MFA Financial, Inc. (MFA) Q2 2015 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for your patience in standing by. Welcome to the MFA Financial Incorporate Second Quarter Earnings Call. At this time, all participant lines are in a listen-only mode. And later, there will be an opportunity for question. [Operator Instructions] And as a reminder, today’s call is being recorded. Right now, I’d like to turn the floor over to Danielle Rosatelli.

Good morning. 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 operation. 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 those described in MFA’s annual report on Form 10-K for the year ended December 31, 2014 and other reports that we 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 second-quarter 2015 financial results. Thank you for your time. I would now like to turn this call over to Bill Gorin, MFA’s Chief Executive Officer.

Thank you, Danielle. I’d like to welcome everyone to MFA’s second quarter 2015 financial results webcast. With me today are Craig Knutson, MFA’s President and Chief Operating Officer; Gudmundur Kristjansson, Senior Vice President; Bryan Wulfsohn, Senior Vice President; Steve Yarad, CFO; and other members of senior management. In 2015, we continue to build on our robust residential mortgage asset strategies. When investment opportunities arise in the residential mortgage asset sector, and in my experience if you are patient they always do, MFA remains focused and is very capable of analyzing the opportunity, and being an early and often sizable investor. I assume we’re on Page 3. So despite the lower interest rate environment, we continue to identify and acquire attractive credit-sensitive residential mortgage assets. In the second quarter of 2015, we generated net income of $74.3 million or $0.20 per common share. The dividend was again $0.20 per share, and book value per common share was $7.96. It’s been nine years since the last federal funds rate increased. The unemployment rate has declined and may continue to decline in 2015, yet the labor-force participation rate remains low, inflation remains low in the U.S. and borders on deflation in Europe and Japan. Interest rates remain low across the yield curve on a global basis. Commodity prices are weak and the strong dollar is impacting U.S. companies. As a result, future US Federal Reserve actions remain dependent on data as it comes in. We remain positioned for a more flexible monetary policy by the Federal Reserve that is responsive to measures of labor markets, indicators of inflation, international developments, and other economic data. The probability of changes in the fed funds rate does go up with time. The exact liftoff date remains uncertain, but we currently anticipate that changes in monetary policy will be measured and gradual. At MFA, we continue to limit the interest rate sensitivity of our portfolio. Our net duration was 0.61. Our leverage ratio was 3.3 to 1. And 73% of our mortgage-backed securities are adjustable, hybrid or step-up. In addition, as Craig Knutson will discuss later in the call, as a further step in the diversification of our lending counterparties, wholly-owned subsidiary MFA insurance, Inc., has joined the Federal Home Loan Bank of Des Moines. Turning to Page 4, please. In the second quarter we continued to identify and acquire credit-sensitive residential mortgage assets to generate earnings without increasing MFA’s overall interest rate exposure. We increased our holdings of securities, backed by re-performing, non-performing loans to approximately $2.6 billion, while increasing our holdings of credit-sensitive residential home loans to over $400 million. In the quarter, our more interest-rate-sensitive investments, agency MBS continued to pay down. Staying on this page, Page 4, looking at the change column, you get to see how our assets turn into cash on a fairly regular basis. This is what we mean by saying mature assets. They indicate good yield to own these credit-sensitive assets, but they are not long assets. As we’ve repeatedly said, we do not own 30-year agency assets. Agencies pay down over $300 million in the quarter. Legacy non-agency, some small amount of sales, but that balance went down about $250 million in the quarter. Now the three year step-ups, we showed positive $274 million. There’s moving parts there. We actually purchased over $600 million of assets, while we had pay-downs of close to $400 million. Turning to Page 5, please. As you can see, MFA’s yields and spreads remain attractive despite the interest rate environment. Leverage remained constant at a 3.3 debt-to-equity ratio. Page 6, please. Turning to Page 6, we present yields and spreads for our more significant holdings. Given the leverage we are utilizing or may utilize in the future, each of these asset types are generating attractive returns to MFA’s shareholders. Turning to Page 7. On Page 7, we illustrate our holdings have evolved from 2014 to 2015. This is neither a rebalancing or a reinvestment; this is continued planned evolution of the company. We’ve incrementally increased our holdings to more credit-sensitive, less interest-rate-sensitive residential mortgage assets over this time period. Turning to Page 8. MFA’s book value was down approximately 2% and that is due primarily to slightly lower non-agency prices. But let’s turn to Page 9 to give you a deep-dive into the impact of non-agency MBS on MFA’s book value, because there are multiple moving parts. We talked about some of this before. Now, the impact of changes in market prices of non-agency MBS was approximately negative $0.09 per share. There were realized gains of $0.02 per share, which was included in net income and was distributed to stockholders. Discount accretion, which is basically income in excess of coupon on non-agency MBS purchased at a discount, was approximately $0.06 per share. This is also included in income and was distributed to stockholders. Let me remind you, we purchased these assets at deep discounts and part of the returns is the coupons and part of the returns are capturing more than our initial share price. So it’s not surprising that this is part of our income and is part of our dividend. Principal pay-downs in excess of the market value increased book value and realized losses decreased the face amount of non-agency MBS and reduced book value. Gudmundur Kristjansson will now present Slide 10, which is an update on MFA’s interest-rate sensitivities.

