Earnings Call Transcript - MFA Q2 2025

Operator, Operator

Greetings, and welcome to the MFA Financial, Inc. Second Quarter 2025 Financial Results Conference Call and webcast. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Hal Schwartz, General Counsel. Please go ahead, sir.

Hal Schwartz, General Counsel

Thank you, 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, 2024, 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 second quarter 2025 financial results. Thank you for your time. I would now like to turn this call over to MFA's CEO, Craig Knutson.

Craig L. Knutson, CEO

Thank you, Hal. Good morning, everyone, and thank you for joining us for MFA Financial's Second Quarter 2025 Earnings Call. With me today are Bryan Wulfsohn, our President and Chief Investment Officer; Mike Roper, our CFO; and other members of our senior management team. I'll begin with a high-level review of the second quarter market environment and then touch on some of our results, activities, and opportunities. Then I'll turn the call over to Mike to review our financial results in more detail, followed by Bryan who will review our portfolio financing, Lima One, and risk management before we open up the call for questions. I'm sure you will all remember the market turmoil that ran in the second quarter with Liberation Day on April 2. 2-year treasuries ended the first quarter at 3.88%, rallied to 3.65% by April 4, sold off to 3.96% on April 11 and rallied again to 3.60% on April 30 and then subsequently sold off to 4.05% on May 14. 10-year treasuries followed a similar trajectory, rallying 20 basis points to 3.99% on April 4, selling off 50 basis points to 4.49% on April 11, closing the month of April at 4.16% and then selling off to 4.60% by May 21. Fortunately, cooler heads appear to have prevailed since then, both in Washington, D.C. and in bond and equity markets. At least until last Friday's employment report revisions, 2s and 10s have generally each settled into their own 25 basis point ranges since mid-May and equity markets have continued to grind higher, again, last Friday, notwithstanding. Mortgage spreads track other risk assets widening somewhat in April and then retracing back to or near levels seen at the end of Q1 by the end of the second quarter. Importantly, the market for securitized mortgage credit assets and non-QM securitizations in particular, continues to deepen as liquidity increases and investor appetites remain strong. Spreads widen and tighten along with other risk assets, but deals get done and priced in a very orderly fashion. This was decidedly not the case as recently as 2023 when at times demand was weak, spreads were much more volatile, and some deals were pulled from the market. The depth and reliability of this market is a powerful testament to this durable source of financing that we utilize to finance over 80% of our loan portfolio. The economic and macro environments, while never certain, seem a bit more clear as the year progresses. Growth, though slower than originally expected, is remarkably resilient. The passage of the tax and spending bill has removed the market uncertainty that had been associated with that. Inflation fears have moderated, particularly as tariff negotiations begin to get resolved at less draconian levels than originally feared. Employment continues to grow, albeit at a reduced pace, although with the substantial revisions in last Friday's jobs report, a strong case can be made that the jobs market is not as healthy as previously believed. Amidst the drama between the President and the Fed Chair, consensus now seems to be for two rate cuts later this year, and lower short rates are always a helpful tonic for mortgage REITs. Finally, housing is languishing somewhat as demand continues to fall off due to interest rate and affordability challenges. Actual home price declines have, for the most part, been concentrated in specific geographies where new supply has saturated these local markets. There's still a fundamental nationwide supply shortage, so it's hard to envision more than a very modest weakness in home prices nationwide. Homeowners with existing mortgages today are generally not over-levered, and years of substantial housing price appreciation, coupled with prudent and sensible underwriting practices, mean that loan-to-values are low enough that even in the event of a job loss, death, or divorce, borrowers have substantial equity and will sell their property to extract their equity and pay off the lender. In the midst of this environment, our portfolio delivered a total economic return of 1.5% for the second quarter and 3.4% year-to-date, which includes our first two quarterly dividends, which we increased to $0.36 in the first quarter. Our economic book value in the second quarter was down very modestly by 1%. Our distributable earnings for the quarter was $0.24 per share and were negatively affected by credit losses incurred on certain business purpose loans that were realized during the quarter. Absent these credit losses, DE would have been $0.35. As a reminder, these credit losses do not impact DE until actually realized. And as Mike Roper has emphasized for the last few quarters, these loans were marked down in 2024 and earlier when they went delinquent. Our fair value assets are marked-to-market every quarter. So the economic credit loss was realized through GAAP earnings and a reduction in book value a long time ago. Said another way, these realized credit losses that reduced distributable earnings in the second quarter are old news. Mike will provide additional color on the actual resolution amount versus the marks on these loans in his prepared remarks. We were active in the second quarter, sourcing $876 million of loans and securities across our target asset classes. These included $503 million of non-QM loans, $131 million of Agency MBS, and $217 million of business purpose loans at Lima One. We issued our 18th non-QM securitization in early May. We sold $38 million of newly originated single-family rental loans and $24 million of delinquent transitional loans. Our overall leverage at the end of the quarter was 5.2x, and our recourse leverage was 1.8x. Once again, the second quarter demonstrated that MFA's investment portfolio, our balance sheet composition, and risk management approach are positioned to deliver results across multiple scenarios and weather unexpected market volatility and uncertainty. And I will now turn the call over to Mike Roper to discuss financial results.

