MFA Financial Inc
NYSE:MFA
Earnings Call Analysis
Q4-2023 Analysis
MFA Financial Inc
Investors may find reassurance in the resilience shown by this company amid 2023's harsh climate for fixed-income markets. The 10-year treasury yields swing in the fourth quarter of 2023 didn't thwart the firm's success; it navigated the volatility to report a substantial 7.8% economic quarter return and a total shareholder return of 30.7% for the year. Even with the broader challenges for investors, the company’s strategic maneuvers delivered a positive 2.7% economic return for the year.
Looking ahead to 2024, the Fed's anticipated interest rate cuts, though not immediately forthcoming, are a consideration in the company's strategy. However, the company has positioned itself to thrive regardless of rate cuts, capitalizing on favorable positions in an elevated rate environment through acquiring high-yielding assets and securitizations. A noteworthy strategic move was the issuance of a successful unsecured senior bond early in 2024, upsized to $115 million due to strong demand. Furthermore, the company proactively covered upcoming maturities by repurchasing $60 million of its own convertible bonds, showcasing sound treasury management.
The company reported distributable earnings significantly surpassing its dividends, attributed to prudent reserve management and reduced general and administrative expenses. Net interest income reflected an incline, bolstered by the carry on their swap positions, leading to a $50 million or 21% increase from 2022. These figures reflect a dexterous adaptation to the 'most aggressive Fed tightening cycle of the last four decades' and lay a promising foundation for the forthcoming year.
The company's voracious appetite for growth led to an impressive $3.5 billion in asset acquisitions in 2023, swelling the portfolio by 20%. Buoyed by Lima One's origination channels, which contributed to more than 70% of loan acquisitions, the company not only grew in size but also in efficiency, with asset yields inflating substantially throughout the year. This strategic asset growth not only reflects the company's ambition but also its capability to source and manage high-yielding loans, heralding a positive outlook for returns.
The company maintains a robust outlook backed by a strong U.S. economy, with GDP growth above 3% and low unemployment rates. Housing markets remained supportive with a 5% rise in home prices. To navigate interest rate volatility, the company adopted a risk management strategy focusing on a short net duration and stability of funding costs through securitization issuance and swap hedges. The anticipated benefits from rate cuts, combined with the maturity of $1 billion of their swaps, bode well for the company's financial stability in the coming year.
The company's agility in a volatile quarter saw it issue over $450 million in bonds. With a high percentage of the loan portfolio securitized, it leverages callable features on these securitizations to potentially reduce borrowing costs or unlock capital for reinvestment at attractive returns. Credit performance remains healthy, supported by a strong labor market and resilient housing sector, with modest increases in delinquencies well within expected ranges. Prepayment speeds reflect the high-interest-rate environment and assets continue to be reinvested to yield even higher returns, showcasing the company's deft management and strategic re-investment capability.
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Ladies and gentlemen, thank you for standing by. Welcome to the MFA Financial Fourth Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, today's conference is being recorded.And I will now turn the conference over to our host, 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 31, 2022, 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 fourth quarter 2023 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 and full year 2023 earnings call. With me today are Mike Roper, our CFO, Gudmundur Kristjansson and Bryan Wulfsohn, our Co-Chief Investment Officers and other members of our senior management team.I'll begin with a high-level review of the fourth quarter and full year 2023 market environment and MFA's results, and then discuss the current macro picture and 2024 outlook. Then I'll turn the call over to Mike to review our financial results, followed by Gudmundur and Bryan, who will review our portfolio, financing and risk management, before we open up the call for questions.The fourth quarter of 2023 was yet another volatile period for fixed income markets, as 10-year treasury yields rose about 40 basis points in the first 2.5 weeks of the quarter before a furious rally that brought them down by about 110 basis points by the end of the year. This bond market rally was obviously friendly for mortgage assets and resulted in strong earnings and book value performance for MFA during the quarter.We generated a 7.8% economic return for the quarter and reported distributable earnings well in excess of our dividend. While 2023 was another extremely challenging year for fixed income investors and for levered mortgage investors in