Ladies and gentlemen, good morning, and thank you for standing by. Today’s conference assembled. Welcome to the MFA Financial Incorporated 2022 Second Quarter Earnings Call. At this time, all lines are in a listen-only mode. Later there will be an opportunity for your questions and instructions will be given at that time. [Operator Instructions] And as a reminder, today’s conference is being recorded. At this time, it’s my pleasure to turn the conference over to our host, Mr. Hal Schwartz. Please go ahead.

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Webcast.

Okay. Let me start over and apologies for the snafu here. 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, 2021, and other reports that it may file from time-to-time with the Securities and Exchange Commission. These risks, uncertainties and other factors could cause MFA’s actual results to differ materially from those projected, expressed or implied in any forward-looking statements it makes. For additional information regarding MFA’s use of forward-looking statements, please see the relevant disclosure in the press release announcing MFA’s second quarter 2022 financial results. Thank you for your time. I would now like to turn this call over to MFA’s CEO and President, Craig Knutson.

Thank you, Hal. Good morning, everyone. And thank you for joining us here today for MFA Financial’s second quarter 2022 earnings call. Also with me are Steve Yarad, our CFO; Gudmundur Kristjansson and Bryan Wulfsohn, our Co-Chief Investment Officers and other members of senior management. As you are all no doubt aware, the first half of 2022 has been an exceptionally challenging investment environment across nearly all asset classes with the possible exception of commodities in the U.S. dollar. The S&P 500 Index was down over 16% in the second quarter and posted its worst first half of the year in over 50 years. Bond markets continue to selloff after a difficult first quarter and bond indices were generally down about 10% for the first half of the year. Mortgage spreads widened materially, as did credit spreads with high yield wider by nearly 300 basis points year-to-date. Persistently high inflation, continued geopolitical tension and an aggressive Fed tightening cycle that markets have not experienced since 1994 have combined to wreak havoc across financial markets. In short, there has been no place to hide thus far in 2022. Our team at MFA has taken steps to preserve capital and manage our duration beginning as early as the fourth quarter of last year when it became clear that the Fed would need to move more dramatically than previously expected. We had $900 million of interest rate swaps at year end and as rates rose and duration extended, we increased this position $2.4 billion at March 31, and again, to $3.2 billion at June 30. We also slowed our loan acquisition pace in the first quarter and again in the second quarter. At the same time, we continue to execute securitizations through the first half of 2022 and into July. Although, wider spreads,…

Thank you, Craig. Please turn to slide six for an overview of our second quarter 2022 financial results. Craig outlined in his opening remarks, mark-to-market adjustments on MFA’s investment portfolio again drove our GAAP results this quarter as further increases in interest rates across the yield curve, combined with spread widening resulted in asset valuation declines. This was substantially mitigated by our active portfolio management, including adding to our swap hedges and further use of the securitization financing. As a result, book value declines were relatively modest and distributable earnings continue to cover the Q2 common dividend. I will now discuss our Q2 GAAP results in more detail. GAAP earnings were negative $109.6 million or negative $1.06 per common share. Net interest income was $52.6 million. Loan interest income increased nearly 3% to $102.4 million as coupons and recent acquisitions have increased. The sequential quarter decline in net interest income reflects the impact of higher funding costs, consistent with the prevailing interest rate environment. Our net interest spread including the impact of swap carry decreased to 1.37% from 1.96% last quarter. However, with the recent Fed increase, our swap portfolio is now in a net revive position and this should benefit our cost of fund the net spread inclusive of swap carry going forward. Our CECL provision for credit losses was $30.4 million, primarily due to a $28.6 million reserve adjustment to write-down to zero and investment in a mortgage originator that recently ceased operations as a result of the current environment. In addition, CECL reserves increased modestly on the carrying value loan portfolio, primarily due to adjustments to prepayment speed assumptions using our credit loss model. That said, actual charge-offs remain modest and at $833,000 for the six months ended June 30 or over 40% loss in the corresponding…