Michael C. Roper, CFO

Thanks, Craig, and good morning. At June 30, GAAP book value was $13.12 per share and economic book value was $13.69 per share, each down about 1% from the end of March. MFA again paid a common dividend of $0.36 and delivered a total economic return of positive 1.5% for the quarter. MFA generated GAAP earnings of $33.2 million or $0.22 per basic common share in the second quarter. Our GAAP results were driven by growth in our net interest income to $61.3 million as well as modest net mark-to-market gains. This marks the third consecutive quarter we've grown our net interest income, driven by additions of higher-yielding assets over the last several quarters. Net interest income also benefited from a nonrecurring $2.6 million acceleration of discount accretion on our MSR-related assets, which were redeemed during the quarter. During Q2, we continued to make meaningful progress resolving nonperforming loans. We reduced overall portfolio 60-plus day delinquency from 7.5% to 7.3% and lowered the balance of loans on nonaccrual status by $33.6 million compared to last quarter. In addition to our more traditional asset management activities, we resolved approximately $24 million of some of our most challenged transitional loans via loan sale during the quarter. We expect to utilize additional loan sales in the second half of this year to continue to accelerate the resolution of underperforming assets, allowing us to unlock and redeploy capital at mid- to high-teen return on equity. Importantly, because our assets are predominantly accounted for at fair value, the expected losses associated with these potential sales and resolutions have already been recorded in our GAAP results and in book value in prior periods, in some cases, years ago as unrealized losses. We mark our portfolio each quarter to what we and our third-party pricing services believe are the levels at which the loans would trade in the secondary market to a level net of expected credit losses. Confirming this belief, during the quarter, we resolved the current approximately $200 million unpaid principal balance of previously nonperforming loans. After reversing previously recognized fair value marks on these assets, the net impact on our GAAP results and our book value for the quarter was a net gain of over $0.03 per share. We believe this net gain on asset resolution highlights the quality of our loan marks and our financial reporting. Moving to our distributable earnings. DE for the quarter was $24.7 million or $0.24 per share, a decline from $0.29 per share in the first quarter. The decline was driven primarily by credit losses on fair value loans, which totaled $0.10 per share for the quarter, approximately $0.06 higher than in Q1, as well as a $0.02 increase in the dividend rate on our Series C preferred, which began floating on March 31. As Craig mentioned, our DE, excluding credit losses, was $0.35 per share, nearly in line with our common dividend. For the quarter, our consolidated G&A expenses totaled $29.9 million, a decline from $33.5 million in the first quarter. Second quarter results included severance and related transition costs of $1.2 million, the result of expense reduction initiatives across both MFA and Lima One. We expect that once complete, these initiatives will further improve our cost structure, lowering our run-rate G&A expenses by 7% to 10% per year from 2024 levels or approximately $0.02 to $0.03 per quarter. Though we expect some short-term pressure on distributable earnings, particularly over the next two quarters, we have confidence in both the current earnings power of the portfolio and the current level of our common dividend. We continue to expect that our DE will begin to reconverge with the level of our common dividend in the first half of 2026. Finally, subsequent to quarter-end, we estimate that our economic book value has increased by approximately 1% to 2% since the end of the second quarter. I'd now like to turn the call over to Bryan, who will discuss our investment activities in the second quarter.