particular, MFA's prudent risk management and continued execution of our strategy produced a 2.7% economic return for the year and a total shareholder return of 30.7%.As we look forward to 2024, the Fed appears to be in a holding pattern as they await further inflation and other economic data. Although the predominant view is for rate cuts in 2024, it seems pretty clear both from recent economic data and Chairman Powell's statements that these much awaited rate cuts are at least a few months away. Inflation numbers continue to surprise on the high side, labor markets are still strong and the U.S. economy remains buoyant, despite recent recession signals from both Japan and England.While a lower Fed funds rate will obviously benefit levered fixed income investors and mortgage REITs in particular, MFA's positioning and strategy is decidedly not dependent on rate cuts. In the elevated rate environment of the last year, we've continued to add incremental assets at higher yields to execute securitizations as a durable source of financing and earn significant positive carry on our interest rate swap position that we put in place almost 2 years ago.We added $860 million of loans in the fourth quarter with an average coupon of 10% and we acquired $3 billion of loans in 2023 with an average coupon of 9.8%. We completed 8 securitizations during the year collateralized by $2.2 billion of loans, including an issuance of over $450 million of securitized debt in the fourth quarter, which included a non-QM deal in mid-December that priced over 50 basis points tighter and 100 basis points lower in yield than similar deals in October.Our strategic objectives and risk management initiatives have afforded us the opportunities and liquidity to grow our portfolio and materially increase its yield, which we believe sets us up well for 2024 and beyond. And finally, we're already off to a strong start to 2024. We issued an unsecured senior bond early in January that was a very successful transaction as we were able to upsize the deal to $115 million and tighten the yield into very strong demand.And this was no accident. We began working with underwriters in November and into December, and we specifically targeted an early January deal launch date to take advantage of investor appetites at the beginning of the year. And finally, we've repurchased in the secondary market, a little over $60 million of our convertible bond that's due in June. These repurchases, together with the proceeds from our bond deal, largely cover this convertible bond maturity.And I'll now turn the call over to Mike Roper to discuss our financial results.
Thanks, Craig. As Craig highlighted in his opening remarks, during the quarter, MFA again delivered strong results in challenging market conditions. For the fourth quarter, MFA generated GAAP earnings of $81.5 million, or $0.80 per basic common share and distributable earnings of $49.7 million, or $0.49 per basic common share.The increase to our distributable earnings versus Q3 was driven primarily by $7.9 million, or $0.08 per share, related to the release of CECL reserves on our carrying value loan portfolio. DE also benefited from a $3.2 million, or $0.03 per share, reduction in our G&A expenses in the fourth quarter, related to the finalization of incentive compensation accruals for 2023. The CECL reserve release reflects an update to our modeling assumptions, due to continued macroeconomic resilience as well as the significant accumulated home price appreciation and strong credit performance of our seasoned carrying value loan portfolio.Net interest income for the fourth quarter was $46.5 million, an increase from $46.1 million in the third quarter. As a reminder, our GAAP net interest income does not include the benefit of positive carry on our interest rate swaps. Net interest income inclusive of this carry was approximately $77 million for the fourth quarter, an increase of $2 million from the same metric in the third quarter.For the full year, our net interest income plus the positive carry on our swaps was $283.6 million, an increase of over $50 million, or 21%, from the same metric in 2022. Our strategic focus on hedging and liability management, along with our disciplined asset acquisition strategy, allowed us to achieve this increase in net interest income, all while markets were experiencing the most aggressive Fed tightening cycle of the last four decades.At December 31, GAAP book value was $13.98 per common share, and economic book value was $14.57 per common share, representing increases from September 30 of 3.7% and 5.3% respectively. MFA declared a dividend of $0.35 per common share for the fourth quarter, and $1.40 per common share for the full year. The change in our economic book value, along with these dividends, led to a total economic return of 7.8% for the fourth quarter and 2.7% for the full year. Finally, subsequent to year end, we estimate that as of earlier this week, our economic book value has declined by approximately 1% to 2% as a result of higher market interest rates.I'd now like to turn the call over to Gudmundur, who will speak to our portfolio highlights and the performance of Lima One.
