Prepared remarks
Greetings, and welcome to the MFA Financial, Inc. Second Quarter 2025 Financial Results Conference Call and webcast. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Hal Schwartz, General Counsel. Please proceed.
Thank you, Kevin, and 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, 2024, 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 2025 financial results. Thank you for your time. I would now like to turn this call over to MFA's CEO, Craig Knutson.
Thank you, Hal. Good morning, everyone, and thank you for joining us for MFA Financial's Second Quarter 2025 Earnings Call. With me today are Bryan Wulfsohn, our President and Chief Investment Officer; Mike Roper, our CFO; and other members of our senior management team. I'll start with a broad overview of the second quarter market environment, followed by some highlights of our results, activities, and opportunities. Then I'll hand the call over to Mike for a more detailed review of our financial results, and Bryan will discuss our portfolio financing, Lima One, and risk management before we open the floor for questions. You'll recall the market upheaval in the second quarter, particularly with Liberation Day on April 2. 2-year treasuries started the first quarter at 3.88%, improved to 3.65% by April 4, dipped to 3.96% on April 11, then rallied again to 3.60% on April 30 before rising to 4.05% on May 14.
10-year treasuries experienced a similar pattern, gaining 20 basis points to 3.99% on April 4, falling 50 basis points to 4.49% on April 11, closing April at 4.16%, and then moving to 4.60% by May 21. Fortunately, cooler minds seem to have prevailed since then, both in Washington and across bond and equity markets. At least until the employment report revisions last Friday, both 2s and 10s have generally stabilized within their own 25 basis point ranges since mid-May, and equity markets have continued to trend upward, despite last Friday's developments. Mortgage credit spreads, which track other risk assets, widened somewhat in April before returning to levels similar to the end of Q1 by the conclusion of the second quarter. Importantly, the market for securitized mortgage credit assets, particularly non-QM securitizations, continues to grow as liquidity increases and investor demand remains strong.
While spreads can fluctuate alongside other risk assets, transactions are being completed and priced orderly. This contrasts sharply with 2023 when demand was weak, spreads were volatile, and some deals were withdrawn from the market. The strength and reliability of this market are robust, representing a crucial financing source for over 80% of our loan portfolio. Although economic and macro environments can be unpredictable, they appear a bit clearer as we move further into the year. Growth, though slower than initially anticipated, is showing remarkable resilience. The passage of the tax and spending bill has alleviated previous uncertainties. Inflation concerns have decreased, particularly as tariff discussions begin to resolve more favorably than expected. Employment continues to grow, albeit at a slower pace; however, recent adjustments in last Friday's jobs report suggest that the job market may not be as strong as previously thought.
Amidst the ongoing dialogue between the President and the Fed Chair, the prevailing expectation seems to be for two rate cuts later this year, which is always beneficial for mortgage REITs. Housing is facing challenges as demand drops due to interest rate issues and affordability concerns. Actual home price declines are predominantly found in certain areas where new supply has overwhelmed local markets. However, a nationwide supply shortage persists, making it difficult to predict anything more than slight decreases in home prices on a national scale. Most homeowners with existing mortgages are not over-leveraged, and years of significant home price appreciation, combined with sensible underwriting practices, mean that Loan-to-Value ratios are low enough that, even in the event of financial distress, borrowers have enough equity to sell their homes and settle their debts. In this environment, our portfolio generated a total economic return of 1.5% for the second quarter and 3.4% year-to-date, including our first two quarterly dividends, which we raised to $0.36 in the first quarter.
Our economic book value decreased slightly by 1% in the second quarter. Our distributable earnings for the quarter were $0.24 per share, negatively impacted by credit losses on certain business purpose loans realized during this period. Without these credit losses, distributable earnings would have been $0.35. It's important to remember that these credit losses only affect distributable earnings when they are realized. As Mike Roper has noted in previous quarters, these loans were valued down in 2024 and earlier when they became delinquent. Our fair value assets are marked to market every quarter, so the economic credit loss was recognized through GAAP earnings and a reduction in book value much earlier. In other words, these realized credit losses, which impacted distributable earnings in the second quarter, are not new developments. Mike will delve deeper into the actual resolution amounts versus the valuations of these loans during his prepared remarks.
