MFA Financial, Inc. (MFA) Q2 2017 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you very much for standing by, and welcome to the MFA Financial Inc. Second Quarter Earnings Call. [Operator Instructions] And also as a reminder, today’s conference is being recorded. I would now like to turn the call to your host, Mr. 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 well, 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, 2016, and other reports that it may file from time-to-time with the SEC. 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 2017 financial results. Thank you for your time. I would now like to turn the call over to MFA’s Co-CEO, Craig Knutson.

Thank you, Hal. Good morning, everyone. I’d like to welcome you to MFA’s second quarter 2017 financial results webcast. With me today are Steve Yarad, Chief Financial Officer; Gudmundur Kristjansson, Senior Vice President; Bryan Wulfsohn, Senior Vice President; Hal Schwartz, Senior Vice President and General Counsel; and other members of senior management. Before we begin, I’d like to note that Bill Gorin will not be joining us on today’s call. As many of you know, Bill has been undergoing treatment for cancer for the past 2 years. And unfortunately, he’s unable to participate today as he focuses on his health. Now turning to second quarter results. MFA had a very active second quarter of 2017, as our team successfully transacted on multiple fronts. Our investment activity continue to execute our strategy of selective investment within the residential mortgage universe. We have many years of experience in analyzing and investing in such assets. And thanks to our permanent capital REIT structure, we have the staying power to hold these assets throughout fluctuations in market value. If you please turn to Page 3. We invested or committed to purchase just over $1 billion of assets, including 4 whole loan packages with an investment amount of close to $350 million. We completed a follow-on common stock offering, our first offering, our first such offering in over 6 years, raising approximately $178 million. And we issued a rated securitization of reperforming whole loans, selling $121 million of AAA-rated bonds with 2.5 year average life and $27 million A-rated bonds with a 6.5 year average life to third-party investors with a blended coupon of approximately 2.75. Despite this period of historically low interest rates, we remain well- positioned to generate attractive returns. In the second quarter, we generated EPS of $0.20, book value per share increased to $7.76 versus $7.66 at the end of the first quarter. And as we have said repeatedly, a lower duration portfolio and lower leverage leads to a more stable book value. If you could please turn to Page 4. MFA began operations nearly 20 years ago, and the company has generated strong long-term returns to investors through volatile markets and through various interest rate and credit cycles. Since January of 2000, we have generated annualized shareholder returns of approximately 15%. As we have over the last 5- and 10-year periods as well. And over the last 12 months, our total shareholder return exceeded 25%. Please turn to Page 5. We lay out MFA’s 2017 Investment Strategy. In the second half of 2017, we will continue to focus on credit-sensitive residential mortgage assets. The credit assets we’ve acquired continued to perform well, tend to be short-term and have less interest rate sensitivity. Many of our assets were purchased at a discount, so they actually benefit from increases in prepayment rates. Investor expectations of improved economic growth have positively impacted credit-sensitive assets, as have continued home price appreciation and repaired borrower credit profiles. Our strategy does require staying power, which gives us the ability to invest-in and hold long- term distressed less-liquid assets. We have permanent equity capital. Our debt to-equity-ratio is low enough to accommodate potential declines in marks and our liquidity combined with portfolio runoff from assets gives us the ability to invest significant amounts as we identify attractive investment opportunities. And again, we invest with the focus on long-term performance. If you could please turn to Page 6. While the Federal funds rate increased again in the second quarter of 2017 as it did in the fourth quarter of last year and in the first quarter of this year, yields on credit- sensitive assets remain relatively flat as investors have priced-in more positive credit scenarios. We stated on our last earnings call that we were actively engaged with several potential attractive opportunities in credit- sensitive loans, and we’re pleased to report that our investment team was able to win 4 whole loan packages in the second quarter, investing or committing to invest nearly $350 million. We continued to see steep run-off in our 3-year step-up securities portfolio, despite investing over $500 million during the second quarter in these assets, that’s versus an investment in the first quarter in these assets of about $150 million. This asset class declined, as we saw, very heavy calls of existing business. Turning to Page 7. I’ll turn the call over to Gudmundur, who will run through our investment activity by asset class and present yields and spread summaries before reviewing our portfolio interest rate sensitivity and prepayment exposure.

