Ladies and gentlemen, thank you for standing by, and welcome to the MFA Financial Incorporated Third Quarter Earnings Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's call is being recorded. I would like to turn the conference to your host Hal Schwartz. Please go ahead.

Thank you, Operator. 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, 2017, 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 2018 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. I would like to thank you for your interest in, and welcome you to MFA Financial's third quarter 2018 financial results webcast. With me today are Steve Yarad, CFO; Gudmundur Kristjansson, Senior Vice President; Bryan Wulfsohn, Senior Vice President; and other members of senior management. MFA had a solid quarter; we are particularly pleased with our investment activity in the third quarter of 2018. Our investment portfolio centered largely around residential mortgage credit assets continues to produce strong results while maintaining stable book value. MFA's muted interest rate sensitivity, coupled with our low leverage multiple, provides these return with a much lower risk profile than many of our peers. Our investment team spent considerable time and effort last year seeking new counter parties and establishing relationships in order to source loan volume. These efforts are now bearing fruit as we've been able to acquire meaningful size in each of the last three quarters. MFA's reputation as a reliable buyer of residential whole loans has enabled us to purchase significant volume of whole loans including in some cases transactions with limited competition. At the same time, we continue to analyze new investment opportunities as we have demonstrated over many years MFA has the intellectual capacity to understand, evaluate and price assets that are difficult to understand and value. Please turn to Page three. We generated earnings per share of $0.19 in the third quarter and paid a Q3 dividend of $0.20 to common shareholders on October 31. This is the 20th consecutive quarter in which we paid a $0.20 dividend. Our estimated taxable income for the third quarter was $0.21 and our estimated undisturbed taxable income as of September 30 remains $0.11 per common share. We completed a follow-on equity offering in August raising approximately…

Thanks Craig. The third quarter of 2018, MFA's net income to common shareholders was $83.4 million or $0.19 per share. As Craig noted, we're pleased that our efforts to further grow our residential mortgage portfolio particularly had additions in recent quarters in performing loans are starting to be reflected in our results. Specifically, our earnings this quarter are primarily driven by high net interest income reversing the trend observed several quarters and over the past two years. In addition higher overall other income and lower expenses also drove the sequential quarter increase in our net income. Please turn to page 7. We present additional information on the key items impacting net income this quarter. In reviewing our results, you will note that there were three items driving the third quarter increase in net income. The first item as discussed with net interest income which is approximately $9 million higher than the prior quarter. This increase primarily reflects growth in our portfolio of recently originated loans. This includes the impact of loan acquisitions that were pending settlement at the end of last quarter as we earn income on these assets for most of Q3. In addition as a result of our robust Q3 investment activity, we acquired and earned income on over $700 million loans and nearly all of these purchases settled during the current quarter. The second item was the overall level of net other income, which was approximately $7 million higher than the prior quarter. This reflects the continued growth and strong contribution from our fair value loan portfolio, which was $2.5 million higher than the prior quarter. In addition unrealized gains on CRT securities, which are accounted for at fair value and thus flow through the income statement almost $4 million higher than the last quarter. Finally, the…

Thank you, Steve. Turning to Page 8, the third quarter was another highly successful quarter for our investment team as we acquired over $2.3 billion of assets and we're active in all of our investment classes, which covers most areas of the residential mortgage universe at this point. We grew our investment portfolio by $1.3 billion in the third quarter and by $1.6 billion year-to-date. And as Steve pointed out on Slide 7, we're starting to see the impact of this portfolio growth in higher interest income. The largest growth was in our whole loans portfolio, which grew by almost $550 million as our new loan initiatives added meaningfully to investment flows. We purchased approximately $760 million of 30-year 4.5 in CMBS in the quarter. These are newly issued specified pools with low pay ups which we believe offer attractive carry of our TPAs and more expenses specified pools stories in the current low prepayment risk environment. We had these purchases extensively with long duration swaps and will actively manage the risk exposure as rates change. Given a large increase in interest rates over the last few years, we believe the risk reward of eight CMBS versus credit investments has improved and they can now be a viable option to invest excess liquidity pending more attractive investment opportunities. We continue to optimize our holdings for CRT securities as you saw a $119 million of older CRT securities at prices in excess of $110 million as those spreads have tightened to overtime to about 100 [DM] [ph]. As they benefited from low delinquencies, lower LTVs and rating upgrades. We replaced them with newly issued bonds with spreads in the low to mid 200s [DM] [ph] Turning to Page 9. Despite almost three years of rising rates and eight such funds increases,…