We were active in the second quarter, sourcing $876 million in loans and securities across our target asset classes, including $503 million in non-QM loans, $131 million in Agency MBS, and $217 million in business purpose loans through Lima One. We completed our 18th non-QM securitization in early May, selling $38 million of newly originated single-family rental loans and $24 million of delinquent transitional loans. Our overall leverage at the end of the quarter stood at 5.2x, with recourse leverage at 1.8x. Once again, the second quarter showcased MFA's investment portfolio, balance sheet composition, and risk management strategies, which are well-positioned to yield results under various scenarios and navigate unexpected market volatility and uncertainty. I will now turn the call over to Mike Roper for a detailed discussion of our financial results.
Thanks, Craig, and good morning. At June 30, GAAP book value was $13.12 per share and economic book value was $13.69 per share, each down about 1% from the end of March. MFA again paid a common dividend of $0.36 and delivered a total economic return of positive 1.5% for the quarter. MFA generated GAAP earnings of $33.2 million or $0.22 per basic common share in the second quarter. Our GAAP results were driven by growth in our net interest income to $61.3 million as well as modest net mark-to-market gains. This marks the third consecutive quarter we've grown our net interest income, driven by additions of higher-yielding assets over the last several quarters. Net interest income also benefited from a nonrecurring $2.6 million acceleration of discount accretion on our MSR-related assets, which were redeemed during the quarter. During Q2, we continued to make meaningful progress resolving nonperforming loans.
We reduced overall portfolio 60-plus day delinquency from 7.5% to 7.3% and lowered the balance of loans on non-accrual status by $33.6 million compared to last quarter. In addition to our more traditional asset management activities, we resolved approximately $24 million of some of our most challenged transitional loans via loan sale during the quarter. We expect to utilize additional loan sales in the second half of this year to continue to accelerate the resolution of underperforming assets, allowing us to unlock and redeploy capital at mid- to high-teen return on equity. Importantly, because our assets are predominantly accounted for at fair value, the expected losses associated with these potential sales and resolutions have already been recorded in our GAAP results and in book value in prior periods, in some cases, years ago as unrealized losses. We mark our portfolio each quarter to what we and our third-party pricing services believe are the levels at which the loans would trade in the secondary market to a level net of expected credit losses.
Confirming this belief, during the quarter, we resolved the current approximately $200 million UPB of previously nonperforming loans. After reversing previously recognized fair value marks on these assets, the net impact on our GAAP results and our book value for the quarter was a net gain of over $0.03 per share. We believe this net gain on asset resolution highlights the quality of our loan marks and of our financial reporting. Moving to our distributable earnings. DE for the quarter was $24.7 million or $0.24 per share, a decline from $0.29 per share in the first quarter. The decline was driven primarily by credit losses on fair value loans, which totaled $0.10 per share for the quarter, approximately $0.06 higher than in Q1, as well as a $0.02 increase in the dividend rate on our Series C preferred, which began floating on March 31. As Craig mentioned, our DE, excluding credit losses, was $0.35 per share, nearly in line with our common dividend.
For the quarter, our consolidated G&A expenses totaled $29.9 million, a decline from $33.5 million in the first quarter. Second quarter results included severance and related transition costs of $1.2 million, the result of expense reduction initiatives across both MFA and Lima One. We expect that once complete, these initiatives will further improve our cost structure, lowering our run rate G&A expenses by 7% to 10% per year from 2024 levels or approximately $0.02 to $0.03 per quarter. Though we expect some short-term pressure on distributable earnings, particularly over the next two quarters, we have confidence in both the current earnings power of the portfolio and the current level of our common dividend. We continue to expect that our DE will begin to reconverge with the level of our common dividend in the first half of 2026. Finally, subsequent to quarter end, we estimate that our economic book value has increased by approximately 1% to 2% since the end of the second quarter. I'd now like to turn the call over to Bryan, who will discuss our investment activities in the second quarter.