Thanks, Mike. We remain very excited about our ability to deploy capital at attractive returns and continue to grow our portfolio in the quarter. We acquired $880 million of assets in the fourth quarter and $3.5 billion in 2023, growing our portfolio by $600 million or 7% in the quarter and by $1.9 billion or 20% in the full year.Business purpose loans and non-QM loans accounted for majority of our acquisitions in 2023, while we also added about $450 million of Agency MBS and continue to approach them opportunistically, as we believe they offer attractive returns, while also providing risk management benefits to our credit-focused portfolio. We expect our fourth quarter acquisitions to deliver around mid-team's return on equity and continue to see similar attractive returns in 2024. Our ability to source high-yielding, high-quality loans has led to significant benefits for our shareholders.Looking at Page 20 in our investor presentation, we can see that our asset yield has increased steadily in the year, up 77 basis points from 5.69% in Q1 to 6.46% in Q4. This combined with our relatively stable cost of funds has positively impacted our distributable earnings throughout the year. The U.S. economy remains strong at the end of 2023 with fourth quarter GDP growth of over 3% and the unemployment rate remaining close to historical lows at 3.7%. Home prices proved resilient in 2023, rising by over 5% in the year, as low supply of homes continues to outweigh low affordability. This backdrop of ongoing housing and labor market resilience continues to provide support to our credit portfolio.The market outlook for the economy continues to shift quickly, which has led to significant interest rate volatility and challenges to interest rate risk management. Our risk management approach has been to maintain a relatively short net duration and prioritize stability of funding costs through securitization issuance and swap hedges that mostly cover our floating rate liabilities. This approach was successful in 2023 and we believe it will continue to be successful in 2024.If, as the market expects, the Fed starts cutting rates in the second half of 2024, we believe we will benefit from the extensive carry on our swaps for most of the year, we'll also be able to gain from lower funding costs next year as $1 billion of our swaps mature at the end of 2024 and early 2025. And with a net duration of about 90 basis points, we believe we are appropriately protected against unexpected increases in interest rates.Turning to Lima One. Lima One closed the year out strongly, originating over $590 million of BPLs in the fourth quarter and $2.3 billion for the full year with an average coupon of over 10%. Since our acquisition 2.5 years ago, Lima has originated about $5.6 billion of BPLs for our balance sheet. This robust origination activity has been key to growing our portfolio and asset yield in 2022 and 2023, with Lima One originated loans accounting for over 70% of our loan acquisitions in 2023. Credit quality in Lima's origination remained strong and consistent throughout the year with average LTV of 65% and average FICO score of 745 on loans originated. Fourth quarter origination remained concentrated in the shorter-term transitional loans, which accounted for about 85% of volume.Demand for Lima's products remained strong with disruptions in the private lending space, providing opportunities to grow market share and attract talent. The first quarter has historically been the slowest quarter for BPL origination and we expect volumes to be lower at around $450 million in the first quarter. The 60-plus day delinquency rate on our BPL loans originated by Lima One ticked up to 3.9% in the quarter, but remained low and consistent with our modeling expectations for this asset class. As always, we remain laser focused on credit monitoring and loss mitigation strategies.Lima One has originated and serviced BPL loans since 2010 and have extensive servicing and construction management capabilities, which we believe when combined with MFA's own extensive credit and asset management experience, allows us to manage delinquencies effectively and efficiently. In continued support of Lima's origination activities, we increased our BPL financial capacity by about $400 million in the fourth quarter and further expanded it this month when we priced our fourth revolving transitional loan securitization collateralized by about $200 million of loans.I will now turn the call over to Bryan Wulfsohn who will discuss MFA's credit performance and securitization activities in more detail.