Thank you, Craig. Turning to Page 7. Our mortgage assets run off due to amortization, paydowns or sale, allowing reinvestment opportunities in changing interest rate and credit environments. In fact, the rapid expected paydowns of our 3-year step-up securities is an important factor in the short duration of our assets. Although, the second quarter paydowns were rather large, it is in line with our expectations that the 3-year step-up securities would be called well before their 3-year coupon step-up or maturity. During the quarter, we found opportunities across all of our asset classes with most of the purchase activity occurring in 3-year step-up securities and whole loans. Turning to Page 8. MFA’s yields and spreads remain attractive and relatively stable, despite recent Fed funds increases and the persistent overall low interest rate environment. In fact, MFA’s second quarter net interest rate spread was little changed from the third quarter of 2016, despite 3 Fed funds increases during that time period. Turning to Page 9. Here we show the yields, cost of funds and spreads for our more significant holding. Given the current yields of our assets and the yields we’re seeing in the marketplace, we believe and with the appropriate amount of leverage, we will continue to generate attractive returns for our shareholders. Turning to Page 10. Here we will review MFA’s interest rate sensitivity. Our asset duration was 133 basis points at the end of quarter. Our asset duration trended up modestly, primarily due to large paydowns of 3-year step-up securities in the second quarter. However, at 133 basis points, our asset duration remains exceptionally low. Our interest rate swap portfolio declined to $2.55 billion as $300 million of very short swaps matured in the quarter. While our hedge duration remains unchanged at 250 basis points, as these short swaps had only marginal contribution to our hedges in the last quarter. In addition to market value protection, our interest rate swaps currently hedge about 1/3 of our repurchase agreements. MFA’s net duration increased by 7 basis points in the quarter, but remains very low at 76 basis points at the end of the second quarter. As the Fed prepares to reduce its balance sheet, which consists primarily of long-term treasuries and 30-year agency MBS securities, it is important to reemphasize that MFA’s assets are relatively insensitive to changes in long-term interest rates and 30-year agency MBS spreads. As such, we believe our portfolio is well-positioned for the impact of a smaller Federal Reserve balance sheet as well as further gradual increases in the Fed funds rates. Turning to Page 11. As we can see from this slide, the discount accretion on our legacy non-agency MBS portfolio continues to dramatically outpace the premium amortization on our agency MBS portfolio. And the impact of agency MBS premium amortization on MFA’s earnings has diminished over time. Continued strong home price appreciation and incrementally better access to credit for legacy non-agency borrowers continues to aid prepayments on our legacy non-agency MBS, while seasoning of our agency MBS portfolio and lower loan balance for our fixed year – fixed-rate agency MBS continues to limit prepayment volatility on our agency MBS holdings. Due to these factors and the fact that the 28-point average purchase discount on our legacy non-agency MBS is much larger than the 4-point average purchase premium on our agency MBS portfolio. We do not believe that large changes in interest rates would cause large changes in prepayments that could negatively impact MFA’s earnings. With that, I will turn the call over to Steve Yarad, our CFO, who will discuss our other income in some detail.