Thanks, Mike. We grew our investment portfolio to $10.8 billion in the second quarter. We continue to focus on our target asset classes of non-QM loans, business purpose loans and agency securities. We sourced and purchased over $500 million of non-QM loans during the quarter. These loans carry an average coupon of 7.8% and an average LTV of 66%. We established relationships with two new originators during the quarter and we will look to add more moving forward. Underwriting standards in the non-QM space remain prudent and mid- to high-teen return on equity remains achievable with securitization funding. The market continues to be supportive of non-QM issuance as the total bonds sold by all issuers so far this year has already nearly eclipsed the total from all of last year. We completed our 18th non-QM securitization in May, selling $291 million of bonds at an average coupon of 5.76%. As Craig mentioned, credit spreads were volatile during the quarter, especially in April when AAAs widened to as much as 175 basis points over treasuries.
But spreads tightened over the remainder of the quarter back to where they were before the trade war turmoil started. On Monday of this week, we priced our 19th non-QM securitization and were able to improve pricing due to strong investor demand. We again added to our Agency MBS portfolio during the quarter, growing our position to $1.75 billion. Our focus remains on low pay-up securities, generally 5.5% that we were able to purchase at modest discounts to par. We plan to grow our agency position further as long as spreads remain attractive. Turning to Lima One. Lima originated $217 million of business purpose loans during the quarter, a slight uptick from the first quarter. This included $167 million of single-family transitional loans with an average coupon north of 10% and $50 million of new 30-year rental loans with an average coupon of 7.5%. As a reminder, we continue to sell newly originated rental loans to third-party investors.
Lima as a whole contributed $6.1 million of mortgage banking income for the quarter, an increase from $5.4 million in the first quarter. Lima again had success adding to its sales force, hiring 15 new loan officers during the quarter. Although origination volumes are down both at Lima as well as across the industry, we expect these new hires, along with significant progress on technology initiatives to lead growth in origination volume and profitability in the latter half of this year. Moving to our credit performance. As Mike mentioned, the 60-plus day delinquency rate for our entire loan portfolio declined to 7.3% in the second quarter. Default rates for our non-QM and rental loans remained exceptionally low at approximately 4% and fell to an all-time low in our legacy RPL/NPL book. We continue to be hard at work addressing our nonperforming transitional loans. We sold $24 million of delinquent transitional loans during the quarter and expect to sell more later this year.
Although the default rate percentage rose again for our single-family transitional portfolio, it's important to note that loan delinquencies actually declined by $2 million, and we received $269 million of principal repayments, up from $249 million in the first quarter. We again resolved $35 million of previously delinquent multifamily loans during the quarter and received $99 million of principal repayments. And with that, we'll turn the call over to the operator for questions.
Questions and answers
Our first question today is coming from Bose George from KBW.
I'm going to start by asking where you see the economic return for the portfolio. You mentioned there's this $0.10 of credit and a couple of cents we gain from the expense side that gets us above the dividend. Is that the economic return, or do you see any additional upside as you redeploy some of the capital from the troubled loans currently?
Thanks for the question, Bose. I think a couple of parts to your question there. So we talk about the economic return of the portfolio regularly on these calls as well as internally and with our Board and setting dividend policy. And one of the sort of downsides of DE and really any accounting metric is that it's backward looking. When we think about the earnings power of the portfolio, we try to think about the go-forward earnings power. And if you think about the sort of ROEs the portfolio is generating on a mark-to-market basis, that's really how we think about the economic earnings power of the portfolio. For example, we have some loans that were purchased in 2021 that are held at a pretty significant discount with a coupon rate of, call it, 4%. Because that asset is accounted for at fair value, if you think about the total economics of that, whether it shows up in interest income or in the mark, that asset clearly is earning more than 4% today.
So when we take that sort of mark-to-market ROE and do the same thing on the hedges and the liabilities and then you layer in your expenses and the P&L that Lima is generating associated with their origination platform, the economic earnings power is much closer to the 10% dividend yield already. I think the second part of your question as far as additional upside, I think the answer is definitely yes. I mean we've been running with quite a bit of dry powder for some time now. Our recourse leverage is 1.8x. And even ignoring the $275 million of cash, we have a lot of capacity to turn up that leverage number a bit. So there's definitely some upside there. And you'll see that we've added a large number of assets again this quarter as we have for the last several quarters.
