Ladies and gentlemen, thank you for standing by, and welcome to the MFA Financial Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to our host, Mr. Hal Schwartz. Please go ahead sir.

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, 2018, 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 that 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 2019 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'd like to thank you for your interest in and welcome you to MFA Financial's fourth quarter 2019 financial results webcast. With me today are Steve Yarad, our CFO; Gudmundur Kristjansson and Bryan Wulfsohn, our Co-Chief Investment Officers; and other members of senior management. 2019 was a very good year for MFA and for our shareholders. Total shareholder return for the year was 27.5%. Our book value was very steady for the year with the largest quarterly change in book value of less than 0.75%. We introduced the concept of Economic book value, which captures the fair value of our loan portfolio accounted for at carrying value for GAAP. These loans represent nearly half of our investment portfolio, and the fair value of these assets is approximately $180 million higher than their carrying value. Also during 2019, we refreshed our at the market or ATM program, which had been dormant for almost 10 years. This offers us the ability to sell shares into the market from time-to-time as market conditions permit. We issued our first convertible bond offering in May, raising $230 million and adding another capital raising tool to our repertoire. We're also proud to report that MFA was one of 325 companies named to the Bloomberg Gender-Equality Index. This is a select group from nearly 6,000 companies across 84 countries and regions and 50 industries. As we close the books on 2019, it's hard to imagine how different the fixed income market environment was a year ago versus today. At the beginning of 2019 the 10-year treasury yield was 2.70. The Fed had raised rates in late December and the market was generally expecting a continuing tightening cycle. Instead, the Fed paused in a very public way with the release a year…

Thanks, Craig. For the fourth quarter of 2019, MFA's net income to common shareholders was $96.9 million or $0.21 per share. GAAP earnings comfortably exceeded the prior quarter, and again covered dividend distribution. Growth in our investment portfolio, GAAP net income higher in each quarter, of 2019, in addition core earnings, which excludes the impact of unrealized gains and losses, on certain investments in residential mortgage securities and related hedges, that are included in GAAP earnings each period, was also $0.21 per common share. Since adopting the core earnings metric in, Q1 of 2019, MFA has delivered very consistent and steadily improving earnings performance, with minimal differences between our GAAP core quarterly results. This is largely the result of the successful execution of our investment strategy and expansion of our investments, in residential whole loans. Please turn to page 9, where we present additional information and the highlights, of MFA's net income for this quarter, which were as follows. Net interest income was $0.03 per common share higher than the prior quarter and -- one, the impact of the early bond redemption, particularly Legacy Non-Agency MBS, which resulted in the recognition of an additional $11.6 million of interest income, this quarter. While the level of fund redemption and the impact on this quarter's results was higher than we have experienced in prior periods, it should be noted that this quarter's net interest income, would have been sequentially higher, even if these bond redemptions had not occurred. Two, continued growth of our residential whole loan portfolio, resulted in a 15.7% sequential quarter increase, in net interest income. In addition, net interest income from residential whole loans, increased in each quarter of 2019 and 2018. And three, as Craig noted, and as Gudmundur will discuss in more detail in the upcoming slides,…

Thank you, Steve. Turning to page 12. The fourth quarter was an exceptional quarter for acquisitions as we purchased approximately $1.7 billion of assets in the quarter and grew our portfolio by approximately $500 million. Most of the acquisitions were concentrated in whole loans of which we acquired approximately $1.5 billion in the quarter. In total, 2019 was a great year for whole loans acquisitions as our average quarterly whole loans purchase volume was approximately $1.1 billion in 2019. This robust pace of acquisitions continues to be driven by our success in building out our non-QM fix and flip and SFR businesses over the last couple of years. We continue to experience elevated levels of early redemptions on NPL/RPL MBS and we opportunistically sold $170 million across CRT Non-Agency MBS and NPL/RPL MBS for a gain of approximately $12 million. Turning to page 13. Our investments team was very active in 2019 and successfully executed our strategy of expanding our holdings of non-QM fix and flip and SFR loans throughout the year. In total, we acquired approximately $5.3 billion of assets and grew our investments portfolio by $1 billion in 2019. Our residential whole loans and REO portfolio grew by 60% and we doubled our holdings of MSR-related assets in the year. We also strategically shrunk our Agency MBS portfolio by 40% in the year to reduce pre-payment risk and allocate capital to higher-yielding credit investments and sold approximately $250 million of CRT securities to take advantage of tighter spreads and mitigate prepayment risk on premium-priced bonds. Turning to page 14. Our strategic push into non-QM fix and flip and SFR loans continues to bear fruit. Our success in incorporating these loan products into our investment strategy remains the primary driver of portfolio growth. Since the third quarter of 2017,…

