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MFA Financial (NYSE:MFA)
Q3 2020 Earnings Call
Nov 05, 2020, 10:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Ladies and gentlemen, thank you for standing by, and welcome to the MFA Financial, Inc. third-quarter earnings call. [Operator instructions] As a reminder, today's call is being recorded. I will now turn the call over to Hal Schwartz.

Please go ahead, sir.

Hal Schwartz -- Senior Vice President, General Counsel, and Secretary

Thank you, Kevin. 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, 2019, 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 2020 financial results.

Thank you for your time. And I would now like to turn this call over to MFA's CEO and president, Craig Knutson.

Craig Knutson -- Chief Executive Officer and President

Thank you, Hal. Good morning, everyone. I'd like to thank you for your interest in and welcome you to MFA Financial's third-quarter 2020 financial results webcast. Also dialed in with me today are Steve Yarad, our CFO; Gudmundur Kristjansson and Bryan Wulfsohn, our co-chief investment officers; and other members of senior management.

Before we begin, I want to again recognize our entire MFA team. This has obviously been a very challenging year and despite what the world has thrown at us, our team continues to persevere regardless of the circumstances. Their dedication and commitment has been extraordinary. From a financial-results standpoint, the third quarter of 2020 was unquestionably the most normal quarter of 2020, but that's not really saying very much.

Financial markets continue to be awash in liquidity and the interest rate environment continues to feature historically low rates and muted volatility. Yet the third quarter of 2020 was also very much the story of market uncertainty. Between the looming election still not decided, government stimulus measures or not, the second wave of COVID-19 diagnoses, and the possibility of future lockdowns, shutdowns, or other economically restrictive measures, it's clear that we are not out of the woods and it seems almost impossible to fathom what the upcoming holiday season will be like, given this backdrop. Recall that MFA entered the third quarter of 2020 only four days out of forbearance with a fortified balance sheet and substantial liquidity.

Given our experience over the prior four months, we were understandably not inclined to immediately and aggressively pursue new investments and to add leverage. But that decision was even easier, given the investment environment, which was challenging both in terms of investment availability and relative cheapness. However, as we mentioned in our second-quarter earnings call, we saw significant opportunities to improve our earnings capability through liability management, and I'm happy to report that we have made substantial progress on this front. While the results of these efforts are largely absent from our third-quarter financial results, they will be somewhat in evidence in the fourth quarter and very much in evidence in 2021.

What is apparent in our third-quarter financial results is the continued price appreciation of our whole loan portfolio that we fought so hard to retain through the crisis months earlier in the year, contributing to both material economic book value appreciation on carrying value assets and income on fair value assets. In addition, our abilities to actively manage residential mortgage credit assets, a capability that we began to develop as early as 2013 has also been reflected in our financial results as we achieved better-than-expected results on credit-sensitive assets, resulting in reversals of prior credit reserves which flow through income. Overall, we are pleased with our progress since July 1 of this year. We have taken definitive steps to enhance our go-forward earnings capability and have a clear path to continue this success over the next several quarters.

Our asset-based liabilities are still largely of a very durable nature. We continue to actively manage credit-sensitive assets to achieve good results, and we look forward to continuing to enhance shareholder value. Please turn to Page 4. We reported GAAP earnings of $0.17 per share for the third quarter.

Unlike the prior two quarters of this year, our third-quarter income was influenced by more normal factors and less by one-time noisy elements. These results were largely driven by unrealized gains on our whole loan assets, as well as the reversal in a credit loss provision on whole loans held at carrying value. GAAP book value was up modestly, but economic book value was up over 10% for the quarter as our carrying value whole loans continued to retrace the writedowns that began with the onset of the pandemic. Our leverage at September 30 was still quite low at 1.9 to 1 and two-thirds of our asset-based financing was non-mark-to-market.

We caught up on all preferred dividends in the third quarter and we paid a $0.05 common dividend on October 30. Please turn to Page 5. Our portfolio, which is also shown in the appendix on Page 20, is primarily comprised of residential whole loans, which have experienced substantial value appreciation since the liquidity-induced sell-off in March and April. Housing prices are very strong, particularly, in suburban neighborhoods outside of major cities.