Thank you, Gudmundur. As Craig and Gudmundur outlined earlier in this presentation, MFA’s financial results for the second quarter were again relatively strong, highlighted by consistent earnings, modest book value growth and stable dividend. I’d also want to take this opportunity to point out some recent changes in the components and geography of MFA’s overall net income. Please turn to Page 12, where we present a summary income statement that highlights the key components of MFA’s net income for the first and second quarters of 2017. While overall earnings remain consistent with the first quarter, with EPS unchanged at $0.20 per common share, we receive an increasing contribution of other income items to overall net income in recent quarters. This is primarily due to, one, runoff in assets and associated liabilities to generate net interest income, including agency MBS, legacy non-agency MBS and 3-year step-up securities. Two, acquisition of assets that we account for using the fair value option. The more [indiscernible] the fair value option on an asset, we would call the changes in the fair value of the asset each period directly in net income. Further, these changes in fair value are presented in our income statement in other income rather than in net interest income. And thirdly, higher-funding costs, primarily reflecting recent Federal Reserve interest rate increases have impacted net interest spreads. It should also be noted that funding costs on our NPLs whole loans are reported in net interest income, while income from these assets are reported in other income. During the second quarter of 2017, we continued to see the impact of this shift as net interest income declined compared to the third quarter of 2017. However, this decline was more than offset by higher other income items, including from: one, increases in unrealized gains in NPL whole loans that we account for fair value as a result of the having elected the fair value option; two, increases in unrealized gains in NPL whole loans that we account for fair value as a result of the having elected the fair value option and thirdly, in the second quarter, gains were recognized due to the early payoffs of certain RPL whole loans held at carrying value. These early payoffs resulted in the recognition of gains that are presented in other income. Yield income for these carrying value loans is recognized in net interest income. The increased contribution of other income to MFA’s overall earnings including some items accounted for fair value as a result of electing the fair value option may result in fluctuations in the overall level of MFA’s net income future quarters. And now, I’d like to turn the call over to Bryan Wulfsohn, who will discuss the performance of our credit-sensitive residential mortgage assets.

Thank you, Steve. Please turn to Slide 13. The residential mortgage credit market continues to enjoy both fundamental and technical support. Interest rates and mortgage rates remain low by historical standards. According to the most recent report from the National Association of Realtors on existing home sales, total existing home sales for June increased 0.7% to 5.5 million median existing single-family home prices in June were up 6.5% versus June 2015. This marks the 64th consecutive month of year-over-year gains. Housing inventory continues to decline. Total housing inventory at the end of June was 1.96 million units, down 1.7% versus June of 2016. According to the June 2017 CoreLogic Loan Performance Insights Report, latest reported end delinquencies dropped 0.5% to 4.8% versus a year ago. Turning to Page 14. Although bid prices for reperforming and non-performing loans were strong due to increased competition, we were able to find attractive investments in 4 whole loan pools totaling an investment amount of nearly $350 million. We were able to purchase loans at more attractive prices by focusing on smaller pools and some unique situations. Supply is expected to remain robust for the foreseeable future allowing us to grow the loan portfolio. Turning to Page 15. As previously mentioned, we were able to add nearly $350 million of loans in the second quarter. In our non-performing fair value portfolio, we brought 141 loans, approximately $26 million at fair value that were delinquent at March 31st to current status as of June 30th. We modified 61 loans in our fair value portfolio resulting in unrealized gains of approximately $1.1 million. In our reperforming carrying value portfolio, our current or 30-days delinquent loans remained at 85%, quarter-over-quarter and over 2% of the loans that were current at the end of the first quarter prepaid during the second quarter. We liquidated a 145 properties out of our REO portfolio, which is our best REO liquidation quarter thus far. Again, as a reminder, our credit-sensitive whole loans appear on our balance sheet on 2 lines; loans held at carrying value, $661 million; and loans held at fair value, $983 million. This election is permanent and is made at the time of acquisition. Typically, we elect carrying value for reperforming loans and fair value for non-performing loans. Turning to Page 16. We purchased over a $0.5 billion of 3-year step- up securities in the second quarter. Current market yields for A1s are in the low- to mid-3s and low- to mid-5s for A8s. This asset class assumes strong demand leading to listed yields getting reissued once callable at lower yields and tighter spreads. Significant appetite from unlevered buyers has been largely responsible for this move in spreads. Turning to Page 17. The credit metrics on the loans underlying our legacy non-agency portfolio continue to improve. 97% of the loans underlying our legacy non-agency portfolio are now amortizing. This principal amortization, together with home price appreciation continues to reduce LTV. Delinquencies are curing. 60-plus days’ delinquencies as of June 30th for the portfolio were 12%. On this page, we illustrate the LTV distribution of current loans in the portfolio. The red bar on the right side represent at risk loans, where the homeowner owes more on owes more on the mortgage than the property is worth. These are the loans that we worry most about transitioning to delinquent and defaulting in the future because the borrowers are underwater. As you can see, these red bars are disappearing. Please also note that increasing large black bars on the left side, loans with LTVs below 80% are attractive refinancing candidates. And 83% of the current loans have LTVs of 80% or lower. A combination of low rates available today and a 30-year amortization term versus the 20-year remaining term on these loans today can offer homeowner substantially lower monthly payments. Of course, given our deeply discounted purchase prices of these assets, we are very happy when the underlying loans prepay. And now, I’d like to turn the call back over to Craig.

