MFA Financial, Inc. (NYSE:MFA) Q3 2023 Earnings Call Transcript

MFA Financial, Inc. (NYSE:MFA) Q3 2023 Earnings Call Transcript November 7, 2023

MFA Financial, Inc. beats earnings expectations. Reported EPS is $0.4, expectations were $0.38.

Operator: Ladies and gentlemen, thank you for standing by. Welcome to the MFA Third Quarter 2023 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Hal Schwartz. Please go ahead.

Harold 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 ended December 31, 2022 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 third quarter 2023 financial results. Thank you for your time. I would now like to turn this call over to MFA’s CEO and President, Craig Knutson.

Craig Knutson: Thank you, Hal. Good morning, everyone, and thank you for joining us here today for MFA Financial’s Third Quarter 2023 Earnings Call. With me are Gudmundur Kristjansson and Bryan Wulfsohn, our Co-Chief Investment Officers. And I would also like to welcome Mike Roper, who is appointed as our Chief Financial Officer in September. Mike has served as our Chief Accounting Officer for the last 2 years, was our controller for 3 years before that and has been with MFA since 2014. And I look forward to introducing Mike to more of our shareholders and research coverage professionals during upcoming equity conferences and phone calls. It’s beginning to sound like a broken record. But once again, the interest rate environment in the most recent quarter of this year was extremely volatile.

Certainly the most challenging quarter of 2023 and perhaps the most difficult quarter since the current Fed tightening cycle began 20 months ago. The Fed does appear to be at or near the end of the tightening cycle, while the bond market continues to adjust to the notion of hire for longer. In addition, exploding budget deficits and a wall of anticipated treasury borrowings over the foreseeable future has weighed heavily on the market as these treasuries need to find a home in a world where the Fed, foreign investors and domestic banks, 3 of the largest buyers over the last 15 years are on the sidelines. You have also no doubt heard on other earnings calls that Agency MBS are at historical wides which is true, at least prior to the end of last week.

But again, the absence of the major buyers over the last 15 years would suggest that the historical range needs to look back further than 2008. Mortgage spreads are indeed very wide today, but they were at similar levels in 1986 and ’87, in 1999 and 2000 and in 2008 before the Fed began its first round of QE. The world is still a nervous place with 2 active wars and global economic uncertainty. So, it’s difficult to envision a completely mellow bond market anytime soon. The third quarter of 2023 was notably characterized by the sharp increase in 10-year interest rates, which significantly flattened the curve. Although still inverted, the spread is now just over 30 basis points, which is as much as 65 to 75 basis points less inverted than it has been for much of the last year.

And while a less inverted yield curve should improve the outlook for levered investor returns going forward, the rapid rise in long rates and heightened volatility mostly during the month of September, punished market values of fixed income investments and of mortgage investments in particular. MFA’s GAAP book value was down 6.5%, and our economic book value was down 8.5% in the third quarter. We do not yet have loan marks for October month end. But given the rate rally and mortgage and credit tightening that occurred last week, our book value is probably flat or maybe up slightly 1% or 2% since September 30. Despite the unrealized fair value losses on loans that are substantially performing, we did have some bright spots in the third quarter.

Distributable earnings came in for the second consecutive quarter at $0.40 per share and comfortably covered our $0.35 dividend. Our net interest spread increased again to 217 basis points, and our net interest margin increased again to 302 basis points. For reference, a year ago, our net interest spread was 164 basis points, and our net interest margin was 243 basis points. So both of these measures have increased by more than 50 basis points over the last year. And this during a period where the Fed raised the funds rate by 300 basis points going back to September 21 of last year. We continue to fortify our balance sheet increasing non-mark-to-market financing on our loan portfolio from 73% to 77%, while maintaining substantial liquidity, ending the quarter with $300 million of unrestricted cash.

This was due in part to executing 2 securitizations during the quarter, collateralized by $600 million of non-QM and single-family rental loans. Subsequent to quarter end, we executed another securitization in October of $225 million of transitional loans. We acquired $800 million of loans and $150 million of agencies during the quarter with an average coupon on the loan purchases of 9.9%. Credit performance continues to be strong with only a very small increase in delinquencies in our purchased performing loan portfolio from 2.8% in Q2 to 3.1% in Q3. Fortunately, we continue to benefit from the hard work we did in late 2021 and early ’22, which effectively fixed our funding costs, while we now have attractive investment opportunities to add new assets at very accretive yields.