Thank you, Gudmundur. Please turn to Page 13. The economy and housing fundamentals continue to benefit mortgage credit. The CoreLogic National Home Price Index was up 5.5% in August from a year ago. However, year-over-year growth has been slowing down recently as a result of higher mortgage rates. CoreLogic projects HPI growth over the next year to be 4.7%. The unemployment rate was level at 3.7% in September and October down from 4.2% a year ago. While, we have seen slight increases in housing inventory, overall levels are still historically low on a nationwide basis. We believe these low levels of supply will further support home price growth. According to the latest release from the Federal Reserve Board, mortgage delinquencies are now down to 3.25%. I'm turning to Page 14, we were able to source over $700 million residential whole loans in the third quarter. We have had success in adding new origination partners and grew our existing relationships. Legacy loan supply has been robust. We have seen volumes year-to-date of more than $60 billion which is an increase over the last year and returns on non-performing loans continue to be consistent with our expectations of 5% to 7%. Again, as a reminder, our whole loans appear on our balance sheet on two lines, loans held at carrying value, $2.5 billion and loans held at fair value $1.4 billion. This election is permanent and is made at the time of acquisition. Typically, we elect carrying value for newly originated and reperforming loans and fair value for non-performing loans. Turning to Page 15, our reperforming portfolio continues to perform well. Nearly 90% of our portfolio is less than 60 days delinquent. In addition although 12% of the portfolio is six days delinquent or greater almost 30% of these loans have been…

Thanks Bryan. Turning to Page 18, we're very happy with our progress in building out our business purpose loan program as we really started to see volumes pick up in the last couple of quarters. We're seeing the benefit of the extensive work that has been put into developing strong relationships with a select group of originators where we collaboratively work to expand volumes and add new loan programs. Since you first began purchasing business purpose loans about a year ago, we have acquired approximately 2500 loans and approximately $600 million in UPB and undrawn commitments. During the third quarter, we doubled their holdings of fixed and flip loans to $329 million UPB with an additional $44 million in undrawn commitments. Credit metrics and performance continues to be strong and our expectations are and we will earn between 7% and 8% yield in these assets over time. As of the end of the third quarter, we held $80 million in SFR loans. Similar to the fix and flip loans, credit metrics and loan performance continued to be strong. Our target yield for this asset class is around 6%. We're excited about the progress we have made in developing our non-QM fix and flip and SFR loan programs as they become a meaningful part of our portfolio and offer attractive returns. With that, I will turn the call over to Craig for some final comments.

Thank you, Gudmundur. Turning to Page 19. In summary, we remain active in the investment market and while we have made excellent progress in growing our asset base, we have substantial capacity to continue to increase our investments by adding leverage to our balance sheet. We have maintained our disciplined pricing approach which sometimes means we don't win bids. We're investing for the long-term, so we are keenly aware that reaching too much for investments can lock in years of suboptimal returns. We've made very good progress in expanding our investment opportunity set within the residential mortgage space by adding what we believe will be reliable, recurring and growing volume of newly originated whole loans. We cannot always predict what the next attractive investment opportunity will be, but we are quite confident that we will have a seat at the table, the expertise to understand and structure the transaction and ample capital to be able to invest in meaningful size. This concludes our presentation, operator would you please open up the call for questions.

Yes. Thank you. [Operator Instructions] Our first question will come from line of Doug Harter from Credit Suisse. Please go ahead.

Thanks. You guys talked a little bit about the ability to expand leverage on the whole loans. Can you talk about what advance rates are like on the financing and where that leverage could go?

Sure, Doug. So I guess the obvious one would be residential whole loans at carrying value, which we show as a debt-to-equity ratio of a little bit less than 1x. So depending on the loan, they could be -- the haircuts could be anywhere from 10% to 20% or so. So at 20% at the maximum that it could be 4x levered. So as I said I don't see our leverage increasing substantially, but to increase from 2.3 to 2.6 or 2.7 or 2.8, is certainly in the cards.

Got it. And obviously a good activity this quarter, I guess as leverage increases either view kind of the opportunity kind of continuing in the coming quarters, it's your ability to continue to find assets?

We are pretty excited about the newly originated whole loans because unlike our previous purchases of reperforming and non-performing loans, these originators originate these loans every day, every week, every month. So we see those relationships continuing to grow and we see it as a reliable source of a product. It takes time to acquire billions, but if you look at what we've done this year, it's -- I think those three asset classes are about $1.5 billion and our first purchases were in the fourth quarter of last year, so we're pretty excited about that.

Great. Thank you.

Sure. Thanks Doug.