Thank you, Steve. Turn to slide seven, home prices increased again in the second quarter with year-over-year growth hovering around 20% in June. But the increase in mortgage rates and higher home prices, affordability has become an issue for many would-be homeowners. These factors led to a slight increase in the supply of homes on market over the quarter. However, supply levels still haven’t reached pre-pandemic levels. The fundamental lack of housing inventory should continue to be a factor for the stability and growth to home prices. Unemployment -- employment backdrop remains strong and delinquencies remained normal [ph]. The credit in our portfolio continues to perform well and given all the volatility and uncertainty, we continue to be cautious over the intermediate term as economic prospects become increasingly uncertain. Turn to slide eight, we reduced our purchases non-QM loans again in the second quarter to $220 million, down from over $600 million in the first quarter, as volatility in rates and spreads remain elevated. We successfully executed on another securitization over the quarter totaling over $400 million of UPB sold. Recently, we have been purchasing loans with coupon between mid-to-high 7% range at moderate premium to par. We believe these new loan investments can generate low-to-mid double-digit ROEs through securitization. Serious delinquencies decreased further in the non-QM portfolio as a percentage of loan 60 days delinquent or greater dropped seven-tenths of a percent to 2.6%. The weighted average of original LTV for borrowers that are 60 days delinquent was 66% and that does not account for any potential home price appreciation post-origination. Many loans that experienced delinquencies and that being paid in full as our borrowers have equity in the property and sell the property themselves. Turn to slide nine, our RPL portfolio was approximately $835 million continue to perform…

Thanks, Bryan. Turning to page 11, July 1st marked the one-year anniversary of our acquisition of Lima One. The integration of Lima One into the MFA family couldn’t have gone better and the strategic vision we have implemented coupled with MFA’s capital markets expertise, strong balance sheet has allowed Lima to continue to grow and attract business from the best real estate investors in the BPL space. None of this would have been possible if it weren’t for the skilled and dedicated team at Lima One, which was executed exceptionally well on our strategic goals over the last 12 months. At the time of the acquisition, Lima’s trailing 12-month origination volume was approximately $900 million. Now 12 months later that stands at $2.2 billion, more than double what it was a year earlier. A key part of our strategy was and remains to improve the financing of the BPL loans that Lima One originates. To that end, over the last nine months, we have securitized approximately $1 billion of BPL loans originated by Lima One and have established securitization programs for all of the various loan products. Despite challenging market conditions for loan originators, Lima One continues to see strong demand for its BPL products and had another strong quarter with approximately $600 million originated in the second quarter. Throughout the year, we have proactively managed origination pipelines, by raising origination rates and making loan level pricing adjustments to ensure that we continue to create attractive investment for MFA’s balance sheet in any rate environment. As rates have risen, we have seen our production mix shift more towards shorter term transitional loans as the more rate sensitive longer term rental loans feel the impact of higher rates more acutely. Despite this shift in product mix, overall volume in our origination…

Thank you, Gudmundur. Please turn to page 14. So the second quarter of 2022 was obviously a challenging period in the fixed income and mortgage markets, but MFA’s active risk management practice lessened the impact on the company through interest rate swaps, securitizations and relatively low leverage. We generated distributable earnings of $0.46 during the quarter, prioritized liquidity and freed up balance sheet capacity that we can deploy as market opportunities arise. Lima One continues to achieve excellent results, despite raising rates to adjust the market conditions and a continued strong housing market benefits our mortgage credit exposure, despite developing affordability issues for homebuyers due to higher rates. Tom, would you please open the call for questions?

Thank you very much. [Operator Instructions] And we are going to begin with the question from Bose George representing KBW. Please go ahead.

Hey, guys. This is actually Mike Smyth on for Bose. Just a quick one on capital deployment, what’s the normalized level for leverage and then what are you looking for in the market to take up leverage and put some of that excess cash to work?

So thanks for the question, Mike. I mean, we have said this before we don’t necessarily target a leverage number. I think the leverage sort of falls out of two things, one is asset purchases, because we do lever assets when we buy them, and then the second is, how we finance them. So as we execute securitizations, typically that will raise the leverage a little bit because we get a higher effective advance rate through securitization. But if you look, it went from 3.1 to 3.3., I mean, I don’t see it really differing materially from somewhere in the low-to-mid-3s at least quarter-by-quarter, now that could change if we go out a few quarters and we buy a lot of really cheap assets. But at this point, I don’t see that changing all that materially.

Great. Thanks. That’s helpful color. And then, can you provide a quarter-to-date book value update?

Sure. So it’s very preliminary. We don’t really have a lot of numbers. But I think our best estimate would be the book value is probably up about 1% since June 30.