As we show on Page 8 of our earnings deck, very few of our $3-plus billion of interest rate swaps matured before the fourth quarter of 2024. Finally, our wholly owned business purpose loan originator, Lima One, continues to produce successively higher volume levels of high-yielding and high-quality assets. Lima delivers significant value to MFA shareholders as a substantial source of internally generated and serviced assets. And I will now turn the call over to Gudmundur to discuss our portfolio activity and Lima One in more details.

Gudmundur Kristjansson: Thanks, Craig. Similar to the last few quarters, we continue to have success in sourcing high-quality, high-yielding assets and acquired over $950 million of loans and securities in the third quarter, growing our investment portfolio by 5% to $9.3 billion. Business purpose and non-QM loans accounted for a majority of our acquisitions at over $800 million. The new loan acquisitions had some of the highest coupons we’ve seen in a long time with an average coupon of approximately 9.9% and a strong credit profile with average LTV of 66% and average FICO of 750. We also continued to execute on our Agency MBS strategy and added $152 million of Agency MBS in the quarter, growing that portfolio to about $525 million.

Agency MBS yielding over 6.25% and the spread remaining at historically wide levels, we believe that Agency MBS is attractive on a stand-alone basis, but that they also provide risk management benefits to our credit-focused portfolio, by improving portfolio liquidity and having the potential to perform well during periods of economic softness. You saw that thesis play out over the last 2 weeks when Agency MBS spreads tightened by about 15 to 20 basis points as rates rallied sharply on modestly softer economic data and the prospect that the Fed might be done with raising rates. When we factor in financing levels and appropriate leverage, we expect mid-teens return on equity for our third quarter additions and see similar return levels faster than we’re adding in the fourth quarter.

Significantly higher rates and spreads in 2023 compared to the last 15 years, combined with our unique ability to create our own credit assets through our wholly owned business purpose loan originator, Lima One, has allowed us to add high-yielding assets to our balance sheet throughout this year. We had acquired over $2.1 billion of loans in 2023 with an average coupon of approximately 9.7% with Lima One originated loans accounting for about 75% of that. This has led to a significant increase in the yield on our interest-earning assets. We sat at 6.35% in the third quarter is up 25 basis points compared to the second quarter and up 111 basis points from a year ago. As Craig mentioned in his opening remarks, rates rose significantly in the quarter with a 10-year treasury rate up about 75 basis points.

We continue to actively manage our interest rate risk in the quarter and reduced our net duration down to 105 basis points from 119 basis points at the end of the second quarter. We’re executing 2 securitizations of longer duration non-QM and SFR loans for a total of about $600 million UPB of loans securitized and adding about $130 million of mostly 10-year interest rate swaps. Fourth quarter end, we continued to manage our interest rate risk by completing another securitization of $225 million of transitional loans and adding over $180 million of 10-year swaps, bringing duration further down to about 100 basis points. The economy remained resilient in the third quarter, with the third quarter GDP coming in at 4.9%, significantly in excess of market expectations.

The labor market has cooled a bit from the red hot pace it was on in late 2021 and 2022, but remains robust with 3-month average nonfund payroll growth of $204,000 and the unemployment rate of 3.9%. The housing market has performed well this year despite high mortgage rates and low affordability. Home prices are up about 5% year-to-date with low inventory and general lack of housing supply outweighing low affordability. The ongoing strength and resilience of the labor and housing markets continue to provide support to our credit portfolio. Turning to Lima One. Lima One originated $671 million of business purpose loans in the third quarter, a 15% increase over the second quarter and a record quarter for the company. Lima continues to demonstrate its value to our asset acquisition strategy.

accounting for over 80% of MFA’s loan acquisitions in the quarter. Lima has originated about $5 billion of business purpose loans for our balance sheet since our acquisitions over 2 years ago, a great achievement and in excess of our expectations at the time. The majority of Lima’s origination in the third quarter was focused in the shorter-term transitional loans, which accounted for about 85% of third quarter origination. Demand for Lima’s products and services remain strong with disruption in the private lending space and less competition from regional banks, providing opportunities to grow market share and attract talent in this space. We expect fourth quarter origination volume to be modestly lower at around $550 million to $600 million and full year 2023 to be about $2.2 billion.