Thanks, Bill. On Slide 10, we take a look at MFA’s interest-rate sensitivities. We continue to maintain a low sensitivity to changes in interest rates, as can be seen by our low net duration of 61 basis points. What equally as important is, the fact that our assets have very limited sensitivity to changes in long-term interest rates. This is due to the fact that 73% of our assets are adjustable, hybrid, or step-up; and our agency MBS are in average five-year seasons and our legacy non-agency MBS are in average nine-year seasons. Another important benefit of our seasoned portfolio is a lower sensitivity to changes in mortgage spreads than on newly-originated mortgages. In the second quarter, long-term Treasury rates increased about 50 basis points, while shorter term Treasury rates increased only about 10 basis points, resulting in the steepening of the curve. Because our assets have limited sensitivity to long-term interest rates, our book value was only modestly affected, as Bill discussed in the last two slides. By maintaining low net duration and limited sensitivity to the long end of the curve, MFA has been well positioned for the increased interest rate volatility experienced this year, and is well prepared for a potential gradual increase in Fed funds in the near future. With that, I will turn the call over to Craig, who will talk about MFA Insurance, Inc. membership of the FHLB as well as our non-agency investments.

Thank you, Gudmundur. So Page 11, as Bill mentioned earlier, our captive insurance company joined the Federal Home Loan Bank of Des Moines in July. As a condition of membership, MFA Insurance has purchased stock in the FHLB of Des Moines, so we view the FHLB as a partner, as well as a counterparty, in fact, when we access FHLB advances to finance a mortgage position, we purchased additional stock in the FHLB in the form of activity stock on which we earn a dividend. So we were effectively capitalizing any borrowing we undertake with the FHLB. The Federal Home Loan Bank offers a very wide array of sophisticated and attractive advances from which we can select to match specific borrowing needs or asset classes. MFA insurance has accessed a small amount, $50 million thus far, of the FHLB advances using agency MBS collateral. We are very excited about this partnership with an extremely solid counterparty and we look forward to working together with the FHLB to further their core mission of supporting housing finance. Turning to Page 12. As Bill also mentioned, we purchased $663 million of RPL/NPL mortgage-backed securities in the second quarter, while experiencing pay-downs of about $390 million, thus growing this portfolio by a little over $270 million. We find these assets to be attractive due to their low sensitivity to interest rates in what we believe to be low credit risk, while at the same time providing low double-digit ROEs. Their low duration is due primarily to the 300 basis point coupon step-up after three years, which gives us confidence that they will have, at most, a three-year final. In fact, most of these deals typically get called well prior to this three-year soft final. While the underlying re-performing and non-performing loans certainly bear credit risk, the combination of significant credit support, approximately 50%, and the locked out nature of the cash flows on the subordinate piece ensure that the senior bonds that we own are well protected and this credit protection increases over time as the deal seasons. Turning to Page 13, the credit metrics on the loans underlying our legacy non-agency portfolio continue to improve. Home price appreciation and principal amortization, approximately 63% of the underlying loans in this portfolio are currently amortizing. Both of those combine to reduce LTVs. Delinquencies are curing 60-plus-day delinquencies as of June 30 for the portfolio have declined to 14.0%. As Gudmundur mentioned, the loans are on average 111 months seasoned and more than nine years seasoned. So on this page, we illustrate the LTV distribution of current loans in the portfolio, and in particular, we focus on the at-risk loans where the homeowner owes more on the mortgage than the property is worth. Although, these mortgages are current, these borrowers are not delinquent today. These are the loans that we worry most about transitioning to delinquent in the future, because of the fact that the borrowers are underwater. As of June 30, less than 4% of the current loans in the portfolio had LTVs in excess of 110%. On