Thanks, Gudmundur. We successfully navigated another volatile quarter issuing over $450 million in bonds through 2 securitizations. In October, we issued our third RTL revolving securitization selling $184 million of bonds at an 8.5% coupon backed by $230 million of collateral carrying weighted average coupon of over 10%.Subsequently, in December, we opportunistically issued our 13th non-QM deal after a significant spread and rate rally selling $268 million of bonds with a coupon in the low mid-6s, which as Craig previously mentioned was 100 basis points lower than other non-QM deals issued just a couple months prior.This month, we issued a fourth revolving securitization backed by our transitional loans originated by Lima One. $160 million of bonds sold were well received pricing at a coupon of just over 7% which was 140 basis points lower than the prior deal issued in October. The loans underlying the deal had a weighted average coupon of almost 11%. We have now issued securitizations backed by over $9 billion in loans since 2020. And the percentage of our loan portfolio financed by securitizations continues to trend higher above 60%.On Page 19 of our presentation, you can see that many of our securitizations are currently callable and others will become callable in the coming quarters and years. Those call features provide the potential to relever our collateral unlocking substantial non-dilutive capital that can be redeployed at mid-teens ROE.Though our strategy is not dependent on lower rates, should we find ourselves again in a lower interest rate environment, the call features also provide an optionality to reduce our borrowing costs. We believe that mortgage securitization will continue to be a significant piece of our loan financing strategy since it is non-recourse, non-mark-to-market funding and further insulates the portfolio from volatile markets.Moving to our credit performance. The strong labor market and resilient housing backdrop continue to support our credit performance. Over the quarter, we saw a modest increase in the 60-plus day delinquencies in our purchase performance portfolio, which increased to 3.8% from 3.1% a quarter ago. This increase remains well within our expectations when we model out expected cash flows for the portfolio. 60-plus day delinquencies in our legacy RPL-NPL portfolio declined by over a point to 24.5%, as we continue to achieve positive outcomes for our remaining delinquent loans utilizing our in-house expertise in asset management.Our asset management team works closely with our servicers to improve outcomes on defaulted loans, including generating gains on our legacy RPLs and NPLs and mitigating potential losses on our newly originated loans. We're proud of our asset management capabilities, since they give us comfort growing our purchase performing portfolio and gives us optionality should distressed loan opportunities arise in the future.Prepayment speeds in our portfolio declined slightly in the quarter, reflecting the higher interest rate environment. CPRs remained in the mid to-high single-digits for our non-QM, SFR, and legacy RPL-NPL portfolios. For the transitional loan portfolio, we had annualized repayment rate of 33%. We had total paydowns of over $400 million in the quarter, which continued to be reinvested into higher-yielding assets. Lastly, we continued to reduce our REO portfolio. Over the quarter, we sold 71 properties for $22.6 million, resulting in over $2 million in gains.And with that, we'll turn the call over to the operator for questions.
[Operator Instructions] We'll go to the line of Doug Harter with UBS.
Hoping you could talk a little bit more about your call strategy. Is this something that you view as attractive kind of even in the current rates, and then lower rates would be upside optionality or just how should we think about how aggressive you would be on exercising those calls?
So it all depends deal to deal, right? For certain deals where they've delevered a significant amount, it may make sense for us to call them, even if interest rates aren't necessarily lower than they were for the deals when they were issued. But for other deals, right, it's going to be opportunistic depending on where rates are.
Okay. And then you talked a little bit about your unsecured issuance during the quarter. I guess how should we think about your appetite for continuing to use that and what that role might be in your capital structure going forward?
Doug, it was a very successful transaction. It's a little bit of a niche product because it's a $25 par amount, so it's a retail product. But I think we certainly proved it out that it's a viable source of financing. So to the extent that we look to raise additional capital, it's one of the tools in the toolbox.
We'll go next to the line of Steve Delaney with Citizens JMP.
Congratulations on a strong close to what was a very good year in a tough, tough market. So looking at the market, obviously, everybody's focused on the Fed and we may be looking at a slightly different mortgage market at the end of this year than we are right here today. I'm just curious what you're seeing out there beyond Lima One, okay? Lima One is doing great. But is there anything emerging out there in terms of non-bank originators of specialized product, not just obviously not agency flow, but non-agency products that have the kind of yield and profile that might be attractive to you guys, sort of a non-qualified mortgage NQM kind of product is what I'm thinking about. Just curious what you're seeing out there in terms of product flow on the consumer mortgage side?