Bryan Wulfsohn, President and Chief Investment Officer

Thanks, Mike. We grew our investment portfolio to $10.8 billion in the second quarter. We continue to focus on our target asset classes of non-QM loans, business purpose loans, and agency securities. We sourced and purchased over $500 million of non-QM loans during the quarter. These loans carry an average coupon of 7.8% and an average loan-to-value ratio of 66%. We established relationships with two new originators during the quarter and we will look to add more moving forward. Underwriting standards in the non-QM space remain prudent, and mid- to high-teen return on equity remains achievable with securitization funding. The market continues to be supportive of non-QM issuance, as the total bonds sold by all issuers so far this year has already nearly eclipsed the total from all of last year. We completed our 18th non-QM securitization in May, selling $291 million of bonds at an average coupon of 5.76%. As Craig mentioned, credit spreads were volatile during the quarter, especially in April when AAAs widened to as much as 175 basis points over treasuries. But spreads tightened over the remainder of the quarter back to where they were before the trade war turmoil started. On Monday of this week, we priced our 19th non-QM securitization and were able to improve pricing due to strong investor demand. We again added to our Agency MBS portfolio during the quarter, growing our position to $1.75 billion. Our focus remains on low pay-up securities, generally 5.5%, that we were able to purchase at modest discounts to par. We plan to grow our agency position further as long as spreads remain attractive. Turning to Lima One, Lima originated $217 million of business purpose loans during the quarter, a slight uptick from the first quarter. This included $167 million of single-family transitional loans with an average coupon north of 10% and $50 million of new 30-year rental loans with an average coupon of 7.5%. As a reminder, we continue to sell newly originated rental loans to third-party investors. Lima as a whole contributed $6.1 million of mortgage banking income for the quarter, an increase from $5.4 million in the first quarter. Lima again had success adding to its sales force, hiring 15 new loan officers during the quarter. Although origination volumes are down both at Lima as well as across the industry, we expect these new hires, along with significant progress on technology initiatives to lead growth in origination volume and profitability in the latter half of this year. Moving to our credit performance. As Mike mentioned, the 60-plus day delinquency rate for our entire loan portfolio declined to 7.3% in the second quarter. Default rates for our non-QM and rental loans remained exceptionally low at approximately 4% and fell to an all-time low in our legacy RPL/NPL book. We continue to be hard at work addressing our nonperforming transitional loans. We sold $24 million of delinquent transitional loans during the quarter and expect to sell more later this year. Although the default rate percentage rose again for our single-family transitional portfolio, it's important to note that loan delinquencies actually declined by $2 million, and we received $269 million of principal repayments, up from $249 million in the first quarter. We resolved $35 million of previously delinquent multifamily loans during the quarter and received $99 million of principal repayments. And with that, we'll turn the call over to the operator for questions.

Operator, Operator

Our first question today is coming from Bose George from KBW.

Bose Thomas George, Analyst

First, I would like to inquire about the economic return for the portfolio. You mentioned a $0.10 credit and some cents from the expense side that help us exceed the dividend. Is that what you consider the economic return, or is there potential for additional upside as we redeploy capital from the current troubled loans?

Michael C. Roper, CFO

Thanks for the question, Bose. I think a couple of parts to your question there. So we talk about the economic return of the portfolio regularly on these calls as well as internally and with our Board and setting dividend policy. One of the downsides of DE and really any accounting metric is that it's backward-looking. When we think about the earnings power of the portfolio, we try to think about the go-forward earnings power. And if you think about the sort of return on equities the portfolio is generating on a mark-to-market basis, that's really how we think about the economic earnings power of the portfolio. For example, we have some loans that were purchased in 2021 that are held at a pretty significant discount with a coupon rate of, say, 4%. Because that asset is accounted for at fair value, if you think about the total economics of that, whether it shows up in interest income or in the mark, that asset clearly is earning more than 4% today. So when we take that sort of mark-to-market return on equity and do the same thing on the hedges and the liabilities and then you layer in your expenses and the P&L that Lima is generating associated with their origination platform, the economic earnings power is much closer to the 10% dividend yield already. I think the second part of your question as far as additional upside, I think the answer is definitely yes. I mean we've been running with quite a bit of dry powder for some time now. Our recourse leverage is 1.8x. Even ignoring the $275 million of cash, we have a lot of capacity to turn up that leverage number a bit. So there's definitely some upside there. And you'll see that we've added a large number of assets again this quarter as we have for the last several quarters.

Craig L. Knutson, CEO

And Bose, just to clarify one thing, Mike said that the 10% dividend yield, he meant the 10% dividend yield on our book value, not on the stock price.

Bose Thomas George, Analyst

Okay. Yes, absolutely makes sense. And then in terms of the different areas where you can allocate capital, like where do you see the best ROEs at the moment?

Bryan Wulfsohn, President and Chief Investment Officer

We appreciate all three areas of focus. As you noticed, we've been particularly active in non-QM loans, along with agency and business purpose loans. Our objective is to gradually increase the originations of business purpose loans, which offer the best return on equity. Additionally, we are expanding our team at Lima One and anticipate growth in that segment. Thus, we aim to maintain activity across all three areas, but if Lima could increase its origination, we would favor that option.