Page 14, we show realized losses experienced on the portfolio over the last three calendar years and for the first-half of 2015. Keep in mind that these realized losses are fully expected and precisely why we have established a credit reserve. Note, that after realized losses of $164 million in both 2012 and 2013, losses in 2014 decreased to $90 million. During the first-half of 2015, realized losses were $41.2 million. The $847 million credit reserve has already been reduced by all actual losses already realized. At one point this credit reserve was as high as $1.5 billion. These realized losses occur when properties securing the mortgage loans are liquidated for less than the outstanding loan amount. In addition, as we have discussed previously, for many of the fixed-rate bonds in the portfolio, unrealized losses are generated when mortgage loans are modified through coupon reductions to troubled homeowners. While the loan modification reduces the interest rate paid by the borrower, the bond that we own has a contractual fixed-rate coupon, so the interest collected from the borrower may be less than the interest owed to the bondholder. In order to cure this interest shortfall, the trustee uses principal receipts to pay interest on our bond. This use of principle to pay interest effectively under-collateralizes our bond as the underlying principal balance of the loans is now less than the principal balance of the loans is now less than the principal balance of the bonds that we own. For some bonds, this loss is recognized in the period in which it occurs, in this case a realized loss. But in most cases, the loss is not realized until the loan balance is reduced to zero and we still have a bond balance outstanding, which is likely obviously many years from now. At that point, those unrealized losses will become realized losses. As indicated in our press release, we again lowered our estimates of future losses in the portfolio and transferred over $5 million from our credit reserve to accretable discount. All else equal, this increases the yield that we will recognize over the remaining life of the bonds. Turning to Page 15. We’ve also become increasingly active in the credit-sensitive residential whole loan space, growing this asset class to $429 million as of June 30. We like this asset class for several reasons. First, investments in this asset class utilize much the same residential mortgage credit expertise that we have effectively deployed in the legacy non-agency space since 2008. Second, supply dynamics suggest that we’ll have significant opportunity to purchase these assets as the current holders are obliged to shed them. Total supply is estimated at between $500 billion and $1 trillion with $30 billion to $50 billion of expected annual sales this year and again next year. Compare this to legacy non-agency, which is a shrinking market with fewer and fewer opportunities to purchase bonds. Third, we are excited to have the ability to oversee servicing decisions on troubled loans. For instance, by offering modifications to borrowers when such a modification will produce a better NPV outcome than foreclosure and liquidation. Again, compared to legacy non-agency MBS, where we have no seat at the table, no visibility into these modification decisions, and we often see losses pass-through that look excessive. Fourth, residential whole loans are good assets for us. That is, they’re qualifying interest for purposes of REIT qualification, which most RPL/NPL mortgage-backed securities are not, and residential whole loans are also qualifying interest for purposes of our 1940 Act exemption, which legacy non- agency MBS are not. And finally, we believe that credit-sensitive residential whole loans further round out MFA’s focus on credit versus interest rate and prepayment risks. Turning to Slide 16, we are buying these credit-sensitive whole loans at material discounts to both their unpaid principal balance and also to the underlying property value. Our $429 million portfolio comprises almost 3,000 loans acquired through 15 transactions with 13 different counterparties. We’ve continued to expand our relationships with key market participants in this asset class. We did add some leverage to this asset class in the fourth quarter of last year, and we’re in the process of setting up an additional warehouse borrowing facility, which will likely increase our leverage slightly in the third quarter of this year. And now, I would like to turn the call back over to Bill.