And Bose, just to clarify one thing, Mike said that the 10% dividend yield, he means the 10% dividend yield on our book value, not on the stock price.
Okay. Yes, absolutely makes sense. And then in terms of the different areas where you can allocate capital, like where do you see the best ROEs at the moment?
We appreciate all three segments. We were particularly active in non-QM, and all three categories include non-QM, agency, and business purpose loans. Our goal is to increase the business purpose loan originations over time, as they offer the highest return on equity. As we've indicated, we're hiring at Lima One and anticipate growth in that area. Ultimately, we're looking to invest across all three segments, but if Lima can handle more originations, we would definitely prefer that option over the others.
Next question today is coming from Steve Delaney from Citizens JMP.
The 15 new loan officers hired, I understand that's at Lima One. Could you comment on that? Are these going to be generalist producers? Is there any product specialty that you're trying to develop? And I guess, most importantly, is there any new geography? Have you opened offices in any new states as a result of the new producers?
Yes. Our hiring focus is primarily in the West and Midwest regions. We are confident that these new hires are high-quality candidates from competing firms. It typically takes new employees a few months to become familiar with our products and processes compared to their previous experiences. While we are currently seeing some growth, we anticipate a much more significant increase in growth in the latter half of this year and into next year as these individuals become fully productive.
Yes. Okay. And how many total producers, you may have mentioned it, I apologize, now as we sit today at Lima One?
Yes. We were pushing, I think, 50, and the goal is to continue growing that, I think, closer to 80.
There's still some runway ahead. Thank you for the clarity on the dividend coverage. I was looking at Page 16 in the presentation, and while it's helpful, the unrealized and realized gains and losses make it difficult for us to assess coverage independently without Mike's assistance this morning. I wanted to suggest considering how this information is presented in the deck. Overall, there is good strategic progress, and I understand that the losses are an ongoing issue that we still need to address. Thank you for your time this morning.
Thanks, Steve.
Thanks, Steve.
Thanks, Steve.
Your next question today is coming from Jason Stewart from Janney Montgomery Scott.
Just to follow a little bit on Bose's question. You talked about growing Lima One. But as we think about the balance sheet going into the easing cycle and maybe post steepener on the yield curve, like how do you envision capital allocation trending between the businesses on the balance sheet?
Yes. I mean, really, if you think about a steepener, right, Lima One is still originating assets that have coupons north of 10%. So if you have steepener and the short end comes down, maybe that coupon goes from 10% to 9% or to 8.5% or something like that. But the borrowing costs against those is also going to come down commensurate. So right now, in securitization, you can get funding in the 5 handles, right? So if that front end were to come down, you would see that cost of funds drop into probably the low 5s, 4% handle. So it's still very sort of accretive to us to originate those loans. And when you look across non-QM, it does benefit our existing portfolio and incremental loans will fund incrementally better, but I would expect those loan prices to be bid up more aggressively as the curve does steepen. So it may be a more competitive environment and may compress yields somewhat there.
Okay. And then thinking through the post steepener, and I guess more specifically then on the agency, would that be a strategy you deemphasize at that point in a flatter curve environment and redeploy that capital into Lima One and other strategies?
That's correct. We see the current spread levels as a good opportunity to invest in Agency MBS. If those spreads were to narrow, we would reallocate those assets and that portfolio into our other credit assets.
Okay. That's helpful. And then just a follow-up from last quarter, you mentioned around $40 million in discounts on multi-transitional. When comparing quarter-to-quarter, how does that relate to the $33.6 million you noted? What would be the appropriate comparison to make there quarter-to-quarter?
Yes. So that number there is effectively the discount in terms of the mark on those assets. So I think it is $34 million this quarter. But if you think about those transitional loans, they're very short duration. So they are much less sensitive to moves in market interest rates. So I think we sort of think about that discount there as does buyer of these loans as a credit discount effectively.
Okay. Got you. So you've worked through the vast majority of that this quarter. I got you.