Thank you, Bryan. Turn to Page 18. In summary, we are very pleased with our second quarter results and activities. In addition to earning $0.20 per share and modest book value growth, we invested over $1 billion, including trade commitments not yet settled, issued an accretive equity offering and completed a rated securitization of credit-sensitive whole loans. This completes our formal presentation. Operator, could you please open up the lines for questions.

[Operator Instructions] And our first question comes from the line of Jessica Levi-Ribner with FBR. Please go ahead.

Craig, congratulations on your new position. A question on the non-agencies. With all the noise this quarter or recently with Wells Fargo and the Trustees taking reserves. How does that impact your portfolio, if at all? And how are you thinking about it in terms of non-agency acquisitions on a go forward?

So it’s a good question. And I guess, I’d have a few things to say. Yes, we had the well-publicized deals that were called in May, I guess, where there was a very large holdback $90-odd million from Wells Fargo as the Trustee on those deals. There were subsequent lawsuits filed. There were some deals called in the month of June. So this is just last week or so. I think there were 6 deals that we know that were called, and one of those was Wells Fargo/Trustee deal. And the amount of the holdback on that was much less. It was – as I recall, it was about $65,000 in the deal that was called last week. And if they had utilized the same methodology that we believe they used in May, that holdback would have been something on the order of $10 million. So I think that’s one fact. But the second fact is, we’ve tried to segment our portfolio and look at deals that are callable today or are callable within the next year or so. And so, I guess, if we back up one more step. If we look at our own portfolio in what deals are subject to these ongoing litigations, it’s about half the portfolio. So those bonds are subject to some litigation of some way shape or form. If we then look at yields that are callable, either callable now or callable within the next year. For us, it’s a total of about $350 million face amount. So it’s maybe 11 – little over 11% of our portfolio. But we can further segment that. Most of the deals that get called are fixed rate deals because underlying loans have higher coupons, and typically the delinquencies are less, so the loans are worth more. So most of the deals that we see called are fixed rate deals, not hybrid deals. And if we look at our exposure there, that $350 million, if you look at fixed rate deals, it’s a number that’s more – it’s less than $20 million. So it goes from $350 million to less than $20 million. And then if we further look at the Wells Fargo/Trustee deals, the total hybrid and fixed is about – within 1 year. And currently is about $160 million or so. But if we look at the fixed rate, it’s about $8 million. So that’s sort of how we decide to quantify it. In terms of market opportunities, we really haven’t seen these securities trade at materially cheaper prices. That said, there probably hasn’t been very much trading. So I think holders of this paper, if bids are much lower, they’re probably not inclined to sell, I’ve seen some dealer commentary arguing that if there is any price weakness, it’s probably an opportunity that to purchases. So we so far, we really haven’t seen much impact on market pricing.

Okay, thank you. That was really in-depth and I appreciate it. In terms of acquisitions on a go-forward basis, are there are any assets that you guys are finding more attractive or maybe more opportunities in? And are there any that maybe you’re going to stay from in the next, maybe the third quarter to fourth quarter?

So it’s obviously hard to predict what happens in the third and fourth quarter. But I think, our focus will be primarily, what it’s been all along, is on the credit-sensitive loans. That said, we’re active in the CRT market. We’re active in the three-year step-up market. We’re – even in the legacy space, if there are opportunities to add and maybe it’s a small piece and it’s an add-on position. I think, we’ve shown in the past that we take advantage of that.

Okay. And one last one, your debt- to-equity ratio ticked down a bit this quarter. Can we expect it to go back to 3x or even running at historically?

