MFA Financial, Inc.

Thank you for standing by, and welcome to the MFA third quarter 2024 earnings conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. If you should require assistance during the call, please press star, then zero. As a reminder, today's conference is being recorded. I would now like to turn the conference over to our first speaker, Mr. 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, 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 third quarter 2024 financial results. Thank you for your time. I would now like to turn this call over to MFA's CEO, Craig Knutson.

Thank you, Hal. Good morning, everyone. And thank you for joining us for MFA Financial's third quarter 2024 earnings call. With me today are Brian Wolfson, 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 third quarter market environment, touch on some of our results, activities, and opportunities, and then I'll turn the call over to Mike to review our financials in more detail, followed by Brian, who will review the portfolio, financing, Lima One, and risk management before we open up the call for questions. The Federal Reserve Board decreased the federal funds rate target by 50 basis points at their meeting on September 18th. This rate cut While more than the 25 basis points expected by many market participants was most noteworthy as a clear signal that the Fed has now embarked on an easing cycle. For levered fixed income investors, this is a welcome development after a very challenging two and a half year period of restrictive monetary policy and the accompanying inverted yield curve. Economic and labor market data has been somewhat mixed over the last few months, which suggests that the easing cycle may proceed more slowly than originally anticipated. But Chair Powell has been clear that a recalibration is merited and a return to a neutral level of Fed funds is in order. Although it remains to be seen how long this easing cycle lasts and how much the Fed ultimately cuts rates, this is a clear and refreshing tailwind for our business. During the third quarter, we announced some management changes, naming Brian Wilson President of MFA, in addition to his role as Chief Investment Officer, and naming Lori Samuels as Chief Loan Operations Officer. Both Brian and Lori joined MFA in 2010 and have played many key roles over the last 15 years. These important promotions are very much deserved and are also a testament to our deep and talented bench of senior executives. MFA turned in solid results in the third quarter of 2024 with distributable earnings of 37 cents, book value that was up about 1%, and an economic return of 3.3%. We acquired over 550 million of loans with an average coupon of 9.4% and added just shy of 300 million agencies at quite attractive yields. We continue to utilize securitizations to fund our assets, closing two deals in the third quarter and two additional deals subsequent to the end of Q3. Our most recent deal, priced just last week, was our first rated deal for residential transition loans originated by Lima One. This rated construct materially improves our funding costs for these high-yielding assets. At Lima One, now led by new CEO Josh Woodward, some recent management changes, together with a refocus away from multifamily originations and some sales channel consolidation, have had a not unexpected impact on origination volume as we funded $329 million of business purpose loans in the third quarter. Non-QM acquisitions in Q3 were relatively flat to Q2, but we added more agencies in Q3, and it turns out that our total asset acquisitions for the third quarter were almost identical to the second quarter. The management team in Lima 1 is working hard to fill some personnel vacancies, including sales positions. And MFA's asset management team is actively engaged with Lima's servicing group, to work through some of the delinquent loans, evaluate underwriting guidelines, and institute process improvements to strengthen the platform for the future. As we have said repeatedly, Lima One is an important differentiator for MFA, as it provides us with the ability to organically create our own high-yielding assets in the business purpose space. Lima One underwrites our loans and borrowers, services the loans, and manages construction draws on transitional loans. This is another important differentiator because we are not reliant on third parties to resolve loans that go delinquent. And finally, we have a unique and instant feedback loop with loan originations at Lima One. Because we are intimately involved with the securitization markets and more recently a few loan sales to third parties, we were able to adjust loan pricing in real time to reflect market developments. In this welcome new period of lower rates and a steepening yield curve, we are optimistic about our business model and excited about the opportunities it will generate for Lima One and MFA. And I'll now turn the call over to Mike Roper to discuss our financial results. Thanks, Craig.