Operator, Operator

Next question today is coming from Steve Delaney from Citizens JMP.

Steven Cole Delaney, Analyst

The 15 new loan officers hired, I understand that's at Lima One. Could you comment on that? Are these going to be generalist producers? Is there any product specialty that you're trying to develop? And I guess, most importantly, is there any new geo? Have you opened offices in any new states as a result of the new producers?

Bryan Wulfsohn, President and Chief Investment Officer

Yes. Our primary focus for hiring is in the West and Midwest regions. We consider these hires to be high-quality, coming from our competitors. Typically, when new employees join, it takes a few months for them to become familiar with Lima One's products and processes compared to their previous experiences. While we are seeing some growth now, we anticipate a more significant increase in growth during the latter half of this year and into next year as these new hires begin to make substantial contributions.

Steven Cole Delaney, Analyst

Yes. Okay. And how many total producers, you may have mentioned it, I apologize, now as we sit today at Lima One?

Bryan Wulfsohn, President and Chief Investment Officer

Yes. We were pushing, I think, 50, and the goal is to continue growing that, I think, closer to 80.

Steven Cole Delaney, Analyst

There's still some room for improvement there, which is positive. I appreciate the clarity on the dividend coverage. I was reviewing Page 16 in the presentation, and while it's informative, the unrealized and realized gains and losses make it difficult for us to calculate on our own without Mike's assistance this morning. It's challenging to determine coverage based on realized losses. I wanted to mention that regarding how it's presented in the deck. Overall, there's good strategic progress, and I understand that the losses are being addressed, but we still have some work to do to fully resolve that. Thank you for your time this morning.

Craig L. Knutson, CEO

Thanks, Steve.

Michael C. Roper, CFO

Thanks, Steve.

Bryan Wulfsohn, President and Chief Investment Officer

Thanks, Steve.

Operator, Operator

Your next question today is coming from Jason Stewart from Janney Montgomery Scott.

Jason Michael Stewart, Analyst

Just to follow a little bit on Bose's question. You talked about growing Lima One. But as we think about the balance sheet going into the easing cycle and maybe post steepener on the yield curve, like how do you envision capital allocation trending between the businesses on the balance sheet?

Bryan Wulfsohn, President and Chief Investment Officer

Yes. I mean, really, if you think about a steepener, right, Lima One is still originating assets that have coupons north of 10%. So if you have a steepener and the short end comes down, maybe that coupon goes from 10% to 9% or to 8.5% or something like that. But the borrowing costs against those are also going to come down commensurately. So right now, in securitization, you can get funding in the five handles, right? So if that front end were to come down, you would see that cost of funds drop into probably the low fives, four handle. So it's still very sort of accretive to us to originate those loans. And when you look across non-QM, it does benefit our existing portfolio and incremental loans will fund incrementally better, but I would expect those loan prices to be bid up more aggressively as the curve does steepen. So it may be a more competitive environment and may compress yields somewhat there.

Jason Michael Stewart, Analyst

Okay. And then thinking through the post-steepener, and I guess more specifically then on the agency, would that be a strategy you deemphasize at that point in a flatter curve environment and redeploy that capital into Lima One and other strategies?

Bryan Wulfsohn, President and Chief Investment Officer

That's right. We see the current spread levels as a good opportunity to invest in Agency MBS. If those spreads narrow, we would move those assets into our other credit investments.

Jason Michael Stewart, Analyst

Okay. That's helpful. Just a follow-up from last quarter, you mentioned about $40 million of discount on multi-transitional. Comparing quarter-to-quarter, how does that relate to the $33.6 million? What would be the right comparison to look at there quarter-to-quarter?

Michael C. Roper, CFO

Yes. So that number there is effectively the discount in terms of the mark on those assets. So I think it is $34 million this quarter. But if you think about those transitional loans, they're very short duration. So they are much less sensitive to moves in market interest rates. I think we sort of think about that discount there as does the buyer of these loans as a credit discount effectively.

Jason Michael Stewart, Analyst

Okay. Got you. So you've worked through the vast majority of that this quarter. I got you.

Michael C. Roper, CFO

To clarify, that discount has decreased from around 40% or 45% to approximately 35%. We have made significant progress, but as I mentioned earlier, there is still some work to be done in the coming quarters.

Operator, Operator

The next question today is coming from Jason Weaver from JonesTrading.

Jason Price Weaver, Analyst

Can you comment on the distribution potential for new transitional loans if we see more relief in rates ahead, and whether you expect securitization financing or loan sales to become a more attractive option under those conditions?

