MFA Financial, Inc.

ladies and gentlemen thank you for standing by welcome to the mfa financial inc third quarter 2022 conference at this time all participants are in a listen-only mode later we'll conduct a question and answer session and instructions will be given at that time if you should require any assistance during today's conference please press star zero as a reminder this conference is being recorded i would now like to turn the conference over to our host hal schwartz please go ahead

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 31st, 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 third 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 MFA Financial's third quarter 2022 earnings call. Also with me today are Steve Yarrett, our CFO, Gudmundur Christensen, and Brian Wilson, our co-chief investment officers, and other members of senior management. The third quarter of 2022 offered no respite from the extremely difficult prior two quarters and was another historically challenging period across all financial markets. Bond markets continued to be very volatile with rates backing up in the third quarter and agency mortgage spreads touching near all-time highs not seen since the great financial crisis, which you'll recall in 2008 for a time it was not certain that Fannie or Freddie credit was good. Equity markets experienced a particularly volatile third quarter. Although the S&P 500 was down only 5% for the quarter, it was up 14% through mid-August and then down 17% over the second half of the quarter. Inflation numbers continue to disappoint with stubbornly high prints despite considerable action already taken by the Fed. Although the Fed has been consistently clear that their sole focus is on inflation, Market participants seem to seize on random and sometimes tenuous signals to anticipate a pivot or a pause, driving yields down and stocks up for a short period until it becomes obvious that this temporary euphoria was ill-advised, at which point we retrace levels in stocks and bonds. With a war still raging in Ukraine and recent financial stresses in the UK and Japan, this market volatility is not likely to subside soon. As a result, financial market investors have generally remained on the sidelines, even as spreads and yields have moved in many cases to historically wide levels. Now, admittedly, the conspicuous absence of the Fed as an active buyer in the market today, as they have been for nearly all of the last 15 years, calls into question any notion of what an average or normal spread is or what was observed over that time period. But even looking back prior to 2007, many of the levels that we see in the market today look quite attractive. Recent agency mortgage spreads as wide as plus 190 versus 10-year treasuries effectively puts a floor on non-agency RMBS, which explains even wider spreads on credit products today. In fact, there were only four times in the last 36 years that agency MBS spreads have been wider. 1986, 1998, 2000, and 2008. And except for 1986, all these periods coincided with systemic and unique financial market crises, and all four times overlapped with periods of falling rates, whereas the dislocation we see today is largely a function of rapidly rising rates. I referred to 1994 during our first quarter earnings call earlier this year when the Fed raised rates six times for a total of 250 basis points and then another 50 basis points in February of 1995. During this time, 10-year yields rose 240 basis points from 563 just prior to the first increase to a peak of 803. Agency mortgage spreads widened from 72 basis points just prior to the first Fed action, to a peak of 116. That's a 44 basis point widening in late April of 94. And then agency MBS rallied through the summer and finished the year in the low hundreds. Contrast this with today, when similar Fed tightening and almost identical increases in 10-year yields have led to over 130 basis points of agency spread widening from the beginning of the year tights in the 50s. A more recent rising rate widening for agency MBS would be the taper tantrum in 2013. Agency mortgage spreads had widened early in 2013 from plus 41 in January and were about plus 70 versus tens before Chair Bernanke's announcement that the Fed would begin tapering asset purchases at some future date set off the taper tantrum, which we all remember set off a sell-off in Treasuries and pushed mortgage spreads wider. Ten-year yields rose from 192 just before the announcement to 3% in early September, and agencies widened, but only by 25 basis points to plus 95 in early July, and they were back inside of plus 70 by September. Somehow my recollection of the taper tantrum was much more dramatic than these actual numbers suggest. And again, this puts today's spread environment in context. While the magnitude of Fed hikes has exceeded some expectations, the direction was foreseeable. Our team at MFA took steps to preserve capital and manage our duration beginning in 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 rate swaps at year-end last year, 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. This swap book has a weighted average fixed pay rate of 1.69, So not only does this lock in what is now considered a cheap funding cost, but we also benefit from a positive carry from the floating rate receive leg, which is now approximately 200 basis points with yesterday's Fed action priced in. We deliberately slowed our loan acquisition pace beginning in the first quarter of the year, and at the same time, we've continued to execute securitizations throughout the year, nine securitizations and over 2.7 billion of UPV. Through our swap position and these securizations, we have now effectively locked in 99% of our asset-based financing costs. 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 was 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, the vast majority of which we will likely hold until payoff or maturity. As of September 30, the market discount to unpaid principal balance on our $6.8 billion of purchase performing loan portfolio is approximately $668 million. We have securitizations that are also marked below par by approximately $325 million. Netting these two discounts produces a potential book value increase of approximately $343 million, or $3.37 per share, assuming the loans and liabilities all 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 loan portfolio. We have also prioritized liquidity for all of 2022, and we ended the third quarter with approximately $434 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 gives us the ability to take advantage of opportunities that arise. We've also fortified our balance sheet, as we show on pages 6 and 7 of our presentation. We've increased non-mark-to-market financing. As of September 30th, 71% of our financing is non-mark-to-market, and our recourse leverage was only 1.7 times at quarter end. Our loan financing agreements are term financings, and 65% of this financing has a maturity date greater than six months. The borrowing spreads and haircuts on existing loan financing is fixed for the term of the financing agreement. Typically, we extend these agreements for another year, a couple of months before their term expires. And despite market volatility, financing is available from multiple counterparties, and we continue to field calls from other significant bank lenders eager to provide financing. Finally, I'd like to talk a little bit about housing and residential mortgage credit. Clearly, the sell-off in rates and widening in mortgage spreads has had a profound impact on mortgage rates, and housing activity has slowed dramatically. We're beginning to see some modest home price declines at least month over month in some parts of the country. After the dramatic home price appreciation over the last two years, this should not be a surprise. However, as we show on page 8, our loan portfolio has considerable embedded HPA, which combined with amortization has lowered the current LTVs in most cases to the mid-50s. So to summarize how MFA is positioned, we continue to maintain substantial liquidity. We have fortified our balance sheet with non-mark-to-market financing, fixed-rate financing through swaps and securizations, and term financing agreements for our loan products. And our loan portfolio has benefited from seasoning and home price appreciation and has a low LTV, so borrowers have substantial equity in their properties. And I'll now turn the call over to Steve Yarrick to discuss additional details of our financial results.