Ladies and gentlemen, thank you for standing by, and welcome to the MFA Financial, Inc. First Quarter Earnings 2021 Conference Call. [Operator Instructions]. I would 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, 2020, and other reports that it may file from time to time with the Securities and Exchange Commission. These risks, uncertainties and other factors could cause MFA's actual results to differ materially from those projected, expressed or implied in any forward-looking statements it makes. For additional information regarding MFA's use of forward-looking statements, please see the relevant disclosure in the press releases announcing MFA's first quarter 2021 financial results and the acquisition of Lima One Capital. Thank you for your time. I would now like to turn this call over to MFA's CEO and President, Craig Knutson.

Thank you, Hal. Good morning, everyone. I would like to thank you for your interest in and welcome you to MFA Financial's First Quarter 2021 Financial Results webcast. Also with me today are Steve Yarad, our CFO; Gudmundur Kristjansson and Bryan Wulfsohn, our co-Chief Investment Officers and other members of senior management. As we sit here today to talk about the first quarter of 2021, it's impossible not to recall where we were a year ago, and the difference between the 2 time periods could not be more stark. A tenacious defensive stance is now a spirited and determined offense. Today, we are reporting strong financial results, continued execution of a strategic plan that we implemented early last fall and a new exciting initiative that we announced today. With vaccinations becoming more prevalent and the gradual easing of restrictions beginning to occur, we have reason to be optimistic about an eventual return to some semblance of ordinary. While it is undoubtedly months away, we are cherishing brief snippets of limited normalcy, and it's great to see our colleagues at work in person rather than on video calls as we have for the last year. A strong economic outlook, additional fiscal stimulus and the expectation of more government spending pushed loan rates higher in the first quarter of 2021. The 10-year treasuries backed up 83 basis points to 1.74 at the end of Q1, which, by the way, is where they were in late January of 2020. And the curve steepened with two 10s widening by about 80 basis points to 158 basis points at March 31. Short rates remain firmly anchored at very low levels, with 2s only 4 basis points wider during the quarter. Interestingly, although 10-year rates at 170 are back to levels seen in late 2019 and…

Thank you, Craig. Please turn to Slide 11 for an overview of our first quarter 2021 financial results. In reviewing our results this quarter, I guess I could say what a difference a year makes, but this simply doesn't do it justice. A year ago, I had the unpleasant task of talking through a myriad of negative numbers on this slide, including realized and unrealized losses on securities and loans, impairment charges, CECL reserves and other large and unusual items. This quarter, I am very pleased to be able to provide a much more positive report. Much of the noise reported in our net income over the past several quarters, resulting from volatile changes in asset prices and cash flow estimates, driven by uncertainty related to the longer-term effects of COVID-19 have dissipated and hopefully are largely behind us. While not fully reflecting MFA's normalized earnings for the short to medium term, I believe that Q1 results do provide a clearer picture of what the key drivers of our earnings will be for the next several quarters. Specifically, our earnings will be driven by net interest income and gains on loans held at fair value. This is - there is also some potential for further adjustments to decrease CECL reserves if unemployment rates and home prices stabilize or continue to improve. But absent any significant future macroeconomic shocks in the near term, I would anticipate that CECL reserve changes going forward will be primarily driven by net increases or decreases in our portfolio of carrying value loans. Additionally, in anticipation of the successful completion of the acquisition of Lima One, starting in Q2, we plan to elect fair value accounting and all future whole loan purchases. This should facilitate appropriate reporting of the economics of Lima One origination and servicing…

Thank you, Steve. Turning to Page 12. Housing has performed exceedingly well throughout the pandemic, and prices have accelerated in recent months. The Zillow median home value was up 10.6% in March from a year ago. Demographic trends, historically low rates and a severe lack of supply have all contributed to the rising prices. The unemployment rate continues to recover from a peak of almost 15% down to 6% as the economy reopens. With the vaccination rollout underway, the pace of reopening should pick up in the coming months, lowering the unemployment rate further. All these factors, combined with monetary and fiscal support have played a part in keeping mortgage credit performance strong and bode well for continued credit performance. Turning to Page 13. Non-QM origination volume increased over the quarter as rates offered to borrowers have been dropping. We purchased over $200 million over the first quarter, which is more than double our acquisitions from the prior quarter. Prepayment speeds remained elevated over the quarter as mortgage rates for Non-QM loans have come down in recent months. The 3-month average CPR for the portfolio remains around 30%. We closed on another minority investment in an originator over the quarter, raising the number of Non-QM originators we have invested into 3. We believe the strategy of aligning our interest with select origination partners will allow us to effectively grow our portfolio over time while ensuring loan quality. We executed on an additional securitization at the beginning of April, bringing a total amount of collateral securitized to approximately $1.75 billion. These securitizations have lowered our financing costs and at the same time, have provided additional stability to our borrowings. Securitization, combined with non mark-to-market term facility has resulted in over 80% of our Non-QM portfolio financed with non mark-to-market leverage. We…

