EPISODES
Episode 13.
Gudmundur Kristjansson, Co-Chief Investment Officer at MFA Financial
Jeff Tennyson (Speaker 1)
Welcome to The Real Estate of things Podcast. I’m Jeff Tennyson, the CEO of Lima one capital. And I am guest hosting today for Dalton Eliot, who’s out for a week, but he’s done a great job building this podcast and putting some great content and a lot of great partners of real estate of things, sharing ideas, sharing thoughts. And so we’re really pleased with what’s been going on with the real estate of things. And today we have a great guest joining us as well. Gudmundur Kristjansson, who is the CO CIO for MFA financial. Gudmundur Welcome to the Real Estate of things.
Gudmundur Kristjansson (Speaker 2)
Jeff, thank you. Thanks for inviting me to join this podcast. It’s fun to be with you here to talk about ppl space and I’m excited for our conversation.
Speaker 1
It’s gonna be a lot of fun. A good mentor is the mentioned the CO CIO for MFA financial MFA is a publicly traded residential mortgage REIT and I guess I should add at the onset, the recent new owner of Lima one capital. We announced collectively July 1, that MFA has acquired all of the shares of Lima one capital and become our owner. That’s been exciting for us. Because, you know, MFA, you and MFA have been Equity Partners and homebuyers of Lima one for four plus years. So the whole transition from partner and whole loan buyer to now owner has been really a fun transition and a fun process. So, no, we’ll get into that maybe a little later in our conversation, but wanted to make sure so, you know, tell us a little bit about MFA, you know, what is a mortgage REIT? How do you and your team play with the business purpose lending space? And just tell the listeners a little bit about what’s going on?
Speaker 2
Yeah, no, Thanks, Jeff. appreciate the question. So MSA financial we are a mortgage REIT. We’re headquartered in New York City, and listed on the New York Stock Exchange, we have been publicly traded for over 20 years, with over 2.5 billion total equity base, we invest kind of across the Residential Mortgage space, which includes both securities as well as home loans, but with primarily focusing on what we call credit related assets and literally means securities, whole loans that derive most of their yield income, if you will, from credit, as opposed to just interest rates. Historically, you know, we invested in securities, this is going back in time to like, you know, the be the early 2000s, to 2010, where we invested primarily in security if these were Fannie Mae, Freddie Mac mortgage backed securities, some private label securities backed by mortgage home loans, non performing REIT performing loans, as well as you know, notes backed by mortgage servicing rights. And, you know, really after the Oh 708 financial crisis, we got really aggressive and deep into credit analysis. And that’s when we acquired a lot of what we call legacy knowledge. CMBS. These were securities that fell in value after the subprime crisis was a great trade for us. You know, it was what went well for us for many years. But more recently, we’ve been primarily focused on, you know, investment activity and what’s called non QM and business purpose, home loans. And that’s where most of our activity is these days. And we’re finding the best opportunities, kind of in the residential mortgage space, you know, we have an investment portfolio of over 7.5 billion off that approximately 1.3 to 1.5 billion is kind of business purpose loans.
Speaker 1
So talk a little bit let’s talk about kind of the whole buying process that you guys go through we’ve got a lot of listeners who were, you know, private money lenders on their own accord, small private money lenders, that could be it would be interested to know, it talked about when you’re buying guys, you know, I mean, you mentioned you know, you bought a big chunk of business purpose loans in q3. And so you’re very invested not only in Lima one but in other lenders if you guys buy business purpose loans from others, talk about what you’re looking for an originator that would get your attention and interest you in buying their loans.
Speaker 2
Right, that’s a good question and as You mentioned that you kind of alluded to it on the on the beginning of the podcast. So we, we have known each other since 2017, when we first got to know Lima, as we got, you know, interested in a broader BPL space. And so we put a lot of effort into kind of researching space in 2017, kind of identifying it as an attractive area to deploy capital. So we met with various originators, you know, figured out what products made sense to us, and, and, you know, started acquiring loans, and we’ve bought over 3.5 billion of business purpose loans, since inception. And really, you know, we’re looking for now that we have, you’ve got a lot of experience under our belt is, you know, we look for partners to think about credit similar to us, it’s important to kind of see eye to eye fundamentally, on where do you want to deploy capital, because when you build a whole loan, trading relationship, there’s a lot of energy and effort that goes into negotiating, you know, loan purchase agreement, various legal documents, setting up the trading process, the settlement process. And so, you know, before you go down that path and invest energy and time into it, you want to make sure you align fundamentally in terms of the approach. So it’s important to us that the originators almost think as principles in the terms that they, you know, want to create, quote, good products, that that, you know, they care about their borrowers that they perform on the mortgage, but also that the borrowers are successful, identify good projects, exit profitably, and so on and so forth. And we find when we make take the time to build those relationships, and identify the right partners, that just bears incredible amount of fruit down the road, because it means that, you know, if when things get rough, we’re all aligned, as opposed to fighting, fighting among ourselves, when there are issues, because it always stuff always happens.