I think – first of all, it’s not really a number that we target or focus on. So you’re right, it did go down. I think it went probably – for several reasons, but I think one of the primary drivers is all the deal calls that we saw in the three-year step-up securities. We saw a lot of those deals get called. We had some appreciation in the legacy non-agency book. And every time that a bond appreciates, we don’t necessarily run to the counter-party and make a reverse margin call to borrow more money. So I think it’s a variety of things, but it’s not a targeted type number. And it’s also – it also changes based on assets that run off in the level of leverage that we have on those assets. So we’re getting the overall – the overall company-wide leverage is really a function of maybe five different asset classes and that leverage that we have on each of those. So if an asset class, for instance, like agencies pays down, the overall leverage ratio will likely decline because anything that we replace those with will use less leverage.

Okay, understand. Thank you so much.

Thank you. And our next question comes from the line of Doug Harter with Credit Suisse. Please go ahead.

I was hoping to just get a little more clarity on Slide 12 on the other income. Is the CRT and the fair value loans, is that other income reflective of kind of the equivalent of interest income? Or is some of that reflective of moves in spreads? And is there any way that sort of separate those?

Sure, Doug. This is Steve. I think your question’s hitting on the right sort of context here because – I think when you have to look at those two line items, you have to sort of – you definitely have to separate them. So when you’re thinking about NPL whole loans that we account for at fair value, you’re right, that includes a component that reflects cash coupon received as well as changes in fair value. So – and if you just look at the first six months ended June 30, 2017, 60% of the income that we recognized on the NPL whole loans, is from cash coupon. But it all gets reported in this other income line. The unrealized gain component of the income that we recognize reflects changes in discounted cash flows that are primarily driven by the underlying collateral values. So if you think about it in terms of – in the absence of any real underlying changes in property values or collateral values. So if you think about it in terms of – In the absence of any real underlying changes in property values or collateral values and if – In the absence of changes of the yields that we used to do discounting, we would generally expect those assets to continue generate income over time, as time line of liquidation decreases or as we otherwise return those assets to performing status. You can contrast that to the CRT portfolio, the changes in fair value there that are going through that other income line are driven by different factors. It’s much more market-driven. And therefore, it’s much more difficult to estimate how those – how changes in future fair values might arise over time.

But the coupon income from those CRT securities is recognized in the net interest income not just on the balance sheet.

That is correct. That’s right.

And Doug, just to give you an example, as I’m sure you know, when we buy a non-performing loan and we elect the fair value option, that’s an irrevocable option. So they’re always accounted for in that way. And Bryan mentioned earlier that we turned, I think it was $26 million of non-performing loans into reperforming loans during the quarter. So once those loans start to reperform, they’re actually cash-flowing, but because we’ve elected fair value at acquisition, that interest income that’s now truly coupon interest income is still recognized in this other income section.

Got it. And would it – If it would be possible to, going forward and maybe it’s in the Q is just to separate out that other income just to know how much is kind of cash coupon versus change in assumptions?

Yes, we actually do have a disclosure that in the Q, Doug. So – where we line out the amount of cash coupon goes to these unrealized gain changes. It’s in the footnote 4.

I appreciate that very helpful.

Thank you And our next question comes from the line of Steve Delaney with JMP Securities, please go ahead.

Thanks for taking question in great please give your best to go, The whole loan purchase is $350 million, let’s say, that’s a large amount. And I’m just curious, is that a record volume in whole loans for you guys in a quarter?

Steve, it’s not quite a record, but it’s very – quite obviously, one of them.

One of your best quarters.

Yes,

Yes, okay, because I realized, I looked back first quarter there, and I know it’s lumpy, but first quarter there were no acquisitions. So congrats on lining up those 4 deals. Now can you let us know – talk about what the split may have been between NPLs and RPLs within the 4 new pools?

Sure. So I would say 2/3 of the purchases would be more NPLs and 1/3 RPLs or performing loans.

Okay. 1/3 on RPLs. Okay. Thank you Bryan And I guess, just thinking about how step-ups have tightened. And obviously, you became an issuer on the RPL side. And this is probably over-simplistic because I know you don’t control your loan flow. But I guess, the first part of the question, have you seen the tightening in the step- ups? Has it been as severe on the NPLs as it has been on the RPLs? Or is it – or is there a differentiation in terms of the current investment opportunity in the 3- year step-up securities between those 2 loan categories?

