MFA Financial Inc MFA
Q4 2012 Earnings Call Transcript
Transcript Call Date 03/06/2013

Danielle Rosatelli - IR: Good morning. The information discussed on this conference call today may contain or refer to forward-looking statements regarding MFA Financial, Inc., which reflects 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, plan, continue, intend, should, could, would, may, 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, but not limited to, those relating to; changes in interest rates and the market value of MFA's investment securities; changes in the prepayment rates on the mortgage loans securing MFA's investment securities; changes in the default rate and management's assumptions regarding default rates on the mortgage loans securing MFA's MBS; MFA's ability to borrow to finance its assets; implementation of or changes in government regulations or programs affecting MFA's business; MFA's ability to maintain its qualification as a real estate investment trust for federal income tax purposes; MFA's ability to maintain its exemption from registration under the Investment Company Act of 1940; and MFA's estimates regarding taxable income and the timing and amount of distributions to stockholders; and risks associated with investing in real estate related assets, including changes in business conditions and the general economy.

These and other risks, uncertainties and factors, including those described in MFA's Annual Report on Form 10-K for the year ended December 31, 2011, its quarterly reports on 10-Q for the quarters ended March 31, June 30, and September 30, 2012 and other reports that it may file from time-to-time with the Securities and Exchange Commission 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 fourth quarter 2012 financial results.

Thank you for your time. I would now like to turn this call over to Stewart Zimmerman, MFA's Chief Executive Officer.

Stewart Zimmerman - CEO and Chairman: Good morning, and welcome to MFA's fourth quarter 2012 earnings call. Joining me this morning are Bill Gorin, President; Steven Yarad, Chief Financial Officer; Ron Freydberg, Executive Vice President; Craig Knutson, Executive Vice President; Harold Schwartz, Senior Vice President and General Counsel; Kathleen Hanrahan, Chief Accounting Officer; and (Goodmunder Christiansen), first Vice President.

What I'd like to do this morning is just go over some of the highlight of the press release that I hope all of you have had the opportunity to look at. I'm not going to go over the whole thing, but just a number of them that I think are important and then very quickly open the call for Q&A.

So, if you are looking at the fourth quarter 2012 highlights, our net income per common share was $0.19 with core earnings per common share of $0.20. Book value per common share grew to $8.89 as of December 31, 2012 compared to $8.80 as of September 30, 2012 and $6.74 at December 31, 2011 For the year, MFA strategy of investing at both Agency and discounted Non-Agency mortgage backed securities generated book value growth share growth of 33% in addition to quarterly dividend payment. At January 31, 2013, our book value has grown to $9.40 as Non-Agency mortgage backed prices have continued to gain additional value.

On March 4, 2013, our Board of Directors declared a special cash dividend of $0.50 per share of common stock. This dividend reflects a portion of re-taxable income in excess of distributions previously paid to stockholders for prior period. This dividend will be paid on April 10, 2013 to stock holder of record on March 15, 2013.

A combination of both home price appreciation and mortgage amortization has led to a decrease in the loan-to-value ratio for many of the mortgages underlying our Non-Agency portfolio. Due to this lower LTV, we have reduced estimated future losses within our Non-Agency portfolio. As a result, in the fourth quarter we transferred $81 million to accretable discount from credit reserve and transferred $152.5 million in total for 2012. This increase in accretable discount prospectively increases the yield on Non-Agency mortgage backed securities and will be realized in income over the life of the assets.

Following a detailed review of tax calculations, initiated my management, we determined that REIT taxable income for certain prior periods exceeded distributions made to stockholders. Consequently, our Board of Directors declared a special cash dividend, totaling approximately $179.4 million.

Approximately $130 million of this distribution will be allocated to the previously undistributed REIT taxable income for 2010 and 2011 with the remainder available to satisfy a portion of 2012 taxable income undistributed to-date. Determination of 2012 taxable income will not be finalized until a timely filing of our 2012 tax return which is expected occur in the third quarter of 2013. Before filing our 2012 tax return MFA may elect to apply on an asset-by-asset basis an alternative methodology for calculating taxable income for non-agency assets acquired in 2012. Application of this alternative methodology may serve to reduce the final determination of 2012 taxable income.

After the payment of the special dividend, we currently estimate that under either methodology taxable income for 2012 is in excess of distributions paid to-date in respect of that year and it expects that our Board of Directors will declare dividends in 2013 to address any undistributed 2012 taxable income.