Thank you. Our next question then will come from line of Bose George from KBW. Please go ahead.

Thanks. Good morning, it's Eric on for Bose. Just a two part accounting question. How much discount accretion did you guys capture through earnings during the quarter? And then, did you guys take a credit reserve release during the quarter and if you did. How big was it? Thank you.

Sure, Eric. So for the quarter, the net amount is discount accretion that went in for the quarter with approximately $12.9 million. And in terms of the release of discount, it was approximately $10 million for the quarter.

Got it. Thank you. But I'm sort of drawn to Slide 13 where you guys show the national HPA and a little ticked down somewhat recently. I mean I guess it begs the question, I mean how granular do you guys get on the fundamentals in an individual housing markets? And I guess do you have the flexibility and the optionality to sort of build out the portfolio around factors that you really like, with regards to things like HPA and employment trends in certain markets or submarkets.

Sure. And Eric, we can go all the way back to the 2009 when we started buying legacy non-agencies. I think we've always taken a very granular approach. And we're not looking at National. Yes, we had to put a slide in the deck, so it lends itself to a national HPA. But, when we look at loans or when we look at securities, we typically drill down to zip code level. And it's never a question of only buying assets in zip codes where we think house price appreciation is likely. It's really about pricing whether it's a security or a loan it's about pricing. So suffice to say, we're probably going to -- all of equal will price a loan higher in a location where we believe there's more house price appreciation potential than in one with lower home price appreciation. But that's been a consistent part of our whole investment process for almost 10 years.

Great. Yes. That's a helpful answer. Thank you. And then, on the non-QM side, can you just talk, I mean I assume the exit opportunity there or the financing anyways to do that through securitization eventually what I assume that you guys have looked at some of the securitizations that have taken place in that market. I mean what are the levered returns that you expect to get in your portfolio and is your portfolio any different than I guess some of the sort of hallmark deals that have taken place already. Thanks.

Thanks. So, yes, this I mentioned on the in the presentation I think the expectation is a low double digit return. And then, really when you execute on a securitization just like anything else, you can sell all the way down to almost retaining just 5%. So that obviously is a lot of leverage, but we probably would take less leverage and take less leverage than that. So again, we think with appropriate leverage we can get to those low double digit returns.

Got it. Great. Thank you guys for the comments.

Thanks Eric.

Thank you. We have a question from the line of Steve Delaney from JPM Securities. Please go ahead.

Good morning, everybody and congratulations on your efforts to evolve the strategy itself; exciting new things happening. Craig, one of the -- when we talked to investors about MFA, one of the things over the last year that people have questioned is that they just look at your GAAP, or if they try to calculate a core just by backing out gains on the legacy RMBS. They look at that and they see numbers that are coming in below the $0.20 dividend. I really appreciate the disclosure this quarter. On page three of the taxable income for the quarter a twenty one as well as the UTI figure. But, looking at a bigger picture rather than just quarter, I was looking at the June 30 Q because I didn't have the September in hand, but it looked to us like -- I think I'm looking at the right asset class, but I'm trying to peg the legacy RMBS. It looked like it was around $2.2 billion to $2.3 billion in fair value against a cost of about 1.75. So let's just call it roughly 500 and some million dollars, 450 million shares it's like $1.20 a share. And my point is, it helped me, if [indiscernible] should understand this. If your mark in the bonds to fair value then that that benefit is in your book value and I assume it went through GAAP earnings. But am I correct in thinking that from a taxable standpoint which is what drives your dividend that as you sell down that portfolio it strikes me that you're going to be creating taxable, EPS that will not necessarily be reflected in GAAP EPS. Am I correct in that assumption? If you could help clarify that for me. Thanks.

And I apologize because it is very confusing when you look at the various asset classes and the way that we're required to account for those because it's difficult to understand. I think, first of all, you're right about the legacy book and the basis versus the fair value but that difference does not flow through our income statement right because those are held on our balance sheet. So it does flow through book value, but it doesn't flow through our income statement. That said, that discount gets accreted per GAAP over the life of the holding period. And so as that discount gets accreted, it gets recognized into income, but it happens a little bit every single period. Your second question about the taxable income, so unfortunately that the taxable income on many of our assets is very different from GAAP income. And it can be higher and it can be lower. The truth is on a large part of that legacy book our tax basis is actually quite a bit higher and it's just because of the quirks of how the tax accounting works. So again, not to generalize about the whole portfolio, but I would say in general the gains that we recognize in legacy sales have been higher than the gains -- the recognized gains for tax purposes. And it's all about how the basis gets accreted for tax versus GAAP.