Thank you, Gudmundur. Please turn to page 19. Mortgage credit continues to be supported by housing and economic fundamentals. Housing affordability has remained elevated as mortgage rates continue to be attractive for borrowers. Home price growth is accelerating again. The CoreLogic National Home Price Index was up 4% in November from a year ago. The unemployment rate seems to have plateaued at a historically low level of 3.6%. The supply of homes available continues its steady march downward. We are now seeing levels we haven't seen in over two decades. All these factors should continue to support stability and growth to home prices. The last reported 90-day mortgage delinquencies are just below 1% and we expect delinquencies could remain low as we believe low unemployment combined with prudent underwriting standards are good ingredients for loan performance. Turning to page 20. Our loan strategy had a record year of acquisitions. We acquired over $4.25 billion in loans in 2019 and $1.5 billion in loans in the fourth quarter consisting of approximately $1.2 billion of non-QM loans and $323 million of business purpose loans. We are developing and growing our existing relationships with origination partners and continue to add new partners. We didn't purchase many seasoned loans over the year, as we found spreads and absolute yield levels less attractive versus our new origination options and the performance of our seasoned loan portfolio has been very strong with the guidance of our asset management team. Turning to page 21. Our RPL portfolio continues to perform well and has remained stable. 87% of our portfolio remains less than 60 days delinquent. In addition, although 13% of the portfolio is 60 days delinquent or greater, almost 30% of these loans have been making payments over the last 12 months. Prepayment speeds remain elevated in…

Thank you, Bryan. Turning to page 24. We've continued to actively acquire business purpose loans in the fourth quarter, as we purchased approximately $330 million in UPB and undrawn commitments in the quarter. Since we started acquiring business purpose loans at the end of 2017, we have purchased approximately 7,600 loans or $2.3 billion in UPB and undrawn commitments. We are excited about our progress and expect to continue to expand our acquisitions of business purpose loans in the future. At the end of the fourth quarter, we held approximately $1 billion UPB or fix and flip loans with additional $130 million of undrawn commitments. Our acquisition strategy remains unchanged with strong cooperation with origination and servicing partners with respect to underwriting standards and management of delinquent loans. Our target yield for this asset class is in the high 6% range. Our SFR portfolio grew by approximately $100 million in the quarter to $457 million at the end of the fourth quarter. Credit metrics and performance remains strong for our SFR portfolio and in line with expectations. Our target yield for this asset class is in the low to mid-5% range. With that, I will turn the call over to Craig for some final comments.

Thank you, Gudmundur. Please turn to page 25. In summary, we remain very active in the investment market. We purchased $1.5 billion of whole loan assets in the fourth quarter and $4.3 billion during the year, increasing our overall portfolio by $1 billion. This growth in our whole loan portfolio has resulted in materially higher interest income over the last year and capital structure optimization together with additional whole loan purchases should contribute to earnings as we move forward into 2020. The strategy that we deployed beginning in early 2017 has proven to be quite prescient and we believe that we are well positioned to continue to capitalize on these strategic initiatives. We are optimistic about our business and eager to move forward in 2020. This concludes our presentation. Operator, would you please open up the call for questions.