This is obviously a good trend for our credit-sensitive assets, but we've been able to take advantage of this in real time, recording over $90 million of REO sales during the third quarter, which is a record quarter for us. Please turn to Page 6. We have also taken advantage of, one, the extremely low-rate environment; two, the paucity of non-QM product available for securitization; and three, the demand for short, high-quality assets by executing two non-QM securitizations totaling approximately $960 million, one in early September and the other closing just last week. As you can see on this page, AAA yields on bonds sold were 1.48% and 1.38%, respectively, and the blended cost of debt sold was between 165 and 180 basis points below the cost of borrowing we replaced.

Also noteworthy is that while some of this replaced financing was non-mark-to-market, the securitized debt is similarly non-mark-to-market, non-recourse, and term. So we actually increased the amount of this more durable financing while substantially lowering the cost. Bonds sold generated cash of approximately 94% and 95% of UPB on the two transactions, which produced a little over $200 million of additional liquidity. Please turn to Page 7.

We are also happy to report that we have fully paid off the $500 million 11% senior secured term note from Apollo and Athene. This so-called rescue financing was critical to our forbearance exit, negotiation of non-mark-to-market financing on our loan portfolio, and to fortify our balance sheet. Obviously, this was high-cost debt, but critically, the loan terms permitted repayment without penalty or any yield maintenance provision. Also noteworthy is the fact that we did not refund this debt with cheaper debt.

The liquidity generated by our portfolio was largely the source of these funds. And clearly, the ROE in this investment of paying down this debt was a compelling one. The results of this paydown will be partially realized in the fourth quarter but will be fully reflected in financial results in subsequent quarters to the tune of approximately $0.03 per share per quarter. I can honestly tell you that when we closed on this loan on June 26, I did not expect that we would be announcing its full payoff on our third-quarter earnings call.

Please turn to Page 8. So although we have made good progress on the securitization front, we still have additional wood to chop. A rated SFR securitization will transition current financing on these assets to cheaper debt while producing additional liquidity. Similarly, we still have approximately $1.5 billion of non-QM loans that will hopefully lend themselves to similar securitization executions as we achieved on our first two deals.

And finally, we have three outstanding nonrated NPL securitizations that can be called and relevered. And at current market levels, this would offer us additional liquidity while also lowering [Audio gap] Please turn to Page 9. We announced today that our board has authorized a $250 million common stock repurchase program. This authorization replaces a scale existing authorization for only about $20 million of stock.

As many of you likely recall, MFA has historically not pursued aggressive share repurchases. This was primarily because even when our stock traded at a discount to book, it was rarely a considerable discount to book value. With our stock trading around 60% of economic book value, we feel that the current market price represents a substantial disconnect versus value. MFA's economic book value calculation is relatively straightforward.

Our assets, primarily residential whole loans with a small mortgage-backed securities portfolio, are not difficult to value. We own neither a large MSR book nor an operating company, both of which are inherently more difficult to value with precision. A share repurchase at current market levels is substantially accretive to both book value and earnings. And just to be clear, there's no conflict of interest in this action.

As an internally managed mortgage REIT, we believe that our motivation is completely aligned with shareholders. Buying back MFA stock does not reduce any management fee. And finally, to address available liquidity to execute this stock buyback, our cash liquidity as of last Friday after paying off the balance of the Apollo-Athene loan and the October 30 dividend was approximately $641 million. I will now turn the call over to Steve Yarad to provide more details on our financial results.

Steve Yarad -- Chief Financial Officer

Thank you, Craig. As Craig mentioned earlier on this call, our results for the third quarter started to normalize and included fewer and less sizable, unusual items. Our net income to common shareholders of $79 million or $0.17 per share primarily reflects the continued recovery in residential mortgage asset valuations, a net reduction in our CECL credit loss reserves, and lower operating and other expenses as we have put forbearance negotiations behind us. However, our results continue to include some items that we don't expect to reoccur in future periods.

For this reason, we continue not to present core earnings metric. Please turn to Slide 10, where we present the key items impacting our results in more detail. Net interest income for the quarter was $10.1 million and reflects the following: firstly, higher net interest spreads for both our residential whole loan and securities portfolios. The net interest spread on our loans held at carrying value rose to 1.24% for the quarter as our overall cost of funds declined post forbearance and due to the positive impact of the non-QM securitization transaction that closed in early September.

