Mfa Financial, Inc. Q1 FY2024 Earnings Call

Thank you for joining us, and welcome to the MFA Financial Q1 2024 Earnings Call. This conference call is being recorded.

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, 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.

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. 2-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 2 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 was 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 push rates higher in April. Friday's employment report reversed some of this trend, but yields are still 20 basis points and 10 to 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 8.875%. 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 5-year treasuries were 65 basis points higher than when we issued our 8.875% bond in January. These 2 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 5-year maturities, but we retain valuable optionality as they're callable at par after 2 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 relever the underlying loans in a new securitization. Even if the cost of debt is marginally higher than in an existing deal, a call and relever 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. And I'll now turn the call over to Mike Roper to discuss our financial results.

Thanks, Craig. As Craig highlighted in his opening remarks, during the quarter, MFA again delivered strong financial results, generating distributable earnings that covered the quarterly dividend and achieving book value stability in challenging market conditions. At March 31, GAAP book value was $13.80 per common share and economic book value was $14.32 per common share, representing decreases from December 31 of 1.3% and 1.7%, respectively. Given our net duration of approximately 1, 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. MFA 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 nonrecurring 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 does not include the benefit 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.

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%, an 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 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 nonfund payroll growth accelerating and the unemployment rate remaining close to historical lows at under 4%. Home prices also remained resilient and, as rising by about 6% last year, continue 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 in 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 about 1 to 2 rate cuts this year versus 6 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 have maintained a relatively short net duration and prioritized stability of funding costs through securitization issuance and swap hedges 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 continued 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 our balance sheet and has been a key part in driving up our asset yield 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. Shorter-term transitional loans accounted for 80% of origination and longer-term DSCR and rest of loans made up the remaining 20%. Credit profile remained strong with an average LTV of 65% and average FICO Score of 749 on loans originated in the quarter. We expect origination volume to be roughly unchanged in the second quarter in the mid-$400 million range. The 60-plus day delinquency rate on our BPL loans originated by Lima One increased modestly 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 rest of the loans decreased modestly. Credit Monitoring and asset management remain important parts of our BPL strategy. The servicing done in-house by Lima One, and MFA's extensive asset management experience, we believe we are uniquely set up to manage delinquencies effectively and efficiently. Finally, we expanded our RTL financing capacity in the quarter as we priced our fourth unrated revolving RTL securitization. We now have over $800 million of RTL securitizations 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.

Thanks, Gudmundur. Market appetite for securitized bonds continues to show improvement in the first quarter following the trend leading into year-end. Capitalizing on this demand, we issued our fourth unrated revolving securitization in February on transitional loans originated by Lima One. We sold $160 million of bonds collateralized by $193 million of loans. The bonds sold carried a coupon of slightly over 7% and a loan securitized carried a coupon approaching 11%. In April, we issued another non-QM securitization, selling $330 million of bonds backed by $365 million of loans. The bonds sold have a 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 nondilutive 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 nonrecourse, non-mark-to-market funding and further insulates the portfolio from volatile markets. Moving to our credit performance. Coming off the past 2 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 RPL/NPL portfolio remained stable at 24% and 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 RPLs and NPLs 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 provides optionality should distressed loan opportunities arise in the future. Prepayment speeds in our portfolio were relatively stable over the quarter across our loan types. Non-QM, SFR and legacy RPL/NPL maintained CPRs in the mid-to high single digits. The transitional loan portfolio had an annualized repayment rate of 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, I'll turn the call over to the operator for questions.

Our first question comes from Stephen Laws with Raymond James.

I appreciate your comment. I wanted to follow up regarding the credit performance. You mentioned that normalization is occurring as we've moved away from the rate lows. Where do you anticipate the peak or plateau will be, and can you discuss the timeline for resolving loans once they reach 60 days? How does the process unfold as you address those loans?

So Steve, it really depends on the loan types, right, because we have some of the legacy reperforming, nonperforming loans. That's one timeline, which has 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.

Yes, that would be great.

Sure. As it relates to non-QM and really both, a lot depends on the geography and the foreclosure timelines depending on the state, whether it's judicial or non-judicial. But a lot of times, we see of our non-QM portfolio because of the equity position that the borrower has in the home, 9 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 1 to 3 years depending on how long the judicial process takes.

Yes. From a macro perspective, as Bryan mentioned in the opening remarks, all delinquencies were likely abnormally low following COVID due to significant government stimulus and monetary policy. Our trends showed a decline until late 2022 and early 2023. For context, the 60-plus delinquency rate on the transitional loan portfolio is currently similar to what we saw in mid-2022. It appears that a normalization process is occurring, which aligns with the tightening of monetary policy, as rates have increased by 500 basis points.

Great. And as a follow-up, I just wanted to touch on kind of your thoughts around dividend sustainability, triple earnings right on top of the dividend level. As you look out, you mentioned in your prepared remarks attractive mid-teen returns on new investments, the ability to kind of call and relever some deals, which frees up additional capital for new investments. On the other side, it 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 cost after the swaps mature with the ability to maintain the current dividend level?