Having said that, what I would like to do is thank you all for your continued interest in MFA and open the call to questions.

Transcript Call Date 03/06/2013

Operator: Henry Coffey, Sterne Agee.

Henry Coffey - Sterne Agee: Good morning everyone and thanks for getting all of us together properly. Looking forward, it's fair to assume that there may be some potential additional distribution coming in '13, as you are going to put the final dots on your September tax filing?

Stephen D. Yarad - CFO: Good question. So, as Stewart pointed out to you, we are yet to finalize our calculations for '12 and what Stewart mentioned is there is two alternative methodologies and we need to use – compare both methodologies to calculate our 2012 taxable income. But what we have said in writing and in terms of call is the special distribution fully satisfied or under distribution for '10 and '11, and based on our estimate of 12, it's only partially paid out all our distributable income for 2012. So, to make these assumptions, there is yet some more distribution relating to 2012 will be correct, but we haven't finalized '12 and we are not ready forecast '13. So, hopefully, that's able to help you with your question.

Henry Coffey - Sterne Agee: Sort of looking forward, the FHFA put out their plan for 2013, they are talking about doing $30 billion worth of in (UPB) of risk-based assets. Have you had any dialogue with them and do you have a sense of what kind of opportunity that might create for MFA?

Craig L. Knutson - EVP: Sure. We've looked at this possible risk transfer, which to-date is not really solidified, but we've looked at that trade for months now. It may make sense for us, it may not. It will depend on a lot of things. It will depend on the risk return and what sort of yields we think are available. It will also depend on what form those assets take. So, for instance, whether or not, those sales are structured as good assets for REIT for instance.

Henry Coffey - Sterne Agee: Are there any other alternative asset classes that are coming down the pipe that might be interesting for MFA to explore and I'll get off the queue – the phone, listen but, again thank you for taking my questions.

Stewart Zimmerman - CEO and Chairman: Andrew we have looked at various asset classes over the years. We've looked at I don't – a myriad of things. So, we continue to do that. Having said that, at the moment there is nothing that is that pressing to us and we still very much enjoy the continued success that we've had in both the agency and the non-agency market, and that's where our concentration is. Having said that, we spent a good portion of our time looking at other assets classes and how that might bring value to our shareholders.

Stephen D. Yarad - CFO: If I might also add, and sort of our mission statement, I mean you know for long-time we've been distributing a good amount of income. But what we've done over the last five years is also benefit, have our assets perform due to improvement in the residential mortgage credit fundamentals, and I think that positions us well for any new activities that may come up in the next couple of years. There is benefit of the shareholders of improvement from residential mortgage credit fundamentals. It's really shown in the fourth quarter performance and it's something that we hope to benefit from in the future.

Operator: Christopher Donat, Sandler O'Neill.

Christopher Donat - Sandler O'Neill: Just one quick question on the excise tax and interest, that's something we haven't seen for a couple of year. Can you remind us exactly what that is?

Stewart Zimmerman - CEO and Chairman: Sure, I'm going to hand it over to Steve Yarad, our CFO and he is going to explain that to you in some detail.

Stephen D. Yarad - CFO: Thanks Chris, this is Steve Yarad. There's a lot of detail around the rules for the excise tax. I'll try to keep this relatively high level. But there's two components to the exercise and interest accrual. The interest portion is calculated on the amount of the undistributed dividends for prior periods, and that situation it's primarily 2010 and 2011, and you pay an interest amount based on the short-term AFR plus 3%. So, in our case, it's roughly 3.5% interest paid on that dividend shortfall for that period. The excise tax comes into play to the extent that you've distributed less than 85% of your taxable income in the calendar year. If you're in that situation, you pay an excess tax that's roughly 4% of the difference between the amount you distributed and 85% of your taxable income. In our financial statement for 2012, we've recorded an accrual for $7.5 million covering both excise tax and interest for the current year and all prior periods.

Christopher Donat - Sandler O'Neill: Then just to make sure I understand this. Filing you put out earlier this week, it states that no material impact to previously issued financial statements from the material weaknesses here and also no expected impact to REIT status. I didn't see that language in the press release, but just want to make sure that that is still the case, nothing has changed in two days, right?

