MFA Financial, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the MFA Financial Announcement 4th Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session with instructions being given at that time. If you should require assistance during the call, you may press star then zero and an operator will assist you offline. As a reminder, today's 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 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 that 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 fourth 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 Knutson.

Thank you, Hal. Good morning, everyone, and thank you for joining us here today for MFA Financial's fourth quarter 2022 earnings call. Also with me today are Steve Yarrod, our CFO, Gudmundur Christensen, and Brian Wilson, our co-chief investment officers, and other members of senior management. The fourth quarter of 2022 was yet another wild ride to punctuate what was one of the most difficult years ever for fixed income and for the mortgage market in particular. Rates ended the fourth quarter only slightly higher than they were at September 30th, but the path is anything but straight. Two-year treasuries began the fourth quarter at $4.28 and sold off to $4.72 in early November before rallying back to close out the year at $4.43. After beginning the quarter at $3.83, 10-year treasuries hit a high for the year of $4.24 in late October before rallying back to end the year almost unchanged at $3.87. This volatility in the rates market wreaked havoc in the mortgage market, with agency mortgages widening out in late October to the widest level since the great financial crisis. RMBS securitization markets, while technically not closed, were quite dysfunctional, with AAA cash flows widening even more than agency MBS spreads. As breathtakingly bad as 2022 was for fixed income and mortgage participants, it was not a total surprise to us at MSA. On our fourth quarter 2021 earnings call a year ago, I stated that we expected ongoing rate volatility with inflation raging at the time, the Fed on the move, and a tense geopolitical environment. On our first quarter 2022 earnings call, I remarked how similar 2022 felt to 1994 when the Fed raised rates six times for a total of 250 basis points. Now, we certainly did not have a perfect crystal ball, but we began preparing for 2022 in late 2021, and we took additional steps early in 2022 to prepare for higher rates. As market expectations changed in 2022, we took further action to protect MFA from market forces. We had $900 million of interest rate swaps on at year-end 2021, And this is when market expectations, by the way, were for three 25 basis points Fed funds increases during 2022. Seems like a long time ago. We increased our swap book to $2.4 billion by the end of the first quarter of 2022 and to $3.2 billion by the end of May. At the same time, we continued to execute securitizations throughout the year, despite higher rates and higher spreads on the rate of securities that we sold. were numerous occasions during the year when we priced the securitization and we were somewhat disappointed with our execution and a week or two later ecstatic that we had printed the deal when we did. The securitizations complemented our interest rate swap positions by effectively fixing our future funding costs and at the same time reduced our exposure to margin calls on repo and warehouse funding. Our management of MFA's funding costs is starkly evident when you look at our cost of funds particularly in the fourth quarter of 2022 we stated on our third quarter earnings call that 99 of our asset-based financing costs were effectively fixed either through securitizations or interest rate swaps our cost of funds in the fourth quarter was 3.7 percent which is only 10 basis points more than it was in the third quarter and this despite the fact that the fed raised rates 125 basis points in the fourth quarter and 200 basis points since their meeting in September. Many others in our space saw funding costs increase by 100 basis points or more in the fourth quarter. And in fact, our funding costs were only 32 basis points higher in the fourth quarter than they were in the second quarter, and the Fed raised rates by 350 basis points between June 16 and December 31st. As a result of when we entered into our interest rate swaps, our weighted average fixed pay rate was 169 at December 31st. Given the current level of SOFR, our interest rate swap book now generates a positive carry of close to 300 basis points, and this positive carry will increase further as Fed funds rates increase further. Finally, as we added assets at increasingly higher yields, our net interest spread has increased in both of the last two quarters. Our book value was down very modestly in the fourth quarter and was down a little over 20% for the year, and our economic return for the year was down 13% on GAAP and 16% on economic book value. While this is a disappointing result for MFA, our proactive hedging and liability management limited the book value decline, as some others saw declines in book value for the year of between 30% and 50%, and economic returns for the year down 25% to 40%. And it's important to note that our book value decline is overwhelmingly due to rising rates rather than to weakening credit fundamentals. In fact, our loan portfolio is marked $732 million below par, or $7.19 per share. Now, to be fair, our securitized debt is also marked below par by $368 million, or $3.62 per share. But netting the two and assuming that our loans pay off at par and that we pay off our securitized debt at par, we have a potential upside in our economic book value of $3.57 per share. Page eight of our earnings deck lays out this case together with the strong credit fundamentals that support the loan portfolio. So looking ahead to 2023, this year has been anything but boring thus far. Rates rallied through the month of January as bond market participants became more and more confident that inflation trends were improving and expectations of further Fed tightening diminished. Agency mortgages looked attractive, particularly on a historical basis, at the end of January. The Fed announcement and press conference on February 1st provided further fuel to this Dove rally. then queue up the January employment report, which came out in early February, followed by hot CPI and retail sales numbers, and the bond rally suddenly became a bond rout, and we're back near November highs on Treasury yields. And once again, we learned that mortgages can look cheap, but that doesn't mean they can't get cheaper. Credit markets have been considerably more constructive thus far this year, with securitization spreads, at least on AAAs, over 100 basis points tighter than they were in November. After printing just one securitization of $235 million of loans in the fourth quarter, we've already executed three securitizations in 2023 and a total of over $650 million of loans. Not only were these spreads tighter for these deals, but they were priced before the recent sell-off in rates. It seems clear to us that the Fed is neither certain about the magnitude of further rate increases nor clear on how long they will need to hold rates at restrictive levels in order to break inflation. but it is pretty clear to us that the game is not over. We can debate whether or not we're in the middle innings, but we're definitely not in the ninth inning. Our rate strategy remains in place as it has been since the second quarter of last year. We'll continue to prioritize liquidity, we'll continue to securitize loans, and we'll adjust market pricing and yields on our asset purchases to conform to market rates and funding costs. 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 to anyone. However, as we again show on page eight, our loan portfolio has considerable embedded HPA, which, combined with amortization, has lowered the current LTVs in most cases to the mid-50s. In addition, delinquency trends have continued to improve across our portfolio. And I'd like to turn the call over now to Gudmundur to talk about our portfolio activity and Lima 1.