On September 30th, GAAP book value was $13.77 per common share and economic book value was $14.46 per common share, an increase of approximately 1% from 1434 at the end of June. We declared dividends of $0.35 per common share and delivered a quarterly total economic return of approximately 3.3%. For the third quarter, MFA generated gap earnings of $48.2 million, or $0.38 per basic common share, up from $41.9 million, or $0.32 per basic common share in the second quarter. Our gap earnings included net unrealized gains on our residential whole loan portfolio of approximately $140 million, These gains were concentrated primarily in our non-QM and SFR loan portfolios and were partially offset by a slight increase in credit-related unrealized losses on our multifamily transitional loans. During the quarter, we sold single-family rental loans with an unpaid principal balance of approximately $236 million. As Brian will detail further in his later remarks, these sales included 74 million UPB of recently originated SFR loans that were sold to third parties by Lima One. These sales represent the first of what we expect to be a new and growing distribution channel for Lima's origination in the quarters and years ahead. We believe that third-party sales provide strategic diversification away from securitization markets, enhance Lima's relationships with other capital market participants, and improve our returns. We report gains derived from loans sold to third parties within three months of their origination as a component of Lima One's mortgage banking income, which is included in our distributable earnings. Sales of recently originated loans contributed $3.5 million to Lima One's mortgage banking income this quarter, driving the increase from the second quarter despite lower origination volumes. During the quarter, MFA again generated DE in excess of our common dividend. DE for the quarter was $38.6 million, or $0.37 for basic common share, a decrease from $0.45 in the second quarter. The decrease in our DE was driven primarily by $0.07 of realized credit losses during the quarter, primarily on our transitional loans at fair value, an increase from one cent of realized credit losses on fair value loans in the second quarter. As we explained in our last call, expected credit losses on our fair value loans are recorded in our GAAP results and in both our GAAP and economic book values as mark-to-market adjustments over the life of the underlying loans, but only impact DE when the losses are realized, generally at the completion of foreclosure proceedings. Our third quarter G&A expenses and our DE were also impacted by non-recurring separation, severance, and retirement-related charges of approximately $3.3 million. We expect that the personnel changes that gave rise to these charges will result in a modest reduction in our quarterly G&A and a benefit to our DE beginning in the first quarter of 2025. Finally, subsequent to quarter end, we estimate that our economic book value has decreased by approximately 3% to 4% as a result of higher market interest rates. I'd now like to turn the call over to Brian, who will discuss our portfolio highlights and the performance of NEMA 1.