Thanks, Craig. So to summarize, we continue to utilize our expertise to identify and acquire attractive credit-sensitive residential mortgage assets. We’ve substantially grown our holdings in RPL/NPL securities and loans in the last 12 months. Credit-sensitive assets are performing well. Future Federal Reserve decisions remain dependent on data as it comes in, and we are well-positioned for changes in monetary policies and/or interest rates. I think from today’s call, you can see we’re making good progress on lots of fronts. In addition, today we tried to give you a little deeper dive and hopefully that was constructive. Operator, this completes our presentation. If you could please open up the lines for questions.

Certainly. Thank you. [Operator Instructions] Our first question comes from the line of Jason Weaver of Sterne, Agee.

Hi, guys. Good morning. Thanks for taking my question.

Good morning, Jason.

Just one here. I was hoping you could talk about your comfort zone around the leverage ratio as the upcoming interest rate environment gets clearer. That is if things look more certain that we will face one or two hikes on the short rate alone as opposed to a prolonged cycle. Would that give you enough confidence to increase leverage?

So historically, it’s not been a forecast of interest rates or accessibility to leveragability that made our decision. It’s a question of gathering assets with like matched liabilities. So, one, you are never going to know exactly what the Fed is going to do. But no, the answer is no, if the Fed declares two and done that doesn’t mean our leverage is going up. We’ve kind of been in this range for a long time and an opportunity can come and that can change. But our use of leverage is not dependent on us forecasting the interest rate cycle.

Fair enough. So I take that as partially an answer that – let me put it this way. How much could you expand your purchases of credit-sensitive loans and RPL/NPL securities from above the current pace that you are buying here? I mean, do you have extra bandwidth, or are you finding sort of cost prohibitiveness as you participate [ph] more aggressively?

So, Jason, we will give you the theoretical answer, but it does not mean that we plan on putting it in practice. If you want to know, requiring haircuts in funding, Craig would be glad to share with them with you or Bryan.

Sure. So haircuts on RPL/NPL, MBS are going to range between 20% and 25%. So you can obtain 3 to 4 times leverage when you are purchasing these assets. And when you are talking about credit-sensitive loans, their haircuts would be in sort of a range of 25% to 30%, so, again, 2 and change leverage to 3 times leverage. So you can sort of extrapolate there on our liquidity. I mean, we also have many – we get many paydowns, so redeploying those paydowns into those asset classes, I don’t think we’re capital constrained at all when it comes to RPL/NPL security [indiscernible] for credit-sensitive [indiscernible].

Fair enough. Well, thank you very much.

Jason, just keep in mind the paydowns that we get and when we say we have a short portfolio, we had almost $400 million of paydowns on the RPL/NPL mortgage-backed securities portfolio agency paid down, what $250 million, $300 million? Even legacy non-agency paid down $250 million. So that’s all cash that comes back and that obviously can get redeployed.

Very good. All right. That’s very helpful. Congrats again on a solid quarter.

Thanks, Jason.

And our next question will come from the line of Steve DeLaney of JMP Securities.

Good morning, and thanks for taking the question. I would like to start with pre-pays, it’s obviously one of the hot topics of the earnings season. Your agency speeds jumped up about almost 5 CPR and knocked 33 basis points off that agency yield. So while that’s not your focus, everything kind of goes into the pot in terms of where earnings come out. So I was wondering, I guess, this is for Gudmundur, if you could give us a sense, I’m speaking specifically to the agency book, where you see speeds coming down in the third and fourth quarter? I’m curious do we retrace over the next six months all the way back to sort of where we were in the first quarter, which was about 11 CPR, or do we end up somewhere in between? Thanks.