Stewart Zimmerman - CEO and Chairman: Sure, Chris, absolutely. When you see our 10-K, which will be filed later this morning, you will see some disclosure around that in our controls and procedures section and what you said is absolutely correct. There is no statement of prior period financials and there is no material impact on our current period financials relative to this matter as well and as you said as well, no impact on our rate status whatsoever.

Christopher Donat - Sandler O'Neill: Is it also just fair to say also just to follow-up nothing changed in the last two days?

Stephen D. Yarad - CFO: Absolutely. No change in last two days.

Stewart Zimmerman - CEO and Chairman: Well, I just want to be precise relative to your question.

Christopher Donat - Sandler O'Neill: Finally for me, the $81 million that was transferred from the credit reserve to accretable discount, just ballpark when I think about the timing of that flowing into income, how does that work?

Craig L. Knutson - EVP: Well, so it's Craig. So, it flows in over the remaining life of those assets. So, basically, we take $80 million and it goes into accretable discount. So, it will translate to a higher yield on those assets going forward. If you look at the total, which was I think $152 million that we transferred from credit reserve to accretable discount during the calendar year 2012, to sort of frame it for you. It's probably – if I just isolate that one change, but forget forward curve, forget assets that pay down, it probably increases the yield on the Non-Agency portfolio by between 20 and 25 basis points.

Christopher Donat - Sandler O'Neill: Right. Thanks for quantifying that for me. I appreciate it. That's it for me.

Operator: Daniel Furtado, Jefferies.

Daniel Furtado - Jefferies: Craig, I missed the tail-end of that response. Are you saying that $81 million or $152 million for the full year is 20 to 25 basis points?

Craig L. Knutson - EVP: The $152 million. For the whole year, if you look at those assets as of the end of the year, it increases the yield between 20 and 25 basis points.

Daniel Furtado - Jefferies: Then another kind of methodological question. You are saying that your credit reserve is approximately twice the underlying 60 plus (BQs). Is it simple – is it simply simple as if you assume that you know you are not going to get two extra 60s and say all the 60s go bad but nothing else rolls into that bucket, does that – that if you could theoretically transfer from credit reserve into accretable discount, is about half of your current credit reserve or is it not linear like that?

Craig L. Knutson - EVP: Well, I think what we say is, we don't say our credit reserve is twice our 60. I think what we say is in our GAAP assumptions that our estimated defaults on the portfolio are equal to approximately two-times the current 60 plus days delinquent.

Daniel Furtado - Jefferies: Where do you believe the market is today in that assumption when competitors or just the market is out buying bonds, I mean is it still at that two times your 60 paradigm when you are pricing bonds or has the market tightened? In that sense are you, how much more conservative versus the market do you believe you are?

Craig L. Knutson - EVP: I can't really speak to how much more conservative or less conservative we are versus the market. What I will tell you is that as we see increased performance in the underlying assets and that can be because LTVs are improving which could be due to the fact that loans are now amortizing in many cases and in addition we've seen some home price appreciation. So, as those underlying LTVs get better and borrowers are less under water or perhaps not underwater at all, our assumptions on future defaults will come down. So, I think, over time if credit reserve changes continue along the same them, what that will mean is that that the ultimate default assumptions will not be twice the 60 plus at some point.

Daniel Furtado - Jefferies: If I may just squeak one last one in, do you have any material swap maturities this year and if so, what's the fixed pay on those that are rolling off?

Stephen D. Yarad - CFO: Okay. Let me give you an update and this will be laid out in the K which will come out today. But in the first quarter of this year a very small amount of swaps run off. It's about $50 million and the average cost there is about (390), so we glad to have those swaps go away. Then you really don't see much high cost swaps running off until the second half of the year in which time we have about $400 million of swaps with a fixed pay rate of 4% run off. So, we are continuing to see improvement, funding costs coming down as these swaps run off. But most of the improvement will occur later in the year.

Operator: Rick Shane, JPMorgan.

Richard Shane - JPMorgan: Just want to talk a little bit about capital allocation and particularly given what we've seen in the market this quarter. You've obviously seen strong continued appreciation on the non-agency paper and during the fourth quarter, your allocation there increased slightly. Given we've seen agency spreads widen out a little bit and potentially rich pricing on the non-agency stuff, are you thinking about shifting back a little bit more?

