper: Thanks, Stephen.

Operator: And next we go to Bose George with KBW. Please go ahead.

Bose George: Everyone, good morning. Just one follow-up on Stephen’s credit question. And what are the typical losses on resolution and how does that compare with where you’re carrying the loans, fair value in the loans?

Mike Roper: So Bose, I would say, well, first of all, the fair value, when loans are delinquent, they get marked as delinquent loans. And so, that gets reflected right away in fair value marks. Second, in terms of losses, again, we have a lot of history and we can certainly talk about the legacy re-performing and non-performing loan book. But as Bryan and Gudmundur both said, the timelines are fairly long. So, we may have some data on some loans and some losses, but I don’t really know that it’s all that instructed, because this is a long process. And if the resolution is that the property gets sold, as Bryan said, because the homeowner has significant equity, that’s typically a payoff in full. So I could give you, we could give you lost numbers, but they really don’t reflect what ultimately ends up happening, because we just need more time. And I’m not talking about months. I’m talking about years in some cases.

Bose George: Yes.

Gudmundur Kristjansson: I think the other thing to keep in mind, Bose is that, if you think about the products we are acquiring, I mean, so for example, on the BPL side, the transition loans, they have a coupon of anywhere from 10% to 12%. And when we think about risk-adjusted returns or risk-adjusted yields, we’re factoring in some assumption about credit costs and credit losses. And so, we do assume that yields are lower than the coupon that’s coming in, that’s how we think about it. But in that context, it’s still providing quite attractive risk-adjusted returns. And to Craig’s point, I mean, look, over the last two to three years, home prices were obviously significantly high and rising out of COVID, which obviously helped out in terms of loss of mitigation. So we’ve had some really good outcomes, but we understand and we know that we’re dealing with credit underwriting and credit investments. So there’s going to be some credit costs associated with it.

Bose George: So, okay, that’s helpful. Yes, I was thinking really about the BPL side just, but yes, that’s helpful commentary. Thanks. And then just one modeling question, just on the expense line, the compen benefits was a little higher, was that, I guess, year-end bonus stuff. And then will that kind of normalize a little bit into the second quarter?