To clarify, that discount has decreased from around 40% or 45% to approximately 35%. We have made significant progress, but as I mentioned earlier, there is still more work to be done over the next couple of quarters.
The next question today is coming from Jason Weaver from JonesTrading.
Can you comment on the distribution potential for new transitional loans if we see some relief in rates ahead, and whether you expect securitization financing or loan sales to become a more attractive option under those conditions?
We have been selling rental loans, which are term loans. The reason for this is that when we originate $30 million or $20 million of these loans each month, it takes time to prepare them for securitization. Taking on spread risk for an extended period is not ideal when we have a strong bid on the other side. Therefore, we have been capitalizing on that bid by selling these loans to third parties. Most of the shorter-term transitional loans are eligible for securitization. These loans have a revolving structure, meaning that as we create new loans, they replace older loans that are being paid off. Currently, we have four deals outstanding. If our originations increase, which we anticipate, we could move from four deals to five or six. However, it's crucial to ensure that we have enough volume to offset the payoffs we are receiving. In terms of the breakdown, about 45% to 50% consists of ground-up loans, with the rest being bridge and traditional Fix and Flip loans.
And Jason, I'd just add one thing. The 30-year rental product is obviously more rate sensitive than the transitional loans. So lower short rates, steeper curve, it's likely that volume would pick up on that product.
Got it. That's helpful. And I want to go back to in the prepared remarks, you mentioned the $24 million in loan sales and you expect to do more in the second half. Talk about the relative merits there. Is that a question of just coincidence you were able to find a buyer on that side? Or is that becoming actively more attractive than pursuing the entire sort of workout process?
Yes, it's about finding a balance. You're examining loans and testing the market to see where the bids stand. If the bids are appealing, we would consider moving forward. If managing the loan ourselves yields the best results, we will take that route. It really comes down to evaluating each loan on a case-by-case basis to decide the optimal outcome.
Our next question is coming from Eric Hagen from BTIG.
On the single-family rental and single-family transitional loans, do you think developers are getting the rental income in like the exit that they expected? Or is there a lot of range around that outcome because of the execution risk is higher with tariffs and other higher input costs and such?
In terms of our execution, many of our development loans are primarily focused on building and then selling rather than renting. The market prices are aligning with the After Repair Value outlined in the appraisal, so we aren't experiencing significant pressure related to tariffs. While there is potential for future impacts, we haven't observed any material effects so far and are monitoring it on a monthly basis. For the rents we do have, they have been sufficient to cover future debt service as these loans are typically refinanced away from us. Overall, we don't see any significant pressure in this area either.
Yes. Okay. That's helpful. You guys break out the loan book by origination year, which is really helpful. But which of the vintages would you maybe label as having higher relative risk versus lower risk just based on when they were originated?
Yes. I would say that the multifamily loans from 2023 were probably more challenging for us. However, in other segments of our portfolio, our loan-to-value ratios are quite low, so we don’t have major concerns about losses there. On the non-QM side, where we have noticed some increased delinquencies, in most cases, borrowers put the property up for sale and sell it, which means we often don't need to engage in loss mitigation efforts. Therefore, we have maintained a neutral stance regarding the performance across those portfolios.
Okay. If I could sneak in one more. I mean, is there a catalyst aside from lower interest rates, which could accelerate the call in the non-QM portfolio, the callability?
I mean it's really an algebra exercise, Eric. So it's pretty easy for us to do. So lower rate environment, yes, theoretically, there are more deals that would be callable. In addition, with lower rates, our preferred Series C would reset to a lower coupon. So there's marginal benefits in a few different ways. If you look at the bulk of the floating rate borrowing, it's for the most part, offset with swaps. So lower rate environment is not necessarily going to have a big impact there. But on the edges, lower rates are certainly helpful.
And I think, Eric, just to add, there could be a deal with respect to the call rights that's maybe out of the money. But if you think about the deleveraging embedded in some of those callable deals, it doesn't necessarily have to be a lower rate to reissue it to still increase the ROE of the portfolio because you're unlocking a lot of capital with the relever.
We reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments.
Thank you, everyone, for your interest in MFA Financial. We look forward to speaking with you again in November when we announce our third quarter results.
Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.