Okay. Something I might follow-up with Steve offline on but I appreciate your comments this morning. Thanks.

Thanks, Steve.

Thank you. [Operator Instructions] We have a question from the line of Rick Shane from JPMorgan. Please go ahead.

Hey, guys thanks for taking my questions. The slides are very helpful. I did want to sort of talk a little bit about Slide 13, and then, [we'll leave] [ph] it to some of the strategies related to whole loans. As pointed out, we're seeing not only the second derivative increase in home price appreciation, but actually our first derivative at this point. I am curious, the new strategies are more credit sensitive, more sort of historical in terms of their credit risk. If you think about where we are now, what is different from making these types of investments prior to the previous cycle?

Well, thanks for the question Rick. I would -- if you look at Slide 17 and 18, I would say that the most stark difference between now and in these investment alternatives, its LTV. It's all about the LTV. So if you look at the non-Q1 portfolio, the weighted average LTV is 66%. It's 65% on the fix and flip and 68% on single family rental. So I think like yourselves, we've been around and we've been through these cycles and I think for us that's really the sensitive thing is LTV. And to your comment about home prices maybe home prices aren't increasing as much as they were. I mean recently we read something that instead of that last year-over-year instead of 6%, it's 5.8%. But again that's in our mind that's really just noise. If house prices start declining by significant amounts, so that it's not a lower increase, it's actually a decrease that could be a little bit more troubling. But again, also keep in mind, if you take the fix and flip portfolio, these loans are very short, they're typically 9 to 12 months. So there's really very little exposure to home prices there when you take the starting LTV and the fact that these loans are typically less than one year.

Also Eric, so even though home prices are kind of appreciating at a slower rate. Another important factor is a fact that as you saw in the unemployment report that the unemployment rate keeps coming down and there is about 200,000 jobs are being created each month. And we finally saw wages rising above 3%. And at the end of the day to make mortgage payments, you have to have a job and it is really helpful if your wages are increasing. So that is a positive factor for mortgage credit in general. And so basically -- probably what we're seeing is the fact that the home price appreciation are probably going to level to the trend of wage growth going forward which is not a bad thing.

Got it. So, I'm really intrigued by the comment about collateral value and I think it's a very fair point, which is that the LTVs on these loans are very different from where we were 10 plus years ago. If we think about three factors that really contributed there was ultimately a collateral issue. It was home price depreciation and I agree that 5% growth versus 6% growth certainly isn't the end of the world and doesn't suggest anything is unwinding. The second was previously there was much less equity upfront. But, the third factor was that the appraisals were unreliable. And so I am curious where if that's the weakness in the system or that was a weakness in the system previously, what do you think changed there because again that 65% LTV is only as good as that appraisal.

Yes. You're right. I would say again we've learned from what we've seen in the past as well. If you take the fix and flip loans for instance before we buy those loans, we actually independently do quite a bit of work to satisfy ourselves that those values are solid and that those appraisals are real. So as -- we don't just look at the number that we get from someone, there's a lot of work that goes on here and part of that's wrapped up into this whole asset management process and we're doing that before we even acquire these loans.

But, also what we have seen, I mean the information we're getting from the originators whether it's [mass appraisals] [ph] for the most part, but as we look at those and we're seeing people are selecting pretty good comps, it's not something that's really far away and it's a completely different home. So for the most part, we are pretty happy with that that information that process. But as Craig also pointed out, we do a lot of work ourselves to kind of to get comfortable with values.

Okay, guys. Thanks for taking my questions. I appreciate it.

Thanks Rick.

Thank you.

Thank you. And we've a follow-up question from Bose George from KBW. Please go ahead.

Thanks for taking the follow up. Just given the rotation into longer duration assets and I guess what we've observed as some modest spread widening on credit assets during the quarter can you just so far during the quarter, can you just give us an update on book value please?

Sure, Eric. So just as a caveat, we don't even have remittance reports on our whole loan portfolio for the month of October yet. So we are at least a week and probably more away from closing our books on the month of October. That said, we do have a few data points so we know that CRTs are a little bit wider versus the end of September. Legacy non-agencies, they might feel a little weaker, but it seems to be do more to a wider bid ask levels and to actual lower prints. So at this point any estimate is obviously a very rough estimate, but I would say book value was down versus the end of the quarter that the order of magnitude is probably not more than 1%.

Got it. Thank you very much.

Sure.

Thank you. And at this time, I have no further questions in queue.

All right. Thank you all for your interest in MFA and for joining us today. We look forward to speaking with you again next quarter in February.