[Operator Instructions] And we'll go to the line of Doug Harter with Credit Suisse. Please go ahead.

Thanks. As we -- now that we're in 2020, can you talk about what's your expected pace for continuing to add kind of new production whole loans? Is the fourth -- was there something that caused the fourth quarter to accelerate? Or is this kind of accelerating trend something that we can expect to continue given the relationships you have?

Sure. We did have – Doug, we did have an exceptional quarter in the fourth quarter in acquisitions, but we do maintain to have robust sources of additional loans through now and our relationships with our origination partners sort of continue to provide us with ample amounts of loans. Will it necessarily always be that strong? I don't know. But we still believe that we have a really good runway for additional loans through 2020.

Great. And then I guess as you're looking forward, I guess to fund that growth, I mean I guess how are you thinking about further portfolio rotation of Agencies or Legacy Non-Agencies into these newer production assets versus looking to raise additional capital?

So -- thanks for the question Doug. So I think at least thus far with all the loan acquisitions that we did in 2019, we certainly didn't feel that we were capital constrained. In fact, I think you saw our leverage tick up a little bit. And we said consistently that we didn't feel that we had fully optimized the capital structure around the capital that we had already. In terms of rotating out of other asset classes, I think to the extent that there are opportunities to maybe rotate out of Agencies into credit assets, we've shown that we've done that. Unfortunately, because of the leverage on the agency portfolio, it doesn't really free up that much capital. So it's certainly a tool. But like I said, it doesn't free up all that much capital.

Got it. Thank you, Craig.

Sure.

And the next question in queue will come from the line of Henry Coffey with Wedbush. Please go ahead.

Yes. Good morning everyone. Great quarter.

Thanks, Henry.

So when you look at the investment horizon obviously the number one issue is economic and credit quality and it's -- we'll keep focusing on that. But what about the opportunity set? As it changes, is there more capital chasing QM or less in the fix and flip and rehab business? I know that's a big initiative of Fannie and Freddie, there abilities for you to enter into that side of the equation maybe with a different product? Or I also know Fannie said that they were going to be putting more assets into CRT. Will that improve the pricing of those assets? It's just -- it's a very efficient market but I'm wondering where the emerging opportunities are?

So it's hard to say Henry. I think as I said in my remarks, I think GSE reform we're not sure where it goes, but it's pretty hard to envision how GSE reform won't at least attempt to shrink the footprint of the GSEs. And to the extent that the footprint shrinks that could create investment opportunities for us. That said, I think we're seeing continued growth in the non-QM space. The fix and flip and single-family rental those are -- most of our origination partners continue to grow. There is a little bit more competition for those assets. I think there are more folks that pay attention to those worlds now than was the case a year or two ago. But again, I think that's where our strategic initiative with these originators that we started almost three years ago really puts us in a good position from a competitive standpoint.

Yes. I would just like to add too. I mean Craig has been very vocal about -- look there's all options are on the table for MFA in the resi space and so we continue to evaluate all kinds of opportunities. But we've been plenty busy with expanding the non-QM fix and flip and the SFR and we feel like there's a good runway for the foreseeable future.

What about CECL? CECL is in very -- many ways solving a problem that doesn't exist, but it does add volatility to your GAAP earnings. With your adjusted numbers, are you going to be able to give us a different metric or a different way of looking at those numbers? I know the SEC has been kind of strict about that. How are we going to be able to kind of look past CECL to get a sense of your earnings and dividend paying capacity?

Henry, sure, it's Steve. Thanks for the question. Yeah. As I sort of alluded to in my comments, we're still sort of evaluating the best way to reflect the economic impact of CECL in our results as we go forward. So it's a little hard to comment on that right now, because obviously we haven't -- we're only halfway through the first quarter and we don't really have a good sense of what our CECL numbers will shake out to be at the end of the first quarter. But you're right. We are thinking about how to reflect that in the Q1 core earnings metric, but you mentioned the SEC comments. We have seen those as well so we're trying to just evaluate what that means for us as well as we think about the topic as a whole.