Yes. Hi, Steve, it’s Gudmundur. So two things. So obviously rates fell pretty fast and rapidly in the first quarter. 10-year total went down to probably 1.67. And what happens through refinancing is there is always a delay between when rates hit rock bottom and between people refinancing and so on and so forth, and that delay can be anywhere from one to three months. Basically, part of the increase in speeds in the second quarter is just the fact that rates fell a lot in the first quarter.

Right.

Another piece of the puzzle is seasonality. And this is often forgotten when people think about prepayments in general is that, speeds in the summer months tend to be much higher than in the winter months just because people are moving and there is more turnover in those months. So what we’ve seen over the last couple of months, sorry, last couple of years is an increased seasonality in terms of speed. So the change from lows in January or February versus the highs in July or August can be anywhere from 30% to 40% in terms of prepayments. So those are the two things that kind of came to push speeds higher. What I would expect looking forward is that, so what you would expect in the third quarter, speeds should remain somewhat elevated, but as you head into the winter months, they should absolutely come down, absent any significant rally in rates.

Okay. That’s helpful. Thanks for clarifying that, Gudmundur. And on the agency book, obviously, I think you haven’t bought an agency bond for three years now or some extended period, but it came down $340 million. I’m just curious as you guys look at all your various tests, do you – the RPL/NPL whole loans, obviously, you are very attractive in terms of that 1940 Act exemption. So how much – the question is how much room do you still have to let the agency book come down further below the $5.3 billion? Thanks.

Steve, you’re right. The credit sensitive loans do satisfy that same criteria, and we’re not all that close on those tests. As you know, we adopted a holding company structure before we embarked on the whole loan business…

Right.

…and that gave us some additional flexibility. So we’re still pretty comfortable.

Okay. So, I mean, the magnitude would be hundreds of millions of dollars of room for agency to continue?

Well, easily, yes.

Easily, okay, maybe $1 billion. Okay, guys. Thanks.

It’s Bill. I just want to add, when you read what you read in the papers about how inefficient very large holdings of re-performing non-performing loans are, the more and more convinced we are that we will have opportunities to buy very large volumes at attractive yields. So this is really not an issue now. We’ve want to make this evolution for a while and you will see us owning more credit-sensitive loans.

That’s very positive color. That business has seemed lumpy, but you guys are on the front lines and that’s encouraging to hear. Thanks, everybody, for the comments, and, Bill, all the best as you start your treatments. Thank you.

Thanks, Steve.

And our next question will come from the line of Dan Altscher of FBR.

Hey, thanks. Good morning, everyone. And, Bill, also let me reiterate Steve’s comments that we are all wishing you the best as you go forward. I think just maybe talking about the FHLB facility a little bit, do you guys have a sense as to how much capacity you might be able to get on that either initially, or maybe looking to increase too over sometime?

So, Dan, thanks for the question. There is definitely significant capacity there, both initially and in the future. As you know, this notice of proposed rulemaking is still not finalized, so there is really no definitive word on what direction that takes. And because of the way that’s worded, any new captive insurance companies that get admitted to the Home Loan Bank system, you may have to leave the Home Loan Bank system depending on what happens with that rule. So we will proceed obviously cautiously and slowly, really pending any final resolution of that.

Okay, got it. That’s fine. And just related to the non-agency book value move, since I guess specifically you all called it out and provided a lot of good detail around it this quarter. In particular, just the book value move on the actual securities that I think was the $0.09. Was there any sort of vintages or any particular type of security you saw that was maybe outsized from a mark-to-market standpoint, or was it just kind of just general across the board?

I would say it’s general across the board and it’s not that much. That $0.09 is a little more than 0.5 point on $4.8 billion face or so…

Yes.

So, but I think it was pretty much across the sector, maybe a little more on hybrids and fixed rate, but we are really splitting hairs.