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 really good about our earnings capability going forward.

Just one follow-up on Steve's credit question. What are the typical losses on resolution? And how does that compare with where you're carrying the loans' fair value?

Firstly, when loans become delinquent, they are classified as such and this is immediately reflected in their fair value. Regarding losses, we have considerable historical data, particularly on our legacy reperforming and non-performing loan portfolio. The timelines for these are quite lengthy. While we do have some information on certain loans and associated losses, it may not be particularly enlightening, as this is a lengthy process. Typically, the resolution involves selling the property because the homeowner has substantial equity, which usually results in a full payoff. Although I could provide loss figures, they wouldn't accurately represent the eventual outcomes since we require more time to see how this unfolds, and I'm referring to years, not just months.

It's important to consider the products we are acquiring. For instance, on the BPL side, the transitional loans offer coupons ranging from 10% to 12%. When evaluating risk-adjusted returns and yields, we take into account certain assumptions regarding credit costs and losses, which leads us to expect that yields will be lower than the incoming coupons. Nonetheless, we find that these investments continue to provide attractive risk-adjusted returns. Over the last two to three years, home prices rose significantly after COVID, which aided in loss mitigation and resulted in positive outcomes for us. However, we recognize that we are involved in credit underwriting and investments, which inevitably include some associated credit costs.

Okay. That's helpful. Yes, I was thinking really about the BPL side but yes, that's helpful commentary. And then just one modeling question. Just on the expense line, the compensation and benefits were 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?

Thanks for the question, Bose. Yes. So I guess a few things on G&A. First, you're exactly right that we had a sort of nonrecurring adjustment to our expense accrual in the fourth quarter that decreased that line item by about $3 million. So it makes it a little bit less comparable. Then the second big change there, and there's a couple of smaller ones that sort of offset. But the second big change there is the acceleration of amortization of non-cash stock-based comp expense related to awards made to retirement-eligible employees. So that expense would normally be amortized over the course of 3 years, but GAAP requires us to effectively recognize it in the first quarter. And you'll see that there's about $1 million left of that for the second quarter. But going forward, that will go back to 0 for the rest of the year.

In your deck, you comment on mid-teen returns on securitizations. Looking at Lima One, obviously, that was a very significant acquisition and it's proprietary, still have a lot more control there than have a device flow in QMs and the street. So I just wondered if you could comment on specifically on the Lima securitization as far as between bridge and then some SFR, just the product mix and how those, can tighten this down a little bit from the mid-teens kind of returns on securitizations generally?

Steve, it's a great question, and I think your observation is a good one. When we were saying mid-teens, we're kind of characterizing, I guess, could return on average. And we understand we'll do sometimes better and sometimes do worse. But to your point, the securitization that we did in the first quarter on the transitional loan securitization, the average coupon on the loans going into the deal was about 10.9% and the average coupon on the bond we sold was about 7.10%. So you can see that there's a significant amount of spread to the tune of over 350 basis points. And so we sold 80% of that deal and we kept the rest of it, but you can quickly get up to kind of 20% plus returns based upon how much leverage we're doing in the deal and how much we're selling. And as it relates to securitization execution, spreads have continued to come in this year. Spreads on the kind of A1 on the RTL side will probably ask why that's 350 over the curve in October of '23, and now they're probably hovering over 250 over on the unrated side. And then on the rated type of execution, there's the potential to do better. So we think, yes, I mean those returns are quite attractive. As it relates to the longer-term DSCR loans, we are creating assets that yield roughly, call it, around high 7s, 8% yields. And the securitization cost of funds probably right now is anywhere in the kind of mid-6s. And so we're doing probably mid- to high-teen returns there as well.

That's good insight. It's important to note that since you acquired Lima One, you cannot manage your risk return profile while working with the market. We are not receiving any relief in rates. However, could you provide an overview, Gudmundur, on what the pipeline looks like for Lima One over the next six months? What feedback are they receiving from borrowers? Are they actively exploring new opportunities? Any details on the pipeline would be appreciated.

Yes. With Lima One, one of the strengths of the brand and the company is the variety of products they offer. They originate single-family bridge and transitional loans that involve some amount of rehab, single-family new construction, and small balance multifamily transitional loans. There are different segments of the market that we operate in, each with its own supply and demand dynamics. We’ve managed to maintain steady levels of origination even as various parts of that market change. Additionally, we have longer-term DSCR rental loans. For instance, in 2022 and 2023, as rates increased, we saw a shift in origination toward short-term transitional loans rather than longer-term rental loans. Moving to today, the initial rate shock over the past two years has eased, and market participants have started to incorporate high rates into their expectations for execution. Specifically regarding ground operators, the supply of homes is currently lower than historical rates, which we see as supportive of home prices, leading to price increases despite low affordability for new homebuyers. This means fix-and-flip operators may have fewer properties to choose from, and we've observed a decrease in quick flips or rapid rehabs. However, the new construction aspect seems relatively stable, with decent demand due to the aging housing supply in the U.S. and a significant deficit of housing units compared to household formation, which we believe will continue to support the market. Lastly, there's been an increase in competition in our sector as rates have stabilized and the returns have become attractive, leading to more capital entering the space. This influx is beneficial for securitization as it enables efficient execution but also increases competition for borrowers in origination.