Sure. So, I'll speak to that first, and then I'll let Bryan address your non-QM question. Steve, I know there's been a lot of talk about possible trends emerging and banks and commercial loan portfolios. But at this point, I wouldn't say that we've identified any screening opportunity right now. Obviously, that can change, and as the year plays out, that may be the case. But I think we're pretty comfortable in the space that we're in and we've been able to add significant amounts of assets over the last 2 years at successively higher rates. So until we find that challenging or until we find that something that's better, I think we're pretty comfortable where we are.
Sure. I would say as it relates to non-QM, right, over the last quarter we bought around, say, $300 million of newly-originated loans, and that continues to be the pace. We haven't really seen a tick-up in production, but there's still a good amount of supply out there to meet our needs. In terms of, like potentially new products, we've always looked at sort of seconds in this environment for a lot of borrowers who have locked in low rates previously but still can't really do a cash-out refinance, but it makes sense for them to draw on a second. We've always looked at that market, and we do it in some small size. But the tricky part is getting to critical mass as loan amounts are generally pretty small, and there's just not a ton of that production out there to date.
Got it. And then my final question is about Lima One's bridge products. And with respect to multifamily, yes, I know they do some single-family rental, a little bit of everything, I think, from an investor loan standpoint. But on the multifamily side, where does it kind of cap as far as the size of a project that they would work on and just the magnitude, how large of a loan might they make?Because multifamily we used to think of as bulletproof, but from covering the commercial mortgage REITs, we're just seeing more and more. I mean, office is still the real problem, but we're seeing a lot of multifamily distress out there. So I'm just curious if you've got any concerns about your multifamily bridge book through Lima One?
Steve, that's a great question. Just for some context, just about the size, and I'll give you a little bit of a broader context also on the multifamily portfolio. So look, these are really small-balance multifamily loans. The average loan size is about $3.2 million, and so -- and we're originating this at our average LTV of about 65%, which means the average property value is probably around in the mid-5s.And when you think about the strategies here, the average profile is kind of a highly experienced borrower that is looking to renovate some units, upgrade common space, improve property management. Usually at origination, the average project has some occupancy ranging between 60% to 80% on day one. So there's some cash flow that helps, the borrower while they're working on the transition. These projects are all light rehabs. The average rehab amount is around kind of $600,000, which is roughly about kind of 20% of the loan amount. So we would think about that as fairly light-touch rehabs.And if you think about it in terms of per unit, that's anywhere from like $7,000 to $12,000 per unit. The goal is to complete the rehab, fully lease out the units and actually in most cases through a GSE takeout financing, which of course is significantly lower than the coupon on the bridge loan. These loans are usually 2 to 3-year term loans with a fixed coupon. And so if you think about that in the context of the last 2 years, because there's a fixed coupon on there, there hasn't been any, payment shock during the time term of the loan. And so it doesn't put a pressure on the borrower as long as the project is underwritten appropriately and the project makes sense.Historically, our underwriting has been fairly conservative, and the underwriting statistics kind of bear that out. The average asset LTV, as I said earlier, is about 65%, and the average after-repair LTV is similar to around 6.5%. And when we think about it in terms of like that yield concept, the average as-stabilized debt yield has been averaged around 9.5% on the portfolio, but in 2023 it's closer to 10.5%.And so in summary, like, we think these are underwriting with plenty of borrower skin in the game and with expected cash flows that can support the refinancing into the longer-term debt. And to date, like from a performance [indiscernible] perspective, the 60-plus-day delinquency on the multifamily part is about 2%, so it is fairly low. And from a perspective, most of our is '22 and '23. I think arguably many would argue that the '21 [indiscernible] probably is the one that would be at most risk across the spectrum because rates were low, things were underwritten, probably looser, frothier, home price appreciation as well as rent increases. And look, as we think about all of these things, we feel very comfortable about the portfolio.
Yes. That sounds like it's rock-solid, you know, workforce housing with a government takeout at the backside. So that's very helpful to get the comfort on which looking inside that portfolio, I think you're pretty solid.
[Operator Instructions] And speakers, there are no further questions in queue from the phones at this time.
All right. Thank you, Operator. Thanks, everyone for your interest in MFA Financial. We look forward to speaking with you again in May when we announce first quarter results.
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