Got it, okay. Thanks, Craig. Appreciate the questions.

And our next question will come from the line of Mike Widner of KBW.

Hey, thanks, guys. I think I just have a few follow-up questions. Maybe, Bill, I think Steve asked the question about the good versus non-good read assets. And I was just, I mean, as we look at it on the surface, I guess, very simply bottom line, there is about $6 billion of whole loans or pass-throughs and about $7 billion of stuff that’s not. And again, it’s pretty kind of simple high level, most people are sort of used to looking at these things and saying, you have to be, at least, 50/50. So, I mean, where is the line, and I guess, maybe if you could talk just a little bit more about, I mean, you clearly indicated you have plenty of room left, but how does that specifically work out and how should we think about that? Thanks.

So I’m not sure about that 50/50 rule. But it’s a question of making sure that the holding company passes its requirements, so it’s a different test than what you are used to. And we could take this offline, but we watch this every day. As Craig says, we have a lot of capacity and I know where our investment opportunities are. If you want more detail, we could take this offline later.

Okay. Yes, I guess, we can do that. Just a detailed question just for modeling, premium amortization in the second quarter, do you happen to have that number for the agency book?

Sure, Mike. This is Steve Yarad. So for the second quarter, the premium amortization on the agency book was about $11.9 million.

Okay, great. Then I guess just thinking about the reserves, I think, it’s really Slide 14. The credit performance is clearly improving and as we look at the amount – and you guys have obviously been taking down the reserves over the last couple years. But just looking at that and thinking about it going forward, $847 million credit reserve, you’re running $90-ish-million a year, I mean, that’s nine years or so worth of credit reserves there. Doesn’t that still seem pretty high, I mean, what kind of loss estimates do I need to get to make it seem like that’s a number that’s not going to keep coming down or that we are not going to keep seeing reserve releases?

So thanks for the question, Mike. So, as we’ve said before, we do a pretty intensive evaluation of these securities every single quarter. And, yes, you’re right; we have continued to knock down the credit reserve. You mentioned that at the current rate that’s nine years. These loans are 11 years old, they’ve got 19 years left to go, so obviously it’s a declining balance. Also, keep in mind that credit reserve is not just for the traditional loans that go bad and get liquidated with a loss. As I talked about, there is also this phenomenon with fixed-rate loans, where they get modified and get lower coupons, where we end up with a principal loss that’s way down the road. And I think we’ve said that that amount is about $47 million right now, and that grows every year.

Okay. So, yes, I mean, so that’s not a huge number, but I guess if it’s – I mean, what’s the rate of growth of that, I guess, is another, I mean, not it’s [ph] usually material, but…?

It went up by – that slide says, it’s $47 million, it was $31 million last year at this time.

Okay, great. Yes, I see that there.

And, again, we don’t know what happens in the future, Mike. So if those loans that were modified and the coupons came down, if we sell that bond, then obviously that changes the loss assumptions. If the servicer increases the coupon sometime in the future and the borrower continues to perform with the higher coupon that will decrease the loss. So there are a lot of moving pieces.

Yes, absolutely. I thought you guys did know the future, so that part is a surprise to me, but [multiple Speakers], all right. Well, thanks for the comments, as always, and my best wishes as well, Bill.

Thank you.

And our next question will come from the line of Douglas Harter of Credit Suisse.

Hi. This is actually Sam Choe filling in for Doug Harter. So actually most of my questions have been asked and answered, but just had one regarding the credit-sensitive whole loans. I was – I mean, you guys talked about the supply dynamics. But I was wondering if you can provide some color on the pricing trend you’ve seen in the asset class post 2Q, and maybe the competitive landscape for these assets after the quarter?

If you want to focus, there are kind of two sides here when you are talking about credit sensitive loans, there re-performing and nonperforming.

Right.