It should also be noted that interest income for the quarter was impacted by an increase in the amount of nonaccrual loans. In particular, at September 30, 2020, non-QM loans with a UPB of approximately $175 million were on nonaccrual status. Under our nonaccrual accounting policy, we stopped recognizing interest income in the period where the loans become 90 days delinquent and reversed any income recognized in the prior period. Accordingly, no interest income was recognized on these loans in the third quarter.

In addition, as loans with a UPB of approximately $145 million became 90 days delinquent during the third quarter, interest income was adjusted by approximately $1.7 million to reverse income accrued on these loans in prior periods. Secondly, interest expense for the third quarter on the $500 million loan from Apollo and Athene was approximately $14 million. Excluding this expense and the cash borrowed that was held on our balance sheet for the entire quarter on a pro forma basis, the net spread generated by our interest-earning assets for the third quarter would have been approximately 1.15%. As Craig has also noted, we reduced our CECL allowance on our carrying value loans to approximately $106 million, primarily reflecting adjustments to macroeconomic assumptions used for credit loss modeling purposes but also partially due to lower loan balances.

This reversal and other net adjustments to our CECL reserves positively impacted net income for the quarter by approximately $27 million. We continue to take a cautious approach in making our estimates for credit losses given the uncertainty in the U.S. economic outlook due to the ongoing COVID-19 pandemic and given the current political environment. Our loans held at fair value performed strongly for the quarter.

Net gains of $76.9 million were recorded, including $58.9 million of market value increases and $18 million of cash income. In the second and third quarters of 2020, our portfolio of loans held at fair value has recovered more than 80% of the market value declines that were recorded in the first quarter of 2020. Finally, our operating and other expenses were $27.3 million for the quarter, down significantly from the prior quarter as we did not incur any further expenses related to exiting from our forbearance arrangement. However, it should also be noted that expenses this quarter included a one-time severance accrual of approximately $3.6 million related to a workforce reduction.

In addition, we anticipate that all else remaining equal, our compensation expense going forward should be approximately $1 million lower each quarter as a result of actions taken to rightsize our workforce. Going forward, we anticipate that annualized G&A expenses to equity should run at about 2% each quarter. And with that, I'll turn the call over to Bryan Wulfsohn, who will review details of our non-QM loan portfolio.

Bryan Wulfsohn -- Co-Chief Investment Officer

Thank you, Steve. Turning to Page 11. Non-QM origination volume is gaining momentum and market demand for paper is strong. This increased demand partially due to improved execution in the securitization market in addition to the overall low-yield environment.

We were able to purchase approximately $40 million in the third quarter and have a growing acquisition pipeline. We successfully closed our first non-QM securitization in the third quarter and the second subsequent to quarter-end. In total, nearly $1 billion of our non-QM portfolio has been securitized to date. Financing of our non-QM portfolio is very stable as over three-quarters of our non-QM borrowings are now financed with multiyear non-mark-to-market leverage.

We will continue to be a programmatic issuer of securitization, which will further increase the percentage of our non-mark-to-market funding, providing stability in addition to lowering our cost of funds. Turning to Page 12. The significant percentage of borrowers in our non-QM portfolio have been impacted by the pandemic. Many of our borrowers are owners of small businesses that were affected by shutdowns across the nation.

We instituted a deferral program at the onset of the pandemic in an effort to help our borrowers manage through the crisis. Through our servicers, we granted almost 32% of the portfolio temporary payment relief, which we believe help put our borrowers in a better position for the long-term payment performance. Subsequent to June, we've reverted to a forbearance program instead of a deferral as the economy opened up. The forbearance program instituted are largely now determined by state guidelines.

And for clarity, deferral program, tax on the payments missed and the maturity of the loan has a balloon payment. Forbearance requires the payments missed to be repaid at the conclusion of the forbearance period. If those amounts are unable to be paid in one-month sum, we allow the borrower to spread the amounts over an extended period of time. Over the third quarter, we saw a much lower level of delinquencies than one might have expected given the high percentage of deferrals granted and have seen improvement in those levels subsequent to quarter-end.