Bryan Wulfsohn, President and Chief Investment Officer

We have been selling rental loans, which are term loans. The reason for this is that when you originate $30 million or $20 million of these loans each month, it takes time to prepare them for securitization. Holding onto the spread risk for a long time does not make sense when we have strong bids from buyers. Thus, we are leveraging that demand by selling these loans to third parties. As for shorter-term transitional loans, almost all of them qualify for securitizations and have a revolving structure. As we generate more loans, they are replacing older loans as they pay off. Currently, we have four deals outstanding. If we increase our originations, we might grow from four deals to five or six. However, we need to ensure that we have enough volume to counterbalance the payoffs we are experiencing. In terms of the loan composition, it is likely 45% to 50% ground-up loans, with the remainder consisting of bridge and traditional Fix-and-Flip loans.

Craig L. Knutson, CEO

And Jason, I'd just add one thing. The 30-year rental product is obviously more rate-sensitive than the transitional loans. So lower short rates, steeper curve, it's likely that volume would pick up on that product.

Jason Price Weaver, Analyst

Got it. That's helpful. And I want to go back to in the prepared remarks, you mentioned the $24 million in loan sales and you expect to do more in the second half. Talk about the relative merits there. Is that a question of just coincidence you were able to find a buyer on that side? Or is that becoming actively more attractive than pursuing the entire workout process?

Bryan Wulfsohn, President and Chief Investment Officer

Yes, it's a matter of finding the right balance. We're currently evaluating loans and testing the market to see where the bids are. If the bids are appealing, we would consider moving forward. If working it out ourselves yields the best result, then that's the route we'll take. It's about assessing each loan individually to determine the optimal outcome.

Operator, Operator

Our next question is coming from Eric Hagen from BTIG.

Eric J. Hagen, Analyst

On the single-family rental and single-family transitional loans, do you think developers are getting the rental income in like the exit that they expected? Or is there a lot of range around that outcome because of the execution risk is higher with tariffs and other higher input costs and such?

Bryan Wulfsohn, President and Chief Investment Officer

In terms of execution, many of our development loans are primarily for building and selling rather than renting. The prices being achieved in the market are aligning with the after-repair value outlined in the appraisal. Therefore, we aren't seeing significant pressure related to tariffs. There might be a potential impact in the future, but we haven't observed any material effects so far, and we monitor these trends on a monthly basis. We haven't noticed any significant issues. When it comes to rents, they have been sufficient to cover future debt service since these loans are generally refinanced away from us. This aligns with what we expected, and we’re not observing any substantial pressure in that area either.

Eric J. Hagen, Analyst

Yes. Okay. That's helpful. You guys break out the loan book by origination year, which is really helpful. But which of the vintages would you maybe label as having higher relative risk versus lower risk just based on when they were originated?

Bryan Wulfsohn, President and Chief Investment Officer

I would say that if you examine the multifamily segment, the vintage from 2023 has been somewhat more challenging for us. In contrast, other areas of our portfolio have very low loan-to-value ratios, so we're not particularly concerned about losses there. On the non-QM side, while we've noticed some rising delinquencies, in most cases, property owners end up listing their properties for sale, and they sell them without us needing to engage in loss mitigation. Therefore, we are approaching these portfolios without a specific focus on vintage.

Eric J. Hagen, Analyst

Okay. If I could sneak in one more. I mean, is there a catalyst aside from lower interest rates, which could accelerate the call in the non-QM portfolio, the callability?

Craig L. Knutson, CEO

I mean, it's really an algebra exercise, Eric. So it's pretty easy for us to do. So lower rate environment, yes, theoretically, there are more deals that would be callable. In addition, with lower rates, our preferred Series C would reset to a lower coupon. So there's marginal benefits in a few different ways. If you look at the bulk of the floating rate borrowing, it's for the most part offset with swaps. Lower rate environment is not necessarily going to have a big impact there. But on the edges, lower rates are certainly helpful.

Michael C. Roper, CFO

And I think, Eric, just to add, there could be a deal with respect to the call rights that's maybe out of the money. But if you think about the deleveraging embedded in some of those callable deals, it doesn't necessarily have to be a lower rate to reissue it to still increase the ROE of the portfolio because you're unlocking a lot of capital with the relever.

Operator, Operator

We reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments.

Craig L. Knutson, CEO

Thank you, everyone, for your interest in MFA Financial. We look forward to speaking with you again in November when we announce our third quarter results.

Operator, Operator

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time and have a wonderful day. We thank you for your participation today.