Credit quality remains fundamental to our BPL strategy and the credit statistics on Lima’s third quarter origination remained strong with average LTV of 65% and average FICO Score of 754 on loans originated. The 60-plus day delinquency rate on our BPL loans originated by Lima One ticked up to 3.2% in the quarter but remain low and well within our modeling expectations for this asset class. The increase was mostly due to a very small subset of borrowers that became delinquent in the quarter, primarily on the longer-term rental loans. In that respect, the increase was mostly idiosyncratic with overall delinquency levels in line with expectations. As it relates to delinquency management and loss mitigation in general, it is important to emphasize that Lima One is a highly experienced BPL servicer, which has originated and serviced BPL loans since 2010.

With Lima One, we have all asset management servicing and construction management of our BPL loans in-house, and we believe this, combined with MFA’s own extensive credit and asset management experience, allows us to manage delinquencies efficiently and effectively. Historically, in the aggregates MFA has had no net losses and liquidations of seriously delinquent loans and REO out of our BPL portfolio, which includes over $7 billion of acquisition and over $3 billion of payoffs since 2017. We remain focused on liquidity and availability of financing to support our BPL origination. We issued our seventh rental loan securitization in the quarter, where we securitized over $200 million of Lima One originated loans and also expanded our transitional loan financing capacity by $50 million in the quarter.

Fourth quarter end, we priced our third revolving transitional loan securitization, we securitized over $200 million of Lima One originated loans, bringing total outstanding securitation for that asset class to over $600 million. The revolving nature of these securitizations means that we can efficiently finance new loans and construction draws in the transactions as older loans pay off. And now I will turn the call over to Bryan Wulfsohn, who will discuss MFA securitization activities and portfolio credit performance in more detail.

Bryan Wulfsohn: Thanks, Gudmundur. In the third quarter, securitization markets exhibited something resembling a roller coaster ride as spreads rallied into August and subsequently widened out in September due to elevated supply combined with some sympathy widening along with Agency spread movement. We were able to execute 2 securitizations in the quarter, one of them backed by $343 million of non-QM collateral pricing at the end of August, followed by a securitization of over $200 million of Lima One originated SFR loans in September, locking in a 6.7% and 7.2% cost of debt, respectively. And as Gudmundur previously mentioned, post quarter end, we issued a third revolving securitization backed by $225 million transitional loans originated by Lima One.

It’s worth mentioning again that these structures provide immense value to MFA as we are able to substitute in new loans and subsequent draws with the cash generated from payoffs of existing loans. We have now issued securitizations backed by over $6.5 billion of MFA’s purchase performing loans since 2020 and the percentage of loans financed by securitization is now over 60%. And although sometimes spreads may be wider than we would like, we are committed to terming out more of our funding through securitization and expect to come to market again in the fourth quarter. We continue to believe that mortgage securitization is an important part of our business strategy as it provides for nonrecourse non-mark-to-market financing which further insulates the portfolio from volatile markets.

Moving to our credit performance. With the backdrop of a strong labor market and the continued limited supply of homes for sale, credit in our portfolio continues to do well. Over the quarter, we had a slight uptick in 60-plus day delinquencies in our purchase performing portfolio to 3.1% from 2.8% in the second quarter. This increase remains well within our expectations when we modeled out our expected cash flows for the portfolio. 60-plus deliquencies in our legacy RPL NPL portfolio improved again by 1.5 points over the quarter to 25.9%. Our in-house expertise in asset management remains focused on working with our third-party servicers to resolve the remaining delinquent assets in that portfolio to the benefit of our investors. And working through over $3 billion of distressed loans, our asset management team has gained vast experience, which has not only benefited our legacy RPL and NPL portfolio but our newly originated portfolios as well.