Thanks, Mike. We grew our investment portfolio during the quarter by adding $565 million of new loans and $294 million of agency securities. NEMA 1 originations and draws accounted for $329 million of the additions. Non-QM purchases sourced from both bulk and flow channels totaled $236 million with an average coupon of 8.2% and an LTV of 64%. We grew our agency MBS portfolio to approximately $1 billion during the quarter, since we believe spreads and carry continue to be attractive. Our purchases have been focused on low payout pools, which provide some prepaid protection without sacrificing yield. We believe these investments currently offer ROEs in the mid-teens and are complementary to our credit portfolio. Runoff across our entire portfolio in the quarter was $629 million, down slightly from the second quarter. The majority came from our transitional loan portfolio, as those loans are designed to pay off quickly, with maturities usually ranging from nine months to two years. In addition to the runoff, we sold $241 million of loans from our single-family rental loan portfolio in the quarter. All of those loans we sold were made by Lima One, and 77 million of them were newly originated. We expect to sell more loans moving forward as the bid for rental loans remains strong, particularly from insurance accounts looking to add duration to their investment portfolios. As Craig touched on, we have been successful in the securitization markets across our loan strategies. The market has been supportive of residential securitized credit absorbing almost double the issuance year to date as compared to last year. We issued a rated RPL transaction in July selling $259 million of bonds a cost of debt of approximately 5.8%. In September, we issued our 15th non-QM securitization, selling 321 million bonds with a coupon just under 5.4%. Post-quarter end, we issued a non-rated deal compromised with NPLs from our legacy RPL NPL portfolio. And last week, we were excited to close our first rated RTL securitization, issuing over 200 million of bonds at a coupon just under 6%. The rated nature of the transaction allowed us to lower our cost of funds significantly from the last non-rated RTL deal. The senior tranche in our rated deal traded 75 basis points tighter than our senior tranche of our last non-rated transaction. We have now securitized over $10 billion in loans since 2020, and the percentage of our loan portfolio financed by securitizations was 70% at the end of the quarter. Many of these securitizations are callable or will become callable in the coming quarters and years. These call options give us the ability to refinance at lower rates if borrowing costs come down, as well as the opportunity to relever our collateral and redeploy capital as bonds pay down. Our estimated duration rose modestly in the third quarter to 1.16 from 1.12 a quarter ago. As a reminder, we hedge our interest rate exposure by issuing fixed rate securitizations, of which we have $5.5 billion of bonds sold outstanding. and with interest rate swaps, of which we had $3.5 billion notional at the quarter end. One billion of these swaps will be rolling off in the next two quarters, and as we continue to add agencies to our portfolio, expect to see additional swap activity and incremental usage of longer-dated swaps to balance out the portfolio. Moving to Lima 1. We originated $312 million of loans in the third quarter, which was down from just over $400 million in the prior quarter. 75% of Q3 origination was in short-term transitional loans and 25% in longer-term rental loans. As previously mentioned, we have begun to programmatically sell rental loans as a way to generate additional income and enhance Lima One's franchise value. We attribute the decline in origination volume to restructuring the Lima sales organization since our shift away from multifamily lending. we have been adding talent to our production team and improving borrower outreach with marketing and technology initiatives that should start to pay dividends with higher volume beginning in 2025. Moving to our credit performance, 60-plus day delinquencies for our entire portfolio increased to 6.7% from 6.5% a quarter ago. The rise was primarily from our non-QM and multifamily loan portfolios. As it relates to non-QM, given our low portfolio LTV, when a borrower falls behind on payments, They usually just sell the home and pay us off in full to protect their equity. In cases where we unfortunately have to get to a foreclosure option, we are often outbid, resulting in full payoff. Multifamily delinquencies increased by $7 million over the quarter to $61 million. In post-quarter end, that figure rose by an additional $33 million. As a reminder, our asset management team has worked through billions of dollars of defaulted loans over the past decade to the benefit of our borrowers and shareholders. We have and will continue to leverage that team to improve outcomes across our entire loan portfolio, including working through delinquent transitional loans with our servicing group down at Lima One. We believe the combined expertise and experience of these teams puts MFA in a strong position to deliver for our investors. And with that, we'll turn the call over to the operator for questions.

And ladies and gentlemen, if you wish to ask a question, please press 1 then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1 then 0 command. If using a speakerphone, please pick up your handset before pressing the numbers. Once again, if you have a question, please press 1 then 0 at this time. And our first question today comes from the line of Doug Carter. Please go ahead.

Thanks. Just first hoping you could clarify the book value comments you made just given how much things are moving around kind of when that 3% to 4% was as of and kind of how you think about dividend accrual in that context.

Yeah, thanks for the question. So that 3% to 4% is probably as of, you know, earlier this morning, and it's a bit of a moving target with, you know, some spread volatility and rate volatility. But that would be net of the dividend accrual.

Great. Appreciate that. You know, and then just how are you thinking about, you know, kind of the earnings power of the portfolio kind of and the sensitivity to, to lower short-term rates as you factor in, you know, kind of the swaps you have and swap expirations?

Yeah, again, thanks for the question. This is something we spend a good amount of time looking at. I think when we think about the earnings power of the portfolio, we try to look at, you know, what those assets and liabilities and hedges would be if we were to effectively restrike those yields today. And, you know, effectively over the long term, whether that's reported as interest income, interest expense, or mark-to-market, that is what the, you know, earnings power of the portfolio is going forward. So, you know, given where things are marked at 930 and obviously returns have increased since quarter end with the sell-off and rates, you know, I think we feel really good about, you know, where the dividend is set and what that earnings power is of the portfolio in the context of the dividend. As for your question about the swaps, you know, yes, we have some swaps rolling off, you know, beginning in the fourth quarter or really at the end of the fourth quarter and, again, in Q1. But, again, we've benefited for a long time from those swaps with really below market pay rates. But as we sort of restrike those yields, again, we feel, you know, really good about the earnings power of the portfolio going forward.

I appreciate that. Thank you.

Thanks, Doug.