Yes, it’s generally the same. The nonrated 2-year step-up securities, they’re going to be – they’re both sort of – they track each other. I think, as you’re asking on the RPLs, yes, we have seen the tightening – significant tightening on the rated RPL side as well.

The instrument Steve, that we did was a rated reperforming loan deal.

Okay. That’s important. And in fact, I did see something come across Bloomberg from DBRS when they were putting their provisional ratings on there. So I should have realized that. So I guess, just generally speaking, do you see more equity being allocated into the actual whole loans rather than the securities? It seems like you’ve got about 15% of your capital in the whole loans now. And is it – I’m just thinking where loans – returns on the loans are versus returns on the step-up securities. Am I thinking about that correctly that if the paper, if the loan pools were available that you might look to build that even though it’s more efficient probably and simpler just to go into the step-up securities?

It is and you’re right. Obviously, it depends on market yields. But at current yields, where those nonrated senior bonds are trading, they’re significantly less attractive to us than whole loans.

Got it. That’s what I was thinking, just looking at what’s been going on. But I just wanted to hear you guys confirm that so we can kind of direct future allocations. And I guess, the last thing, about the whole RPL/NPL, this is a sector. This is a question I get a lot from investors, and that is, where are these loans coming from? And what people are getting at is, here we are almost 10 years past the crisis, and we’re still seeing lots of loans changing hands that are in some degree of distress. And I’m curious if – when you guys look into these pools, is – are you beginning to see any loans that have more recent post-crisis spinages, but for whatever reason, whether it’s loss of employment, divorce, whatever your – I guess we’re still making some non-performing or reperforming loans? I was just curious, if that more recent volume is becoming a material factor in the market or if we’re still dealing with legacy paper.

We’re still, for the most part, dealing with legacy paper. There are a few loans that get sprinkled in, but it’s really – that’s – it’s a tiny minority of the loans that we see out there.

Got it. So just the old stuff still changing hands, it sounds like. Thanks go ahead.

Well the other thing we’re seeing, Steve is I would say the supply is leaning more towards reperforming than non-performing. So look, lots of non-performing supplies has been liquidated. And so now you have more loans that used to delinquent but are now reperforming.

Okay, thanks for the comments guys.

Thank you. Our next question comes from the line of Bose George with KBW. Please go ahead.

Hey thanks, good morning. It’s Eric on for Bose. The bump-up in yield quarter-on-quarter on the RPL/NPL MBS step-ups. Can you tease apart for us, how much of that was due to faster prepays versus changing credit assumptions?

On the 3-year step-ups or on the legacy?

Well, it looks like the yield jump was mostly on the step-ups? 4.38 this quarter versus roughly 4 last quarter? And in your opening remarks, I think, if I heard you correctly, your – the bond prepays anyway jumped up pretty significantly quarter-over-quarter?

Right. So we had purchased a few different securities that were maybe a little bit further down in credit and they yield more. It’s not a change of assumptions, plus all of the deals that got called away tended to be lower yielding. So we’re sort of shifting the portfolio a bit around to pick up a little bit more yield there.

Got it. Got it. That’s helpful, Bryan. And then the assets sales that you guys have been doing for, I guess, 20 straight quarters. In your press release you mentioned that you’re pulling the trigger on those when your projections for cash flow looked different relative to market pricing. I’m just curious, what it is that accounts for the difference between your projections and maybe with the rest of the street is using?

It’s just – it’s all assumptions. I mean, the three primary assumptions are, how many loans default in the future and at what losses are earning and what prepayment rates in. Yes, there may be some idiosyncratic deal issues occasionally with deal structures. But it’s – most of it’s assumption-driven, some of it may be, we believe we may have some insight on some type of deal structure. Or it could be a – it could be a low loan count deal, which might trade at a cheaper price, and we tag it on to a larger piece and get more of a round lot price.

Got it. Any color on asset sales since the end of the quarter?

No. I mean, I don’t – nothing significant. But we typically don’t comment within the quarter.

Okay. One more from me, if you don’t mind. You mentioned, some of the deal economics for the securitization that you guys did, but what’s the ROE that you expect to capture from the securitization that you did in June?