Great. Thanks. Yeah.

And just to be clear, Henry, any CECL charge that runs through our income statement for purchased loans during that quarter where we setup a life-of-loan loss model, it's obviously a non-cash item and it's a non-tax item. So, I guess, as we think about it we're -- we understand that that's GAAP and that's how it works. But we also -- as I say we understand that it's a non-cash item and it's not a tax item either.

I mean, obviously, if you pay a $0.20 dividend and your economic book value is stable then that's a message to us that the overall earnings power of the business is enough to cover that $0.20 dividend.

Yeah. And I think we've been saying for probably two years that portfolio growth will drive earnings. And I think especially in 2019 you saw that, right? And we pointed out the interest income line was up sequentially each quarter. And it takes a while to acquire that many whole loans, but I think you're starting to see some real results from it.

Super. Thank you.

Sure, Henry.

And our next question here will come from the line of Eric Hagen with KBW. Please go ahead.

Hey, guys. Thanks. Good morning. One question on your capital structure. You guys have your preferred equity in your baby bond MFO up for redemption as soon as next month. I'm just curious what the rate incentive would need to be for you guys to call and refinance that capital and make it accretive to shareholders?

So thanks for the question Eric. Obviously those markets have been active away from us so far this year. And suffice to say we're on top of what's going on and we're aware of those opportunities.

Okay. Okay. And how should we think about the servicing expenses for the non-QM portfolio? I really appreciate the additional detail on delinquency rates in that portfolio, but -- and I think we agree that the credit performance in that segment of your portfolio will probably continue to be very stable, but is the servicing costs going to be proportional to the level of delinquency in those loans? Just curious how that line item shakes out.

Hey, Eric. Thanks for the question. It really -- as it relates to the servicing expense for the non-QM loans and similarly some of the new origination loan, it really depends how the assets are acquired. If the assets are acquired where we own the servicing that expense is going to run through. If we acquire them net, it's just that the net coupon runs through the income side and you don't really see -- there really is no servicing expense that runs through. So it's -- really it just depends on how the asset is acquired.

Okay. But sort of the nature of my question though is really did servicing costs increase in proportion to the level of delinquency for those loans?

So not really. Because -- so if we're buying – especially, if we're buying the loan servicing is retained. So there is a strip that -- a fixed strip that the servicer retains. And whether it's more expensive for them to service if a loan goes delinquent that sort of -- that's their problem it's not -- that's baked into the cost. So it doesn't increase -- incrementally increase our servicing expense.

Got it. Okay. Thanks for that color. That's really helpful. Thank you.

Yeah. Sure.

And we're at the line of Stephen Laws with Raymond James. Please go ahead.

Hi. Good morning.

Hey, good morning.

I wanted to follow-up a little bit on Doug's questions about the originators and just the pipeline of the non-QM loan investments going forward. Do you currently -- I think you said five partners. Are you looking to grow that? And then what percentage of their origination do you guys currently acquire? Is it 100%? Or is it something less than that that you'd like to increase? Kind of how do you look at what your capacity is in the pipeline that you're choosing from?

Sure. Thanks for the question. So as far as the five originators we have a lot more than five originators that we buy loans from. It's five originators that we've made capital investments in. As far as what percentage we buy, we don't buy 100% of anybody's production. I would say in most cases, we probably don't even buy 50% of the production from most of the originators. And I think that's as it should be. I'm not sure we'd ever want to be at 100%. So it's hard to say exactly what the pipeline is, although, I will say that for the most part all of the originators that we have relationships with and across all those product types it's probably give or take 20 or so, they're all continuing to grow. So, I think, we're pretty optimistic, although, again, it's not something that we can forecast with any precision, yeah.