Great. Thanks a lot for taking the questions.

Sure, Mike.

Next we are going to the line of Steve DeLaney representing JMP Securities. Please go ahead.

Good morning, everyone. Thanks for the question and congrats on the progress made to Lima One on both sides of the rental and the Fix and Flip. Craig, I think you mentioned in your comments that you might have done two securitizations in July. We saw the one, the INV2, which was the rental loans. Was there another one done post quarter end, another product?

Yeah. Hey, Steve. This is Bryan. Yeah. We completed…

Hi, Bryan.

We completed a securitization of RPL loans. So if you like RPL loans. Yeah. That was the other one.

That was the other one. Okay. Good. So I think the -- Gudmundur, you mentioned, so the total securitization so far on the rental loans is two total including the one in July?

So we -- so, yeah, for the rental loans, we did one in April and then…

Yeah.

… we did another in July. That’s correct.

Got it. Okay. All right. Thanks. And Craig, back when we had the first quarter call, obviously that was in the midst of all the volatility and I think everyone was worried about liquidity, margin calls, et cetera, et cetera. Comment just generally on -- and I believe on that call, you spoke quite a bit about warehouse lenders and your relationship with your warehouse lenders. Could you just give us an update on that in terms of the willingness the warehouse lending community to support you are building up of inventory ahead of securitizations? I’d appreciate that. Thanks.

Sure, Steve. Thanks for the question. I would say that, we have very strong relationships with our lenders. They don’t just lend us money. They are the ones that do the securitizations and sell the securities. So it’s really a soup to nuts relationship. We have certainly seen no reticence at all from any lenders, and in fact, there are various parties that would like to lend us money on our loan portfolio and we would love to be able to do that, but we just don’t have enough borrowing to go around. So, I think, if you think about what happened in the conventional space, right, all these lenders have probably massive balances out to just the agency originators and so if anything there is probably balance sheet to spare. But like I said, we have had no issues whatsoever. I talked about margin calls, because we under-lever a significant portion over half of that mark-to-market financing, we got very few margin calls. I think our loan margin calls in the second quarter, might have been $10 million for the whole quarter and we probably netted $50 million of cash in from our swap position. So it’s been not that difficult to manage that liquidity. Also our recourse leverage is also ticked down. Our recourse leverage is now just 1.8 times. So this -- I think this policy of securitizing frequently and often and all the various product, it was going to serve us well over time.

Okay. That’s great. Really appreciate the comments. Thank you.

Thanks, Steve.

And our next question comes from the line of Eric Hagen representing BTIG. Please go ahead.

Hi. Thanks. Good morning. Hope you guys have doing well.

Good morning.

Maybe a few from me. Hey. Good morning. Maybe a few for me. How do we think about the value and the NPL portfolio at this point, like, what would you say is the duration of the spread over benchmark assets that you might look to describe the value that you are getting there? And then can you also say how much liquidity you have beyond the $400 million in cash, whether there is a minimum level of liquidity that you target over the near and kind of medium to longer term?

So, probably, thinking about the value of the NPL portfolio and the duration of it, it’s really -- the value is up. All of those loans are to continue to be fair value, but half of that book now is actually performing, right? So it’s going to have plus or minus 5% coupon purchase that is big significant discount to par and then the other half of the portfolio, they are just waiting to be liquidated. And given what we have seen in HPA and given what the prospects are for HPA going forward, you don’t need to see too much growth to continue to see that sort of expected yield somewhere between 7% and 8% on those assets.

Got it. That’s helpful.

And Eric, this is Steve Yarad. Just addressing your question on additional sources of liquidity and it’s quite referred to, we do have a significant under borrowing on some of our warehouse -- mark-to-market warehouse loans and that’s as much as $120 million to $150 million at the end of June.

Got it.

So said another way, Eric, when we could borrow another $125 million or $150 million on those assets that we have pledged, we just don’t, because it’s a sort of self-imposed discipline in creating that question.

Got it. Okay. That’s helpful. And can you say whether, sorry, any of the retain tranches from securitization get pledged as collateral for financing?