That was great color, Gudmundur. Congrats to the team on hitting the $10 billion portfolio benchmark.

Hoping we could discuss the possibility of calling your previous securitizations. How are you assessing the need for capital based on the investment opportunities available? Considering the higher cost of funds, what are your thoughts on the level of accretion currently related to freeing up that capital?

Today it's Bryan. If you consider the immediate potential, we have some unrated deals from a few years back that have significantly paid down. If we choose to call one of those deals, it could unlock $70 million to $80 million in liquidity, with a financing cost of around 200 to 250 basis points more. However, the returns on equity generated are in the mid to high teens. Therefore, it certainly makes sense for us to carry out that type of transaction. For other deals, it’s not something that will happen immediately; rather, it’s more likely to occur in the next 2 to 3 years when we will have chances to call those.

And Doug, just to add a little more color to Bryan's example. So if you think about a nonperforming loan resecuritization done a few years ago, calling that deal what Bryan said will unlock additional liquidity, but a substantial number of the loans in that deal are likely now performing and those could be resecuritized as rated reperforming loan deals, which trade at obviously lower yields than an unrated nonperforming loan deal. So there's a lot of nuance in this, and it's just something that we want to point out is something that we're keenly aware of and there are opportunities that will continue to be opportunities to optimize that liability structure.

Yes. Doug, just to put a pin in that. We think of this also as a significant optionality from the liability structure. So to the extent that like the world can change and think can evolve in many different ways. So to the extent that rates are lower, for example, if it is cutting rates and the curve is deeper. Most of these deals are priced on the front end of the curve. So to the extent that the curve is deeper in the future, it just gives us an optionality to recycle capital perhaps at the same cost or better over the next couple of years. And so for equity investors, I think it's important to understand that optionality. And that's really kind of what we're trying to point out for the next couple of years.

Got it. If you don't call the deals, are they generating cash flow? Or are the subordinated deals still paying down the senior ones? It's just about how to consider the alternative if you choose not to call the deals.

So again, it depends on the deal, Doug. So in some rare cases, there might be a step-up after so many years where the coupon will step up. But in most cases, we're not obliged to call the deal. I think on the RTL side, the revolving period ends, there's more incentive to call the deal because you can't add new loans to the deal. But it's really deal and type of deal-specific.

Great. Just curious if there is any notable extension or modification activity this quarter for the transitional book, like we've seen some other BPL lenders over the last couple of quarters? And if so, under what terms are those made?

Yes, that's a good question. For our portfolio, the percentage that was extended related to UPB at the end of the first quarter is approximately 12%. This has increased slightly from about 8% to 9% at the end of the last quarter, but it remains quite modest historically. In the usual course of business, extensions occur, which is not unusual. This typically happens when there is a need for more time to market and sell a completed project, or when there are delays in completing rehabilitation or construction. However, the project remains feasible and attractive. In the case of small balance multifamily properties, additional time may be needed to lease the property and achieve a stabilized state for long-term financing. Importantly, we do not extend delinquent loans, so one must be current to qualify for an extension. In normal business operations, we do see extended loans getting paid off. Last quarter, around $35 million to $40 million of previously extended loans were paid off. From our viewpoint, this is a standard part of business and comes with the territory.

Great. And just one more question about the new stock repurchase and ATM program announced earlier in the quarter. It seems like neither of those programs have been utilized recently, but I’m curious about the conditions under which you would consider using either of them.

Sure. So look, our ATM program, I think, expired almost 1.5 years ago. So our recent refresh of the ATM program was simply that. We don't really feel that we're capital constrained, and we've recently demonstrated the ability to raise money through an unsecured bond at much more favorable terms for shareholders than issuing common stock at a substantial discount to book. I'll also point out that we simultaneously refreshed our share repurchase authorization. And I would characterize both actions, Brian, as administrative in nature.

At this time, we have no additional questions in queue.

All right. Well, thank you, everyone, for your interest in MFA Financial, and we look forward to speaking with you again in August when we announce second quarter results.

Ladies and gentlemen, this conference will be available for replay from 12:40 Eastern Time today and through August 6 at midnight of this year. You may access the replay by dialing 866-207-1041 and entering the access code 9944909. International participants should dial 402-970-0847. Once again, those numbers for replay are 866-207-1041 for domestic, and 402-970-0847 for international and the access code to use is 9944909. That does conclude your conference call for today. We do thank you for your participation, and thank you for using AT&T Event Conferencing. You may now disconnect.