Thanks, Bryan. Turning to Page 17. First of all, I would like to say that we are very excited about the acquisition of Lima One. The acquisition enhances our position as a long-term capital provider to the business purpose lending space, which we believe continues to benefit from positive fundamental and structural trends, and offers one of the most attractive options to deploy capital in the residential mortgage credit space. We worked closely with Lima One since 2017, first as a loan buyer and later as an equity investor, and have seen firsthand the quality of their loan origination and servicing operations. From our extensive experience in the BPL space, we know that Lima is one of the best operators in the space and look forward to collaborate with Lima's talented management team. Lima One is a leading nation and originator of business purpose loans with a strong brand recognition in the BPL borrower community with over 50% of loan origination coming from repeat borrowers. Their product offerings are diverse, serving the needs of short and long-term strategies within the BPL space. They have an established track record of originating fix and flip and new construction loans, longer-term rental loans and small balance multifamily value-add and bridge loans. Lima has originated over $3 billion since inception and has shown that they can reliably originate over $1 billion annually. We believe that by combining MFA's permanent capital and capital markets expertise with Lima's capabilities, we can create a differentiated platform capable of providing best-in-class financing options to investors with a clear path to grow well beyond $1 billion in annual volume. This acquisition will provide MFA with a reliable access to high-quality, high-yielding assets that are difficult to source in the marketplace. We believe based on current market conditions, at loans…

Thank you, Gudmundur. We are pleased with the results of the first quarter of 2021 and even more excited about the future at MFA. We are continuing to execute our strategic plan to lower and term out borrowing costs, and we're beginning to see the results of this activity in our income statement. The strength of the housing industry has obvious positive implications for our mortgage credit investments. We have repurchased nearly 25 million shares of our common stock at levels that are accretive to book value and earnings. And today's announcement of our acquisition of Lima One is an important initiative that will enhance our ability to deploy future capital in the BPL sector and grow our future earnings power. Tony, would you please open up the line for questions?

[Operator Instructions]. Our first question comes from the line of Bose George with KBW.

This is actually Mike Smith on for Bose. Congrats on the acquisition. So on that, what is the pro forma breakdown of the capital allocation to the investments business versus the originator?

I mean it's not a large capital allocation to the originator, right, relative to our balance sheet. We already own 43%. So I mean, I don't think it's really a material change in how we allocate capital.

Yes. I think it's more going to be on the investment activities. So as we've said, we expect Lima will originate between $1.2 billion and $1.3 billion in 2021, and we believe that they can sustainably originate over $1 billion on an annual basis. And so based on that and the funding profile of the assets, you can make some assumptions that - if we're deploying 20% to 25% of equity to those types of trades that would support over time anywhere from $250 million to $300 million of equity deployed to those types of investments.

Okay. Great. That's helpful. And then how much excess capital will the company have after deploying capital into the transaction?

Well, what did we show for cash at 331, $800 million?

Yes, it's roughly $800 million, 331.

It will be over $700 million.

Okay. Great. Great. That's helpful. And then kind of on a different note. Thinking about buybacks, how do you - if you look at GAAP or economic book value? And kind of with that in mind, your expected excess capital, how should we think about additional buybacks from here?

Sure. So in answer to your question, what do we look at? We look at economic book value because I think something like 70% of our loan portfolio is not marked to market on our balance sheet for GAAP purposes. So it's purely economic book value. And I think as the stock trades, don't forget when we put the share repurchase plan in place, I think the stock was probably around 60% of economic book value. And it's now north of 80. So suffice to say, our appetite to repurchase stock is not as voracious at above 80, as it was above 60, but it's still one of the tools that we have.

Great. That's helpful. And then just one more. Can you provide some thoughts on how book value has trended during the month of April and into May?

So we haven't closed our books for April yet. We're still in the process, but just from what we can see from our sort of daily reporting, it's not materially different.

Our next question comes from the line of Doug Harter with Crédit Suisse.

This is John Wachowski [ph] on for Doug. Congratulations on the quarter. Just a quick question on the securitizations. You had a few successful securitizations this quarter and last quarter. Kind of going forward, what should we think in terms of the pace of securitizations and how it will affect your cost of funds?