Speaker 1
Yeah. I mean, is there a size limit? That I mean, because there’s a lot of work on both sides. I mean, there’s work on your side and approving an originator to buy their loans. And I’m assuming you’re expecting on the other side originators, to also have some processors procedures. So what’s the typical size of a book of loans? Yeah, I’m assuming you don’t buy one loan at a time and that type of thing, you’re looking at larger book purchases.
Speaker 2
That’s right. I mean, we like to set up as you say, bolt purchases, but you know, most likely, it’s what’s called a flow arrangement where you’re routinely buying a pool or bulk of loans, you know, every single month, multiple times a month, and so on, and so forth. And look, since we are a large publicly traded company, I mean, we have, as I mentioned, early 2.5 billion in total equity, and over seven and a half billion in assets, you know, we are looking for something that is meaningful as that can make a difference for our shareholders. And so as you think about that, and put it into context, I mean, you know, I, we ideally, we’d like to see someone who is, you know, has the ability to sell us, you know, 25 to 50 million a month of paper, right, but the other way we think about it, too, is if you get them to buy someone of quality, you know, that has maybe an undersized, you know, operation, but clearly has the ability to grow, we can be, you know, somewhat patients, and in help them in other ways to grow. One is to provide the certainty of the take off from long perspective, but also in some cases, you know, make equity investments or capital commitments to nurture those companies and grow over time, similar to what we did with Lima back in Oh, 17 and 18.
Speaker 1
I think, you know, people listening to this should recognize that’s exactly from Lima. One perspective. I mean, you know, we were doing 15 20 million a month in total production when we first met. And you guys, you know, help buying, you know, 3 million, 5 million 10 million, those kinds of things. But you had a vision, as did we, to get to where that 25 50 million a month was something that was worth your time. And so it’s a, it’s because I’m assuming, typically, when you’re buying these loans, you’re not actually table funding, you’re buying closed loans that these originators have already underwritten closed and have them on their warehouse lines today.
Speaker 2
That’s correct. We buy close loans. NFA is, you know, we’re not an originator. We’re not licensed Associates which requires, you know, other legal operational aspects which you as an originator quite well know. And so, we are an acid aggregator and as such, you know, we work with multiple originators to source our loans and purchase from multiple entities. And so you know, which is which can be challenging it you know, you guys manage multiple relationships, you, you know, you got to build them, you got to nurture them, and you got to identify the right partners. And it’s also, you know, competitive space out there. So, you know, from our perspective, again, like I said, like, it is very important to identify the right partners, and then, you know, work on those relationships, not unlike, you know, any other successful relationships, you know, to get bigger over time, and like, we, you know, we, we also like to, you know, support our partners, as I said, to help them grow, because selfishly, you know, if we, if they are producing good, good quality loans, that that are attractive and high yielding, it’s in our best interest to allow them to do more origination, so we can acquire them for loans.
Speaker 1
Well, I think a lot of times, so many private lenders, or small, entrepreneurial lead originators, and they’re like, how can we get large and big like, you know, the larger national lenders, it really starts with teaming up with somebody like yourself, who, because there’s the need for capital is horrendous at the point as you begin, because whether you’re doing, you know, putting on your warehouse lining holding it to you can aggregate enough to send you 25 to 50 million, or, you know, topic, I want you to spend a little bit of time on today as securitizations. You know, it’s impossible to do a large securitization without a pretty big slug of capital. So I think that I think the, the message to some of these smaller private money lenders is find a good institutional partner, that will allow you to grow, that will support your ideas and, and strengths. And, you know, fortunately for Lima, one, we found MFA and grew together. And it made a big difference, as we did grow together and build together, we learned your strengths, and you learned our weaknesses at times, and we kind of pull those together to make those all work.
Speaker 2
But to your point, I mean, like, from the perspective of growing, like, in terms of, you know, desire to get big, I mean, it’s, it is sometimes a double edged sword, because you can be quite profitable and successful managing a small operation where, you know, you’re controlling all aspects of the loan creation process, you know, you can identify, you know, higher coupons may be your higher fees that you can charge on a smaller subset of loans in your local area, right. And so, and that can be a nice niche. But if you want to scale up and gain volume, you really have to make it a repeatable process, you have to make it a repeatable process, not just to yourself and the next two or three people that you that you trust, but your whole organization, and then you have to start trusting people in the process. And to do that to scale up successfully, you need to then start focusing more on the infrastructure in the operation, as opposed to optimizing the revenue on each individual loan. And that’s where, you know, the strength of really specialization comes in like allowing, for example, Lima, this case to focus exclusively on creating good loans, expanding the products, the product offerings, and then, you know, utilizing other fees, you know, cheaper cost of capital and experience, as you mentioned, in in financing in the securitization market. I think when you do that in a team up like that, you kind of build a whole manufacturing process where you’re really creating value along the entire chain. Yeah.
Speaker 1
Makes a lot of sense. Well, let’s you bring up securitization, I think let’s move to that. Because we get a lot of questions from just industry partners and others about the securitization market. You guys are very active MEMA, Fei is very active in that space. You know, what, what is the securitization? And particularly, how does it work to be a good source of financing for a mortgage free and with business purpose loans?