And if there are any additional questions at this time, please press one followed by the zero on your touch tone phone. Once again, if there are any additional questions, please press one followed by the zero. And our next question comes from the line of Eric Hagan.

Please go ahead. Eric Hagan, Good morning. Can you talk about how much loan warehouse capacity Lima One has to retain loans on the balance sheet? in a scenario where the securitization pipeline maybe doesn't turn over as quickly and spreads were to widen?

So we have ample capacity and several RTL revolving securitizations outstanding. So, you know, there's really combined between MFA and Lima One, you know, we have over a billion dollars of potential borrowing, you know, on those assets away from securitizations. So, you know, really there's plenty of room.

Okay, got you. What would you say are some of the considerations or constraints, if you will, to taking the agency portfolio back up again and, you know, increasing leverage there?

I mean, really we just look at what spreads are available in the market and versus our other assets. So we do think it's a complementary asset to our credit portfolio. We grew it to a billion. I think if you were to look out, if spreads remain where they are and the shape of the curve continues to steepen out, we could see that growing to maybe a billion and a half to two billion in the coming course.

Got you. All right, that's actually really helpful. Thank you.

Thanks, Eric.

And our next question comes from the line of Brian Cialino. Please go ahead.

Great. Thanks for taking my question. Just was hoping to get some more detail on the programmatic loan sale outlook. I guess how big could that distribution channel get over time? And is it only SFR? Could we see some transitional loan sales as well?

So, Brian, I'll take that. It's Craig. So, you know, I think it could be a significant part of, particularly on the rental side. As Brian said, you know, the demand is pretty significant there. It's still an asset that we like and that we also have in our portfolio. But I think these third-party sales, they validate pricing. They validate marks. They open an additional distribution channel. Right now, I think our rental loans were about 25% of the origination in the quarter. In a lower-rate environment, that could grow over time. So I think it's another arrow in the quiver. It's not what we'll do with all. rental loans, but, you know, it's a good outlet to have. You know, if you fast forward and imagine Lima One's origination volume, you know, growing significantly over the next couple of years, you know, it may be a more necessary outlet at some point. But for now, I think, you know, we're really just developing another distribution channel.

Okay. Great. Thank you very much. That's it for me.

Our next question comes from the line of Bose George. Please go ahead.

Good morning. Actually, can you talk about how much was the credit mark on the multifamily piece of the BPL? And then just can you remind us just how much exposure you have left there?

Yeah, so during the quarter, it was about $15 million. And we now carry that portfolio at, I think it's a four-point discount to the total UPV. The total UPV at 930 was right around a billion through the exact number. It's 1.1 billion as of 930.

Okay, great. Thanks. And then can you just talk about the competitive side of the BPL business? Obviously, the demand side seems very strong, but are you seeing incumbents trying to grow, or just can you characterize how that's developing? Okay.

Yeah, it's definitely competitive. But, you know, as we mentioned, you know, volume was down slightly. We're sort of out in the market trying to attract talent. And really the way that we believe you grow, there's sort of three ways, right? It's having a good sales force. And then there's, you know, marketing and sort of technology improvement. We think we're sort of getting to, you know, improving on all three of those fronts. And we're aware that it's competitive, but we think there's enough room for us to get back that volume that we sort of had lost over the past quarter.

OK, great. Thanks.

Thanks, Bose. And if there are any additional questions at this time, please press 1 followed by the 0 on your touchtone phone. Once again, if there are any additional questions, please press 1 followed by the 0 at this time. and it does appear at this time there are no further questions from the phone lines please continue thank you operator thanks everyone for your interest in mfa financial we look forward to speaking with you again in february when we announce fourth quarter results and ladies and gentlemen today's conference will be available for replay today after 1 p.m eastern You may access the AT&T replay system at any time by dialing 1-866-207-1041, entering the access code 433-8621. International participants may dial 402-970-0847. And those numbers again are 1-866-207-1041 and 402-970-0847. Again, entering the access code 4338621, and that replay will be available through February 6th of 2025. That does conclude your conference for today. Thank you for your participation and for using AT&T Conferencing Service. You may now disconnect.