I would say on the non-performing side prices have remained pretty steady. I mean, you’ve seen results, recently Freddie Mac had a sale and they published their results, and those prices seem in line to where things are – where loans are trading in the last quarter. And then on re-performing loans, it’s very – I would say the general trend is a little bit higher, but it is tricky in that some re-performing loan pools can look very different from others. So it’s harder to sort of pinpoint and say, okay, they are up one point, two points, three points, but I would say that the general trend on re-performing loans has been a little bit higher.

Got it, okay. Thank you.

Your next question comes from the line of Joel Houck with Wells Fargo.

Good morning. Did you guys talk about what type of collateral you will pledge to the Federal Home Loan Bank, what type of assets you are going to finance?

Well, we initially – and again we just were granted membership in early July, so we posted agency collateral initially. But it’s actually a good question, because if you look at our asset classes, a lot of those asset classes don’t necessarily matchup particularly well. So our legacy non-agency book really doesn’t work very well because typically they would have to be rated even better than investment grade, which as you know those are not. The RPL/NPL securities portfolio, those are not rated. Non-performing loans are not pledgeable. So, right now, I would say the best fit is with agency collateral. However, again as I said before, any significant growth there will really probably wait on some final resolution of this proposed rulemaking, but it might open additional asset classes for us, for instance newer production loans.

Okay. I’m not reading anything in here, but do you guys have any plans of going into commercial? I know a lot of the REITs have used commercial mortgage loans in the FHLB.

Joel, we are always looking at all options. But I would say, as of this moment, no, we’re not particularly looking at commercial investments.

Okay. And last one, I guess, is more conceptual. I mean, one of the themes that has emerged last several quarters is that everybody is kind of moving away from agency assets where they can, and MFA is no different. We are now seeing, and I guess, one can make the argument we see this every year, where you get hope spring eternal in terms of growth in the spring and then as we get for the end of the summer it looks like the economy is slowing. This time, however, there does seem to be a lot of data out there that suggests we are near a recession or perhaps entering a recession, and this year it now seems like the Fed is actually going to raise rates. At a point, the 10-year is barely above 2.20%. I mean what’s the risk, reward thinking of the company in terms of continuing to deemphasize agency assets at the – obviously you’re putting more credit sensitive assets and we may be heading into a recession. I don’t know if you agree with that or if your views of the probability of a recession have changed in the last quarter or two, but Bill, it might be helpful to kind of hear your overall thoughts on that?

Sure. I need to complement Joel. Joel had a good read on interest rates [indiscernible], but we believe fundamentally nothing works – and he has been saying this for years – unless housing is stable. And we are very comfortable with our credit-sensitive assets, because what are the absolute yields, the spreads, the return relative to interest rate exposure? We continue to feel that way, the absolute yields on agencies – and this is not the last two years for us. This is more like seven years we’ve been sort of saying the same thing. In terms of interest rates, let’s be real big picture. Unemployment is not low – or high. GDP is not exceptionally low, yet federal funds rate still looks like an emergency rate of zero to a quarter. So what do we all know together? I will have to quote a British girl band here, the Fed has told us what they want, what they really, really want. It’s to raise, the Fed funds rate this year. That is the reality. Your argument is a correct one. There’s no compelling economic reason to do so, but we do want to attack some of the complacency. None of this makes us alter our strategy. We continue to expand our strategy on the credit side. Yields we generate – if you look at the cash flow last quarter, on the paydowns it was nearly $1 billion in a quarter. If you’re getting paid a 4% yield and you’re getting $1 billion back, that is high value-added for investors. That is generating a good ROE with a very short asset. So we are not adjusting our thoughts on strategy. We probably like our credit strategy more now than ever.

Okay. I appreciate the comments. And, again, Bill, best of luck with your procedure going forward.

Thanks, Joel.

And the next question will come from the line of Rick Shane of JPMorgan.

Hey, guys, thanks for taking my questions. Bill, you just made me smile with your response to Joel’s question and I did want to wish you all the best in your treatment as well, so thank you. In terms of business stuff, I would love to just talk a little bit about the whole loan purchases and I would actually like to talk about two aspects of it. I think we understand the asset class in terms of what it means on the left side of your balance sheet, but I’d love to talk about operationally how you due diligence this, what the flow of the business looks like. And then, secondarily, right now, you are financing it primarily with equity and a modest degree of repo. Is there an opportunity to be long-term to permanently finance those once you build critical mass?