Current state of affairs is unique as although we have seen economic stress and high unemployment, home values have been increasing as low levels of supply, combined with low mortgage rates, have supported the market. In addition, our strategy of targeting low LTV loans should mitigate losses under a scenario with elevated delinquencies. In many cases, borrowers which no longer have the ability to afford their debt service will sell their home in order to get the return of their equity. Turning to Page 13.

Our RPL portfolio of $1.1 billion has been impacted by the pandemic, which continues to perform well. 80% of our portfolio remains less than 60 days delinquent. Although the percentage of portfolio, 60 days delinquent in status, 20%, over 23% of those borrowers continue to make payments. Prepay speeds in the third quarter rebounded from the slower speed seen in the second quarter.

This portfolio exhibited a similar percentage impacted by COVID as the non-QM portfolio, and we are working with our servicers to ensure positive outcomes post forbearance. Turning to Page 14. Our asset management team continues to drive performance of our NPL portfolio. The team has worked through the pandemic in concert with our servicing partners to maximize outcomes on our portfolio.

This slide shows the outcomes for loans that were purchased prior to the third quarter ended 2019, therefore owned for more than one year. 35% of loans that were delinquent at purchase are now either performing or paid in full. 44% have either liquidated or REO to be liquidated. We have significantly increased activity or activity liquidating REO properties, selling 67% more properties versus the third quarter a year ago.

21% are still in nonperforming status. Our modifications have been effective as three-quarters are either performing or paid in full. We are pleased with these results as they continue to outperform our assumptions at the time of purchase. Now, I'd like to turn the call over to Gudmundur to walk you through our business-purpose loans.

Gudmundur Kristjansson -- Co-Chief Investment Officer

Thank you, Bryan. Turning to Page 15. We saw an improvement in delinquencies and an increase in paydowns on the fix-and-flip portfolio in the third quarter as the strong housing market supported by record-low mortgage rates and large monitoring and fiscal stimulus positively influenced home sales and credit conditions in the quarter. MFA's fix-and-flip portfolio declined $164 million to $699 million in UPB at the end of the third quarter.

Principal paydowns were $175 million as project completions and the pace of home sales increased in the quarter. The quarterly paydown is equivalent to about 59% CPR on an annualized basis. We advanced about $18 million of rehab draws and converted $7 million to REO and made no new investments in the quarter. The average yield on the fix-and-flip portfolio in the quarter was 5.41%.

And importantly, all of our fix-and-flip financing is non-mark-to-market debt with the remaining term of 21 months. The total amount of seriously delinquent fix-and-flip loans declined $39 million in the quarter. Due to lower delinquencies, lower fix-and-flip holdings in general, and improved credit conditions, loan loss reserves on the fix-and-flip portfolio declined $7 million in the quarter. We have maintained strong relationships and an ongoing dialogue with our originating partners throughout the pandemic and started acquiring new fix-and-flip loans in the month of October.

Turning to Page 16. As previously noted, seriously delinquent fix-and-flip loans declined $39 million in the quarter as we sell out $51 million of loans either pay off in full or cured to current of 30-day delinquent pay status. While we completed foreclosure on $7 million of loans and $19 million became new 60-plus day delinquent loans. We are pleased with the improvement and believe it is due to the efforts of our asset management team, as well as a strong housing market where the pace of home sales has increased recently, which is helpful for fix-and-flip loans where the payoff is often dependent on the sale of a property.

Approximately two-thirds of the seriously delinquent loans are either completed projects or bridge loans where limited or no work is expected to be done, meaning these properties should be in generally salable conditions. In addition, approximately 20% of the seriously delinquent loans are already listed for sale, potentially shortening the time until resolution. We believe that our experienced asset management team gives us a tremendous advantage in loss mitigation. And combined with the term non-mark-to-market financing of our fix-and-flip portfolio, we believe we will be able to patiently work through our delinquent loans to achieve acceptable outcomes.