And on the financing side, as you think about using securitization and the benefits that -- I know there's a number of benefits that provides, but what would the cost savings be as you think about where similar deals or pricing with similar collateral to what would have in the securitization? Kind of how do you think about potential -- the leverage that would be in the structure as well as potential cost savings versus the current financing that you're using?

Sure. As it relates to the leverage, it just gives us the confidence to sort of take-up the leverage a bit when we have sort of non-recourse, non mark-to-market financing versus having loans on repo. So where -- we sort of said over the past, however, many quarters and years, we sort of considered ourselves to be a bit under-levered. So that really -- when you're under-levered you're not really too concerned about where your financing sources are coming from because you have incredible amounts of liquidity. As you continue to grow the portfolio and use warehouse lines that's when you think about okay maybe I should diversify the financing sources into a securitization-like format. In terms of the cost savings there -- as LIBOR has come down dramatically they're not as much as they were previously, but they're still meaningful to be in the order of 10 basis points to 20 basis points to 30 basis points given where spreads are sort of moving around. But we do see it as a good option for us as we continue to grow the portfolio.

Yes. And how much of it would do you guys intend to retain? The bottom 5% or a bigger piece of the stack? Or how do you think about what you'll retain there?

So it would really depend on pricing, right? So I think as we look down the stack and consider how deeply to sell down we're looking at the yields on those. And at some point it starts to look like an expensive liability. And therefore it looks like an attractive asset. So that's just sort of how we think about that. There's no magic number. If I had to guess I would guess that we'll retain certainly more than 5% for sure.

Okay. Great. I appreciate the color on that. And then lastly on ATM you said you put it -- it's back in play. Have you guys utilized it year-to-date? If so how much? And how should we think about using the ATM versus reallocating capital? I know that was covered a little bit but there's minimal equity in the agency portfolio. But how do we think about the ATM going forward?

Yes. Thanks, Steve. I mean we did put the ATM back in place in the third quarter of the year. And we had it let lapse for a number of years. So we really -- did it really just to add another tool to our toolbox. We did some disclosure in our third quarter 10-Q of usage and that will be carried forward to our 10-K which we expect to file a little later today. It's been very minimal to date in terms of the usage. I think it was roughly -- I'm just going from memory here. I think it's roughly about one million shares. So very minimal usage at this point. But suffice to say, it's a tool in the toolbox. And we could -- we'd use that when it makes sense to do that going forward.

Right. Appreciate the time.

Thanks, Stephen.

And we'll go to the next question. It will come from Rick Shane with JPMorgan. Please go ahead.

Hey, guys. Thanks for taking my question this morning. Look, I think, slide 13 actually really validates Craig's description is prescient in terms of the shift over the last several years when we look at investment flows. I am curious as the portfolio shifts how you think about the return characteristics of the portfolio that you're building and the trade-offs in terms of risk whether it is credit or leverage? Will you be able to achieve the same returns and maintain the same sort of risk controls?

So thanks for the question, Rick. I mean I think the short answer is, yes. I think as we look at these new investments -- and clearly these are mortgage credit investments. We're -- and it's different from the credit that we've had exposure to in our past right? Because when we started buying Legacy Non-Agency back in 2008 and 2009 these are loans that have been made years before and we're buying them at a discount and it was a very different world. These are newly originated loans. And so I think we're very cognizant of LTVs for instance because at the end of the day that's your biggest protection. And I think -- I'm happy to say if you look across those portfolios the LTVs are pretty low right? They're in the mid to high 60s or so. We've been around long enough to look at this in a somewhat jaded fashion. And over time will LTVs increase? I can't tell you but we'll certainly have our eyes wide open if we do see origination start to change. And as far as leverage I think the leverage -- I don't think the leverage will change all that materially. I think if you go back years our leverage was probably between 3 times and 4 times and that's probably appropriate given this asset class. If it's repo or warehouse line borrowing for loans and it's a 20% haircut then mathematically we couldn't be more than 4 times levered. We might get a little bit more through securitization. And as Bryan said maybe securitization makes us more comfortable. But I don't see it really deviating much from sort of low 3s to mid-3s.