Rick, we will address your question. I just want to preface it by saying we pretty specifically said on this call this is what we are investing in, so don’t expect us – we want to keep you comfortable and informed, but we need to keep our competitive advantages. So I just want to preface the answers that will come with that.

Fair enough.

So I guess first we could look at the long-term financing aspect. So we would potentially in the long-term – one, we have the ability to borrow against the re-performing and non-performing loans we have, the loans that are particularly unpledged. We have that ability. We may choose to borrow against those in the future. It’s just there are – it’s somewhat of a process, so you would rather have – like you said, you’d rather have a critical mass to go do that rather than to just get financing on a sort of onesie-twosie basis just because of the work that goes into it. So, yes, we have that ability to do that in the future. In terms of diligence, we take a pretty – we have a strong approach to our diligence. We do pretty much – we do 100% diligence on everything we buy when it comes to all – I guess standard industry practices. Title work, service in common, history, all that collateral work; so I would say we are very strong from a diligence perspective.

And, just to follow-up on that a little bit, when we think about this business evolving, should we be thinking about your infrastructure evolving, either from an expense perspective, or – are there implications of this that we should be thinking about longer term?

Well, we have always attempted not to build a high fixed cost base, but incrementally, yes, we do have to add key people in certain places. But I don’t see it being a very high headcount change. But you’re right, systems-wise key personnel there incrementally is some impact.

Okay, great. Thank you very much.

Thank you.

[Operator Instructions] And our next question comes from the line of Brock Vandervliet of Nomura Securities.

Thanks for taking the question. So I guess going back to one of the first that you got, given the interest rate inflection that we seem to be at, what is your perspective on the shape of the curve? Do you think we can enter this new phase essentially as steep as we are now or do you really think it’s going to flatten materially? Thanks.

Our strategy is not based on us forecasting the shape of the curve. With that being said, Gudmundur would be glad to offer his views.

Yes. I mean, as Bill said, it’s not essential to our strategy and you can see that in our book value change, it says it’s long and it’s moving up or down, it really doesn’t affect our book value that much. But I mean if you look big picture, you can think of two things. So in the U.S. there’s modest growth, there’s not great growth. Unemployment has come down, with – the labor market keeps getting stronger. So that would indicate, all else being equal, that the Fed is probably close to raising rates. And they’ve told us numerous times this year that they are on track to raise rates, which would mean that the front end would move up. But they’ve also told us that’s going to happen gradually. Now the long end is the more complicated story. The long end tends to react to inflation and inflation expectations. And as you look across the globe, you can see that inflation pressures around the world are actually pointing towards deflation, or at least not increasing prices. You see commodity prices falling and the dollar strengthening. All these things mean that the long end comes with a downward pressure. So if the Fed is moving, my personal view is that they would move gradually because they would probably concerned about flattening the curve out at too low of a rate.

Okay. Thank you. And separately, with respect to the credit sensitive initiative, on the loans that you are acquiring are you swapping out any servicing relationships, number one? Two, are all these loans typically serviced by one servicer or are you dealing with a collection of third-party servicers? Thanks.

All of the loans that we buy and have purchased have been servicing released, so that means when we buy the loans, we take them to a third-party servicer of our choosing. So I would say almost 100% of the time servicing is being moved. There may be instances where the loans may be re-performing and they are at a servicer that we already think does a good job. In that instance we may leave the loans where they are. But still we purchase them servicing release, so if we would then decide to move the servicing in the future, we have that ability. So and I guess to answer your question about the number of servicers, we currently utilize three different servicers that we are pretty happy with and that sounds like a good number to us. You want to have a backup in case anything happens to one of them.

Got it. Thanks for the color.

Thanks, Brock.

Operator, could we wrap up the call.