Well, it’s not really changing the overall ROE. We really – what we’re doing is, we’re changing the leverage component, right, because we lowered our cost of funding somewhat so the average coupon that we sold between the AAAs and the As was 2.75%. If we funded those reperforming loans on a warehouse or repo lines, they probably fund at LIBOR plus 2.25%. So there is a savings there, but the amount of leverage that we get via the transaction, probably not more than – not materially more than what we get through repo financing. So it’s a small benefit. And then that was a coupon and we sold, but there is some deal expenses, right, the rating agency fees, the legal fees. So if you bake all that in, maybe we think 25, 30, 35 basis points something like that. And so if it’s 3x levered, it may increase the ROE by 100 basis points.

[Operator Instructions] And our next question comes from the line of Rick Shane with JPMorgan.

Hey guys, thanks for taking my question. I did want to talk a little bit about capital. And if I sort of view on a levered basis an analysis of your capital returns last quarter. It looks to me like you got about $150 million of net equity back based on the reinvestments during the quarter. You raised a $175 million. So effective you’re sitting on $300 million of incremental capital. That’s fine, but I am kind of curious where you expect to deploy that. And if you come back and said, the agency market given the wide spread, that wouldn’t have surprised me, but it seems like your steering away from that still. So I’m just curious how you expect to deploy that capital.

Well, I think, one of the reasons why we see that is because of – we had a very, very heavy call schedule on the 3-year step-ups securities. I think, it was about a $0.2 billion of those that called away during the quarter. And obviously, that’s not predictable. We don’t know when those deals will get called. So we were somewhat surprised now. That said, we put out over $500 million back into those securities. And then, as Bryan said earlier, some of that money that we put back out went into down the credit stack a little bit. And when he gave yields, he talked about A1s and he talked about the A2s. But I think, in terms of deploying capital, we book across all the asset classes. If you look at the – if you look at the sheet where we show funds flows, we actually bought an agency security in the second quarter. So the investment team is actively engaged in all the asset classes that we play in, and some maybe that we haven’t bought yet as well.

Got it. So does that comment suggest that if you’d known you were going to get the magnitude of repayments on the 3-year step-ups for the calls on the 3-year step-ups that you did, that you wouldn’t have raised the equity? And the reason I say this is that, if you sort of look at where consensus is, if there is a little bit of a gap between dividend and consensus. And the incremental $300 million of equity is a drag on ROE, which seems to be sort of the crux of the issue here. And so I’m just curious how to think about this, given dividend coverage over the next 10 to 12 months?

Well, as you recall, I’m sure, our dividend is primarily governed by our taxable income, which tends to be higher than our GAAP income, and it has been for years. And it’s because of many of the idiosyncrasies of how taxable income is calculated on our asset classes, which is very complicated. So – and in terms of if we had a crystal ball and we knew, I mean, it’s – it’s not really a question I can answer, because unfortunately, we don’t have a crystal ball.

Understood. Look I wish I had a crystal ball too. I guess, maybe the way to frame this, as you raised money in May, at the beginning of May, when did those repayments occur? And objectively, when you contemplated that equity raise, did you anticipate the magnitude of repayments that you received or calls that you received during the quarter?

Well, that’s easy. We did the equity raise in early May, and the calls came in at the end of the month. But we had heavy calls at the end of May. We had heavy calls at the end of June. And we also said at the time that we were actively engaged in several whole loan transactions. And as this turns out, we actually bought four of those whole loan packages. So I think at the time that we did that, the asset class that we identified is where we saw the opportunity was in whole loans. And as you know, sometimes it’s frustrating bidding whole loans because it’s a winner take all, only one guy, wins. And so you spend all the work and you spend all the time, and you bid it. And it’s unlike a syndicated deal, we might get allocated. You might cut back in your allocation. Only one winner buys the whole loan packages. So we’re pretty happy that we were able to hit on all four of those. And all those came, by the way, after we did that equity raise.

Got it. Okay, I appreciate that. And Craig, after kind of pushing back on you a little bit, this will sound a little hollow, but it’s not meant to be. Congratulations on your new role as well. Thanks Craig.

And currently, there are no further questions. Please continue with any closing comments.

So I want to thank everyone for your participation today. And we look forward to speaking with you next quarter.