So we expect to be out in the market regularly. I mean and we still have a good chunk of the portfolio that can be securitized. But really, once we work through that, it's just going to be the regular flow that we're purchasing, that is what we expect to securitize. So the majority of our financing going forward will be financed through securitization.

Our next question comes from Steve Delaney with JMP Securities.

Exciting times. Congratulations on the acquisition. I think it really adds something to the story and your franchise value. Craig, with the Lima deal, should we - can we read through that, just because you had a lot of options, I'm sure. Does this tell us that you see the BPL product to be the most attractive of the non-agency residential loan types that are in the marketplace?

So it's certainly - yes, we certainly view it as a very attractive sector. I think we also view Non-QM in a similar fashion. I think with Lima One, we've obviously been very familiar with that company for a long time. There's a lot more competition to acquire these assets today and to acquire these originators than there was previously. So I think we're - I think it was a strategic minority investment that we made in 2018. And I think it put us in a very good position to affect this transaction. There's probably no originator that we know better than Lima One, right? We bought over $1 billion of loans from them. And we've seen firsthand how their loans have performed relative to other BPL originators, particularly through a difficult 2020 period. We've been to Greenville. We worked closely with the management team, their servicing group, their accounting folks. So there's a lot of very good touch points between our companies. And I think while this is a big transaction, it's an unusual transaction for us. I think it should be a pretty seamless transaction.

Yes. You know what you're getting. So on the NQM side, obviously, I don't know whether it's - Bryan can probably tell us whether it's a larger market on NQM than BPL, they're both pretty good size. But on the NQM, should we assume you've got a strategic investment there as well. And there really are 2 different sourcing methods. So I mean, if you wanted - it would seem to me that if you wanted to do something in NQM, you might need to make another acquisition of someone specialized in that product.

We mentioned that we - we've made another minority investment in a Non-QM originator. I think it's all about sort of fact and circumstances, right? What is the originator looking for? And so I think at least for now, these minority investments have worked pretty well. They've helped us secure loan production. We also get to know these originators a lot better. We've always said when we meet new originators, and we can talk about capital needs. But one of the first things we say is we'll get to know each other a whole lot better when we start buying loans. So I think it's all a process, Steve, and it will really depend on where we stand and where these originators stand and what they're looking to do.

Sure. I understand. It's kind of like a marriage thing, right? It's got to be the right time and the right place. Yes, absolutely. And you don't want to make a mistake there I can tell you from experience. It costs, it's expensive. And just to close it out, one for Steve Yarad. So I was just trying to get - you had some big items. So I was trying to get to sort of a normalized first quarter. So I take the $8 million from the non-Agency RMBS, great recovery there. I get $0.02 there. And then the CECL reversal, $23 million, I get $0.05. So I'm looking at sort of $0.07 off of the $0.17 reported. Is that a reasonable adjustment, Steve? Or am I missing something else that you would say is an unusual or abnormal, which - should you need to add anything to that?

No. So I think certainly, the $8 million adjustment on the Non-QM bond that we have paid got redeemed. That's somewhat an unusual one. CECL, as I said in my comments, I mean, we've released a lot of CECL reserves over the last 12 months or so. And there could be some potential for some more. But I don't know that it will be as dramatic as what we've seen over the last 12 months. In terms of the rest of the income statement, as I said, it really is approaching what we think is a more normal level. Obviously, the carrying - or the fair value lines have performed extremely well over the past several quarters. So whether we can produce $50 million a quarter, that remains to be seen depending on pricing. But if you look in the details of that, it very consistently produces around $20 million of cash income each quarter. And you look in the footnotes to the 10-Q, which we'll file later today. So it's not like that's certainly going to be substantially different and with - as Craig mentioned, with the prospects of further economic recovery and stimulus, it could still continue to perform quite well.

[Operator Instructions]. I'm not seeing any additional questions in the queue. Please continue.

All right. Thank you, everyone, for your interest in MFA financial. We look forward to our next update when we announce our second quarter results in August.

Ladies and gentlemen, this does conclude your conference for today. It will be available for replay after 12:00 p.m. Eastern through August 6, 2020. You may access the AT&T replay system at any time by dialing 1-866-207-1041 and entering access code 4522814. International callers may dial 402-970-0847. Those numbers again are 1-866-207-1041 and 402-970-0847 with access code 4522814. That does conclude our conference for today. We thank you for your participation and for using AT&T conferencing service. You may now disconnect.