So up until very recently, the answer would be no. There have been a couple of deals that we have done since June, I am sorry, since March 31st, where some of the pricing on, say, for instance, some of the IG, the investment grade rated bonds was pretty wide and so we did retain a couple of those. They are typically fairly small tranches. And again because we have a strong balance sheet, we can sort of impose that discipline on the market that if the pricing is really to wide, we can just retain those securities. And so, particularly those investment grade-rated tranches, we will borrow on those, because those are actually pretty easy to borrow -- to lever. And we could sell those in the future, right, should the levels become attractive. But for the time being, if the bonds is going to -- if the tranche is going to priced at 7.5% or 8%, we would rather own that.

Great. That’s helpful. And then on the non-QM, can you remind us, is there a call option on the securitized debt and how you might look to exercise the call option and even if the market is relatively wide because the debt itself has de-levered a little bit?

Yeah. So generally we will have a call option, say, two years to three years time for 30% of the UPB -- of the original UPB, whichever comes sooner. And really it’s deal by deal kind of exercise that we will look at to determine how far down it’s delevered where our spreads and in the market today and that will determine whether we call back the loans to reissue.

Right. Thank you. I appreciate the comments.

Thanks, Eric.

Thanks.

We have a question from Doug Harter with Credit Suisse. You are open.

Thanks. Can you talk about the relative return differential versus -- as you do securitization versus holding it on the warehouse lines?

Yeah. I mean, I think, so it’s -- securitization I think widened during the year. I think if you are securitizing non-QM collateral in general with -- right, non-QM will -- SFR loans we have, the all-in cost of funds is probably between 5.5% to 6%. It can range from collateral and type of yield. On the warehouse, we are probably close to LIBOR plus 200 to 250, something like that. So with LIBOR at 275 to 300, the cost of funds on warehouse is still lower, probably, by the tune of anywhere from 75 basis points to 100 basis points. But for us, it’s not necessarily all about just the cost of funds. The securitization provides tremendous benefits from a risk management perspective to think about liquidity, as well as the fact that it’s non-mark-to-market non-recourse. We think by moving more into securitization, it’s definitely the path we want to do and that’s what we have done obviously over the last 18 months to 20 months. And so, you should expect us to continue to securitize in the future, but for now there is a benefit on warehouse versus securitizations.

Got it. And then, I guess switching to Lima One, I guess, how do you view the level of profitability that you able to generate in the second quarter and the sustainability of that and what’s clearly become a more challenging market?

No. Thank you for the question. I think the way we think about Lima One, is really -- it’s not one quarter to the next, but it’s a business that we believe in terms of the long-term ability to generate attractive assets for us on our balance sheet. And as you have seen over the last 12 months, we have taken that business to a whole new level and the way we think about it is, we will continue to nurture them, give them all the tools that they need to improve their efficiencies and grow. And I guess, more importantly, as you have seen, we have raised rates dramatically there with the market and as we said in our prepared remarks, the pipeline now has coupons of approximately 8% and they are rising every day. And the way we think about that is that we are creating our own credits, which is going to perform really well going forward. And that’s really how we think about as opposed to whether they generated ROE each quarter and we see instead portfolio growth for us over time.

Yeah. Doug, one thing I would add is, I think, the strategic benefit of Lima One is, it’s a captive source of really high-quality, high-yielding assets. And if we had to go buy those assets out in the marketplace and compete for those assets, we would be paying a lot more for those assets, the yields that we buy them, that would be significantly lower and it would just be more difficult to acquire size of those assets. So it’s a little hard to quantify the strategic important to that, but I think it’s a real thing. And the other thing I would just add from a -- as we think about the business. We effectively think about the Lima creating these assets roughly at costs for us. So over cycles and over time, we would expect that their origination fees, servicing fees and that asset fees that they generate in normal course of business will kind of roughly offset the G&A and that’s kind of how we would think about it over the long-term.

Got it. And maybe just then the portfolio would be more profitable to Craig’s point, that you would have to pay more to acquire those in the open market?

Exactly.

Exactly. And that can be a huge difference, I mean, for example, on the Fix and Flip side, people are usually buying loans with stripped down coupons with anywhere from 200 basis points to 300 basis points. So that’s obviously a huge benefit to us to retain all in our balance sheet.

Okay. Thank you, guys.

Thanks, Doug.

And our speakers, there is no other participants queued up at this time.

All right. Thanks, Tom. I’d like to thank everyone for your interest in MFA Financial and we look forward to our next update when we announce third quarter results in November. Thanks, Tom.

Thank you very much. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and using the AT&T Event Services. You may now disconnect.