As an example, our in-house asset management group works well with our servicing team at Lima One, which helps reduce risk when delinquencies arise in our BPL portfolio. Prepayment speeds in our portfolio were relatively stable quarter-over-quarter. CPRs remained in the mid- to high single digits for our non-QM SFR and legacy RPL and NPL portfolios. For the transitional loan portfolio, we had an annualized repayment rate of 37%. Total paydowns were again over $400 million for the quarter, which were reinvested into loans carrying a coupon of approximately 250 basis points higher. Lastly, we continue to take advantage of the lack of supply in the housing market, selling properties out of our REO portfolio. Over the quarter, we sold 77 properties for $26 million, resulting in over $3 million in gains.

We believe the low LTV of our portfolio combined with prudent credit underwriting of our portfolio well positioned for the current economic environment. And with that, I’ll turn the call over to the operator for questions.

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Q&A Session

Operator: [Operator Instructions]. Your first question comes from the line of Bose George from KBW.

Bose George: In terms of negative, the fair value mark that you guys took this quarter, is that fully recoverable? And can you usually have that slide for how much of book value is sort of upside to book value. Is that — can you just sort of tell us where that stands as well?

Michael Roper: This is Mike Roper. I’ll let Ken talk about the unrealized losses, but that number is 457 and 930.

Craig Knutson: And so as you know, Bose, the vast majority of that is on loans, which, for the most part, we get back at par. So the change in fair value was really due to market interest rate movement overwhelmingly. But obviously, it takes time to recoup part because things don’t prepay as fast in the current interest rate environment as they once did.

Bose George: Okay. Great. Yes, that makes sense. And then actually, switching to just to the transitional loan portfolio. The multifamily, the 49% of that’s multifamily, is that takeout for most of that GSE permanent financing?

Gudmundur Kristjansson: Yes, this is Gudmundur. Yes, that’s correct. The vast majority of that, if not all, qualify for small balance agency takeout. And if you think about the multifamily part of the transitional loans, these are small balance multifamily loans. The average loan size is about $3.2 million. So these are really small loans in that context. And so and most of them are concentrated kind of in the South and the Southeast where there’s great demographic trends and things of that nature. And yes, they would almost all qualify for the small balance takeout.

Operator: Your next question comes from the line of Steve Delaney from JMP Securities.

Steven Delaney: Mike Roper nice to meet you live on the call. I’d like to — I’d like to start with Lima broadly. I mean the numbers there, kind of given the environment, in particular that we’re in for the broader mortgage market and CRE are just kind of remarkable. And I’m just curious like if — Craig, you had to attribute it to 1 or 2 things. Are you recruiting there? Are you seeing competitors go out of business? Maybe just strategically some color about how and why Lima is performing so well as it clearly is.

Craig Knutson: Sure. So I’ll start, Steve, and then I’ll let Gudmundur add. I think in answer to your question, yes and yes, Lima has been hiring and they have been hiring experienced people from either former competitors or diminished competitors. I think Lima One has continued to expand and grab market share where others have faded to some degree. And I think that’s for a lot of reasons, right? It’s a very tight operation, which we knew long before we bought them. But also the fact that the way that MFA and Lima One interact is really one organization. And so it’s not an originator that’s originating loans and wondering sort of what they’re going to do with those loans. It’s a very integrated operation and we price loans together we’re obviously very involved in the securitization market. And so we have an immediate feedback loop in terms of loan pricing. So it’s a lot of things. But obviously, it’s worked extraordinarily well.

Steven Delaney: And how great — go ahead. I’m sorry.

Gudmundur Kristjansson: No, sorry, [indiscernible] has been added. I mean what Craig brought up is a really important point. So like the thing is the organizations are fully aligned. They’re all moving in the same direction. So one of the things that we have that is quite unique is that we have a combination of skill set that are both macro and micro. And so usually originators are operating independently. They’re finding borrowers low values to buy loans and things of that nature but what we have been able to do over the last 2.5 years is Lima learn from MFA and MFA to learn from Lima and take all those lessons to create a more robust organization. And I think especially in 2022, that was quite important because rates were rising rapidly.