In addition, we believe recent macroeconomic trends have been helpful for loss mitigations as fiscal and monetary policies continue to be supportive of the housing market. Turning to Page 17. Our single-family rental loan portfolio continues to perform really well through these challenging times. In addition to benefiting from strong fiscal and monetary support, it continues to benefit from short- to medium-term demographic trends as the push for people to move out of apartments in densely populated cities to single-family homes for more space, as well as long-term trends toward increased rental percentage of single-family households supports this asset class.

The portfolio yields have remained relatively stable and was a healthy 5.65% in the third quarter. After rising modestly in the second quarter, delinquencies have stabilized, and 60-plus-day delinquency declined 10 basis points to 4.9% at the end of the third quarter. Prepayments have remained relatively muted due to strong prepayment protection, a three-month CPR of 12% in the third quarter. We made no new SFR investments in the quarter but have maintained strong relationships with our origination partners throughout the pandemic and resumed SFR loan acquisitions in October.

Finally, as Craig alluded to earlier, we are exploring a possible securitization of a portion of our SFR portfolio, which could meaningfully lower our cost of funds given current market condition. And now, I will turn it over to Craig for some final comments.

Craig Knutson -- Chief Executive Officer and President

Thank you, Gudmundur. I believe that MFA has made great strides since July 1 of this year. Significant asset price appreciation, which drove earnings and book value, substantial progress in moving our asset-based financing from expansible, durable debt to equally durable but materially cheaper securitized debt and, most recently, the payoff of $500 million of 11% debt. Considerable market uncertainty still exists, and the world continue to face challenges around the pandemic, politics, and monetary and fiscal policy.

MFA is well-positioned to weather these uncertainties, respond to opportunities as they arise, and we are taking proactive steps to further position our company to thrive in the future. Kevin, would you please open up the line for questions?

Questions & Answers:


Thank you. [Operator instructions] First question is from the line of Doug Harter, Credit Suisse. Please go ahead.

Josh Bolton -- Credit Suisse -- Analyst

Hey, guys. This is actually Josh on for Doug. Wondering if you can talk about the pace of share repurchases. And maybe more generally, how are you thinking about the trade-off between buybacks and incremental investments just given where the stock is trading and the incremental yields you're seeing on new purchases? Thanks.

Craig Knutson -- Chief Executive Officer and President

Sure, Josh. Thanks for the question. The stock repurchase plan is a 10b-18 plan, and so I think we're limited as to how much we can purchase. I think it's about 25% of the last four weeks' average daily trading volume, so it's still pretty significant.

But you're absolutely right. I think we weigh repurchasing stock with other investment opportunities because, in essence, that is an investment opportunity. So I think it will properly depend on where the stock is trading relative to book and also what other investment opportunities exist out there. So it's clearly a trade-off, but I think our eyes are wide open.

But just to be clear, at the level where the stock is trading versus book value, we do see that as an attractive option.

Josh Bolton -- Credit Suisse -- Analyst

Great. Makes sense. And then I'm not sure if I missed this, but can you give us an update on where you're seeing book value performance quarter to date? Thank you.

Craig Knutson -- Chief Executive Officer and President

Yes. So we didn't mention it. We actually don't even have loan marks for the end of October yet because it takes a week or two to process those. I would guess that we're flat and maybe up a little bit.

I think loan marks arguably could be up a little bit, particularly non-QM loans, given where recent sales have executed. So flattish to maybe up a little is, I guess, the best I can give you.

Josh Bolton -- Credit Suisse -- Analyst

Great. I appreciate the comments.

Craig Knutson -- Chief Executive Officer and President

Sure. Thanks, Josh.


Thank you. [Operator instructions] At this time, we have no further questions in queue.

Craig Knutson -- Chief Executive Officer and President

All right. Well, I would like to thank everybody for their interest in MFA Financial, and we look forward to our next update when we announce year-end results in February.


[Operator signoff]

Duration: 31 minutes

Call participants:

Hal Schwartz -- Senior Vice President, General Counsel, and Secretary

Craig Knutson -- Chief Executive Officer and President

Steve Yarad -- Chief Financial Officer

Bryan Wulfsohn -- Co-Chief Investment Officer

Gudmundur Kristjansson -- Co-Chief Investment Officer

Josh Bolton -- Credit Suisse -- Analyst

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