Got it. And look when we look at the trends, obviously, the whole loan portfolio is going to continue to grow. We would expect the MSR portfolio continue to grow the Legacy and RPL/NPL MBS likely to shrink. I guess the one question I would have is do you consider Agency MBS to be still an opportunistic opportunity that's terrible. But you get you understand what I'm saying. Is that something that we will see flex based upon spreads widening or contracting and what your opportunities are in the other core portfolios?

I think, as Gudmundur said earlier, I think, we say, everything is on the table every day. So, we can't possibly forecast, what will happen with spreads in all these various asset classes, over the next year or so. That said, I think, we've made a clear choice that we see better risk return characteristics on the mortgage credit side, at least in the past. But that could change. And we're not allergic to agency mortgages by any means.

Thank you very much.

Thanks,

And we'll go to line of Steven Delaney with JMP securities. Please go ahead.

Thank you for the question and congratulations on a strong year, especially in your whole loans. Steve, I'll -- Stephen I'll touch on this, but I'd like to ask if you could give us some color on, what you're seeing in the universe of private mortgage originators of NQM and BPL products out there. Are you seeing down in circo? I mean, it's a very entrepreneurial industry. But are you seeing more new shops coming up, that are picking up the phone and offering product? Or is it still a relatively limited number of potential counterparties? Thanks.

So, I guess, if you take non-QM, I would say, there are -- I wouldn't say there are a lot of new entrants in the non-QM space. That said there easily are dozens of them out there.

That's helpful to know dozens. That frames it, Craig. Thank you.

But I don't -- we don't see a lot of new entrants there. On the business purpose particularly the fix and flip side, there's probably -- there could be hundreds of them out there. And a lot of them are very small. And so it's -- there are some bigger players, in that space, but there are a lot of players. It's a very fragmented space.

That's helpful. And I assume you've bought loans from more originators than you have in terms of just your strategic partners the five. Can you give us any sense from how many different originators whether it's NQM or BPL you may have worked with over the last several years, just a rough idea.

Sure. So I said earlier, that the -- so we've made capital investments in five originators, but we transact with about 20.

Okay.

So it's not 100. We're not a conduit.

Understand.

And we know all the entities very well. But the number is probably somewhere in the vicinity of 20.

That's helpful. And we recently saw or read of the sale of one of the early and large originators of NQMs to a New York credit fund. I'm just curious if -- I don't know whether you did business with that counterparty. But I know they were fairly significant. Do you have any idea whether -- despite the change of ownership, whether they will still be selling product to other investors? Or do you think it's, the buyer of that entity is just buying it to control 100% of the flow? And obviously, I'm asking this on a no-name basis.

Sure. Sure. So we're obviously familiar with that. I think, it's probably too soon to tell what happens to that production, but we'll see.

Okay. And you've been consistent. But I'm just going to go ahead and ask. Is it still -- in terms of the way you see the market and the opportunity, do you still see that you'll be able to accomplish your objectives without having to go into the origination business yourself? Is that still the -- sort of the outlook?

Yeah. I mean, we've looked at those companies for sale. And I'll never say that we'll never do that. But I think -- so far, I think, we're pretty happy with the strategies, we've deployed where we've made some -- we have some strategic partnerships. We've made some capital investments. But we haven't bought a company, but again there could be an opportunity some time in the future we'll never say never but I think we're pretty happy with the strategy that we've deployed so far.

Right and Steve, remember, if we buy 100% of an entity as Craig mentioned prior, we contract with 20 different partners. So if we buy one of them one of the other 19 all of a sudden thinks of us…

Absolutely.

…So we're very cognizant of maintaining good relationships with all of our partners.

Well, what you're doing is working. So keep up the good work. And thanks for the comments.

Thanks, Steve.

And for -- currently no further questions in queue.

Okay. I want to thank everyone for joining us. And we'll speak to you again, next quarter.

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