Stewart Zimmerman - CEO and Chairman: Let me start the answer and then we can give you some detail. As I've said, I don't know how many times on other calls, we continue to see value in both sides of it, in terms of the agencies and non-agencies and you're right. When you look at the appreciation on the non-agency side, it's certainly some dramatic. But we've also seen opportunity. I'm going to turn over to Goodmunder Christiansen in a moment just to give you some color on the agency side where we have also continued to see some value. GOODMUNDER, why don't you let them know what you've been seeing?

Goodmunder Christiansen - VP: You are absolutely right. I mean, in the first quarter of 2013, yields have gone up and spreads are widening on agency securities. So, they are incrementally more attractive in the first quarter of 2013 relative to what they were in the fourth quarter of 2012. Yields on the assets that we are acquiring, we are seeing them about 185 basis points and with spreads including funding costs is about 125 basis points.

Stephen D. Yarad - CFO: So, incrementally, we are investing in the same way, but an important point, some of runoff doesn't need to be invested because some of that run-off is being used for the special dividend.

Richard Shane - JPMorgan: Given the opportunities that you are seeing and the stability we've seen in the capital base over the last couple of years, do you feel like you have the right amount of capital right now for market opportunity that you see?

Stewart Zimmerman - CEO and Chairman: The answer is generally, yes. There are always exceptions, but again as you know, as we've had discussions before, I think we've been very disciplined in raising equity. We will continue to be very disciplined. If we see those opportunities and the opportunity to raise equity is there, we will certainly approach that, but we are very comfortable about how we sit today.

Stephen D. Yarad - CFO: Rick, as you know, we are internally managed and our incentives and shareholder incentives are the same. So, we've been still happy with the performance of the assets that we have. We really didn't want to share it much with too many shareholders. So, we continue to work for the benefit of existing shareholders.

Richard Shane - JPMorgan: Fair enough guys. Thank you very much and I am smiling at that response.

Operator: Gabe Poggi, FBR.

Gabe Poggi - FBR: I just had a quick question on the agency side of things. Your speed had declined in the fourth quarter from the third quarter. Any color kind of year-to-date you can provide and then as you're rotating, as you're getting those prepays, where you guys allocating capital in the agency bucket? That would be helpful.

Craig L. Knutson - EVP: Yes, on the agency side, I mean the speed in the first quarter should be in line with what we've seen over the last couple of quarters. Jan and Feb were about 20 CPR, so I guess that gets you two-thirds there. In terms of what we're looking at and what we're finding most attractive, I mean, we have been focused on the (indiscernible) and we continue to favor that with the hybrids and I don't see that change going forward.

Operator: Stephen Laws, Deutsche Bank.

Vlad Rudnytsky - Deutsche Bank: This is actually Vlad Rudnytsky dialing in for Steven. I just had a quick question, kind of just looking ahead and given Bernanke's comments last week. If you just have any thoughts on just as Bernanke said that he might just let the securities runoff upon the QE exit and what if the Fed decided to put some of these Agency MBS out on repo and what the impact would be on the funding cost?

Stephen D. Yarad - CFO: Sure. So, ever since the QE started and ever since the Fed has been buying assets, the natural question will be, how do you get out, and he's been answering it the same way since it started, either we could sell the assets, we could borrow against the assets or we just let the assets payoff. This answer has been the same for years, so no news there. Those are the only three ways out. Remember, if his goal is not to increase liquidity but to decrease liquidity, but to decrease liquidity, the sale or borrowing against it, is going to achieve the same thing. You've been pulling liquidity out of the market. So, what's the standard is, to remain the same; no new news there.

Vlad Rudnytsky - Deutsche Bank: I guess, I'm just wondering about the impact on the actual funding costs if the Fed was to put these out on repo?

Stephen D. Yarad - CFO: Again, it's the same – if you have a new competitor, it incrementally would impact letting costs going up. But this question – we've answered this question for many years on these phone calls. Yes, incrementally if the Fed became a competitor for repo funding, it would have an impact on agency repo funding costs.

Operator: I show no further questions in queue at this time, sir. You may continue.

Stewart Zimmerman - CEO and Chairman: So, at this point, I would like to thank you for your continued interest in MFA and we look forward to speak with you next quarter.

Operator: Thank you ladies and gentlemen for attending today's conference. This concludes the program. You may now disconnect. Good day.