MFA Financial, Inc.

Ladies and gentlemen, good morning. Thank you for standing by as today's conference assembled, and welcome to the MFA Financial Incorporated 2022 Second Quarter Earnings Call. At this time, all lines are in listen-only mode. Later, there will be an opportunity for your questions, and instructions will be given at that time. If you require any assistance today, please press star followed by the zero, and an AT&T operator will assist you. And as a reminder, today's conference is being recorded. This time, it's my pleasure to turn the conference over to our host, Mr. Hal Schwartz, please go ahead.

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, 2021, 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 2022 financial results. Thank you for your time. I would now like to turn this call over to MFA's CEO and President, Craig Knudson.

Thank you, Hal. Good morning, everyone, and thank you for joining us here today for MSA Financial's second quarter 2022 earnings call. Also with me are Steve Yarris, our CFO, Gudmundur Kristiansen, and Brian Wolfson, our co-chief investment officers, and other members of senior management. As you are all no doubt aware, the first half of 2022 has been an exceptionally challenging investment environment across nearly all asset classes, with the possible exception of commodities and the US dollar. The S&P 500 index was down over 16% in the second quarter and posted its worst first half of the year in over 50 years. Bond markets continued to sell off after a difficult first quarter, and bond indices were generally down about 10% for the first half of the year. Mortgage spreads widened materially, as did credit spreads, with high yield wider by nearly 300 basis points year to date. Persistently high inflation, continued geopolitical tension, and an aggressive Fed tightening cycle that markets have not experienced since 1994 have combined to wreak havoc across financial markets. In short, there's been no place to hide thus far in 2022. Our team at MFA has taken steps to preserve capital and manage our duration, beginning as early as the fourth quarter of last year, when it became clear that the Fed would need to move more dramatically than previously expected. We had $900 million of interest rates lost at year end, and as rates rose and duration extended, we increased this position to $2.4 billion at March 31, and again to $3.2 billion at June 30. We also slowed our loan acquisition pace in the first quarter and again in the second quarter. At the same time, we continued to execute securizations through the first half of 2022 and into July. Although wider spreads combined with higher rates increased the cost of these deals, we have significantly reduced risk by terming out close to $2 billion of securization financing in 2022. In fact, over 95% of our asset-based financing is now fixed via securitization or economically fixed via interest rate swap hedges. And with last week's Fed increase, our swap book now generates positive carry of about 60 basis points, as the floating rates receive leg exceeds the fixed rate pay leg. Future Fed rate increases, which are widely expected, will increase this positive carry further. We slowed our acquisitions during the second quarter, particularly of non-QM loans, as market volatility made pricing difficult and created additional uncertainty about the cost of securitization. Taken together, these steps mitigated our book value decline. Although MFA was certainly not immune to book value diminution, our relative book value performance versus many in the peer group has been considerably better. It's also worth noting that a significant portion of MFA's book value decline is due to fair value marks on loans on our balance sheet that we will likely hold until payoff or maturity. As of June 30, the market discount to unpaid principal balance on our loan portfolio is approximately $475 million. Now, to be fair, we also have securitizations, which are accounted for at fair value, that are marked below par by approximately $233 million. Netting these two discounts produces a potential book value increase of approximately $242 million, or $2.38 per share, assuming that the loans and the liabilities pay off at par. This amount would be offset by any realized losses on loans, but expected losses are relatively low, particularly on our purchase performing loans. And home price appreciation over the last 10 plus years on our legacy NPL and RPL loans has significantly affected outcomes on these loans. Indeed, we've realized gains on REO liquidations for each of the last six quarters. We also prioritized liquidity during the first and second quarters of 2022, ending both periods with close to $400 million in cash. While holding a substantial portion of our equity in cash obviously creates a drag on overall ROE, this was not the time to swing for the fences. Having a sizable liquidity position provides a cushion in volatile markets and also gives us the ability to take advantage of opportunities that arise. Finally, I'd like to talk a little bit about housing and residential mortgage credit. We have seen dramatic home price appreciation over the last two years as demand for housing has far outstripped supply. This was due to many factors, among them increased household formation, post-pandemic trends leading to added demand for single-family homes, lack of new and existing supply of homes, and very low interest rates. Now of these influences, only the interest rate component has changed. The other factors driving housing prices still exist. And in fact, new home construction has fallen even more recently. Additionally, LTVs of purchase performing loans have generally been low and underwriting standards conservative. So overall mortgage credit is generally strong. Future home price appreciation will certainly slow. but any significant home price declines are hard to envision at this point. In fact, it strikes me as funny that I sometimes read that some percentage of home price listings has experienced list price reductions or that some percentage of homes did not trade at a premium to the listing price as evidence of housing weakness. It seems a more apt analogy would be a shift from a boil to a simmer. Lima One was a continued bright spot for MFA as they turned in another strong quarter with approximately $600 million of originations. Because we are intimately involved in the securitization market, we have an instant feedback loop with our business purpose loan originator and can adjust rates in real time, thus reducing the typical drag suffered by originators in a rising rate environment as their pipelines fill with sub-market coupons. Lima One's current origination BPL pipeline of about $450 million as a weighted average coupon today of approximately 8%. These high quality and high yielding assets will generate attractive returns as these loans close and are added to our balance sheet. Please turn to slide three. As previously mentioned, a difficult environment led to a book value decline of 8% for both gas and economic book value, $1.42 and $1.56 respectively. I would again point out that the aforementioned net discount from PAR of loans and securitized debt is $2.38 per share. Some of you will remember the credit reserve that we had 10 years ago or so on our legacy non-agency RMBS portfolio that many analysts and investors believed would be accretive to book value over the long run. We reported a gap loss of $108.6 million in the second quarter, primarily due to unrealized losses on residential hold-ons at fair value. Distributable earnings came in at $47.2 million, or 46 cents per share, and we paid our common dividend of 44 cents last Friday. Leverage ticked up from 3.1 to 3.3 times, primarily due to book value decline, but I would point out that our leverage is increasingly now in the form of securitized debt. Please turn to page four. As I stated in my introductory remarks, our acquisition pace slowed in the second quarter, with nearly 70% of our loan acquisitions coming from Lima One. Our overall loan portfolio was slightly lower at quarter end, although that is mostly due to fair value marks rather than lower balances. We also executed three securitizations in the quarter and two more in July, and we now have nearly $4 billion of financing in the form of securitized debt. These transactions add durable, non-recourse financing, create additional liquidity, and provide more balance sheet capacity that we can deploy in the future to acquire new loans that are now priced at higher yield levels. We reduced interest rate risk during the quarter by adding interest rate swaps, and we prioritized liquidity given the volatile market environment. Finally, our asset management team has continued to take advantage of a strong housing market with limited supply by liquidating $40 million of REO properties this quarter, posting a net gain of $7 million. Please turn to slide five. This slide illustrates the components of our investment portfolio and also the nature of our asset-based financings. While the liability pie chart shows $2.6 billion of mark-to-market borrowing, about $1.5 billion of this borrowing is at a significant discount to our available borrowing amount. This under-levering creates a cushion that increases the amount of asset price decline that needs to occur before we receive a margin call. During the second quarter, we experienced very minimal margin calls on our loan portfolio. And at the same time, our interest rate swap position generated cash from reverse margin calls. And I will now turn the call over to Steve Yarrett to discuss additional details of our financial results.