Speaker 2
Right now? That’s a good question. I mean, you know, look, the securitization securitizing is nothing really, it’s nothing new. I mean, securitizations have been around for a long time. And those that want to study I can read up on the birth of the CMO market in the 80s, and the 90s. And all kinds of various structures, obviously made famous in the subprime crisis by, you know, various movies and books, you know, but at the end of the day, like the really, like, the basic concept is you’re pooling a, you know, group of assets are similar to it to each other, in this case, hole loans into us into enough size, and then you take those loans and you you’ve pledged them or they provide collateral to securities or bonds or notes that you issue and sell to investors in the in the secondary marketplace. And, you know, by doing that, you essentially, you know, create liquidity for either an originator that does it themselves or an asset aggregator like ourselves, and you know, at the same time Have you give investors that don’t have access to this these types of particular assets and ability to invest in that type of credit, or whatever the risk exposure is, and therefore creating liquidity for everyone across the whole food chain. And so, you know, from that perspective, it really is a, you know, elegant mechanism. And in most cases, someone who’s securitizing or securitize her, they usually retain a certain amount of bonds, they always retain risk in it or skin in the game. And in fact, right now, it’s, you know, it’s essentially regulations or laws, you have to retain a minimum of 5% risk retention in the in the securitization, that you issue. So essentially, by doing that you’re aligning interest that the people issuing these bonds have continued involvement with them. And if they if the underlying assets go bad, they suffer along with all the other investors. Now, as you pointed out, because of that, obviously, you have to have capital and balance sheet to retain that interest. And typically, MFA retains anywhere from five to 10% of the of the bonds of the securitizations that we do. And so from that perspective, you need to have capital. And so a large balance sheet helps with that in terms of retaining those interests.
Speaker 1
So just to be clear of kind of the mechanism. So when you talk about a retained interest of 5% retained in a typical securitization would be 200 million 300 million in size.
Speaker 2
Yeah, so securitization kit, like I think, like 200 million is usually that’s the size that you want to do. And we can get into a little bit later. I mean, there’s costs associated with that. So you, you kind of want to gain some efficiencies there in securitization can’t get they can be as large as a billion dollars. Right. But, you know, typically, what we see in our market is probably anywhere from 200 to four or 500 million from deal size.
Speaker 1
And then, and so I mean, I think that’s important for people to truly understand, when you say retained, there’s two elements to that one, a 5%. Retention on a $200 million deal means you have to basically put into this deal. $10 million. That’s right. And not only that, but by being the bottom part of the capital structure in this example, or the bond structure, the first losses are going to come in to that $10 million, that you have to reserve for a year from a year to five years to 10 years to however long the bond is.
Speaker 2
Yeah, that’s right. So you’re highly incentivized, obviously, for the underlying loans to perform, because you take the first losses. And so you’re incentivized to make sure the servicing is up to up to par. And like, you know, it’s, you know, we spent a lot of time when we, you know, market these deals to make sure people understand that our interests are aligned and private predominantly through this because our, our capital is at risk if something goes wrong.
Speaker 1
Yeah, yeah, I think that’s important for people to know. I mean, you can’t just do a $5 million securitization, primarily because of the legal costs and the regulatory costs and all the different components that go with that. And, and again, that’s the value of a large partner, institutional partner, like an MFA to folks like all that that’s the reason you buy the loans, hold them and deal with that oftentimes, as opposed to Lima, one being the issuer of a securitization. Yep, that’s right. And then in the BPL space, what’s the big advantage of mean of the business purpose loans today and that securitization market? Are you seeing it across the board and all the products that we offer? We’re Where are you seeing the strength of securitization at this point?
Speaker 2
Yeah, I mean, so yeah, so the securitization market has been quite vibrant and lively over the last 18 months on a lot of volumes in just the broader markets, space. And obviously, in the conforming space, there’s a lot of loans created with all the refinancing. But in the BPL spaces, it’s essentially two markets, broadly speaking, one is the, you know, turmeric rental loans, and then you have, you know, the fix and flip rates and the ground up aspect of it. And so, on the term rental loan side, that market is more established, more mature, it’s more accepted. Most of those deals are A rated, so there’s a rating agency that will rate the bonds in those deals. And the ratings go from triple A all the way down to double B. So it’s triple A single a double a single a triple B, double B Henson, cookie, and so on and so forth. And that those letters represent the credit quality on a particular security issues. So because they’re rated, there is a certain amount of standardization and it’s well understood by various fixed income investors. Who also buy, you know, securitizations or, or bonds backed by other types of loans, you know, loans that homeowners owners owns. On the on the fix the flip side, the rating agencies, they don’t have the same amount of experience, track record data to analyze losses, because that’s predominantly what they’re looking at when they’re putting the ratings on is, is you know, what can go wrong. And so the models don’t fully capture all those aspects of a, of a bridge loan of a fix and flip loan. So they just struggle with rating those types of deals in any meaningful way. And so, those deals tend to be non rated. And therefore, there is, you know, more diversity in terms of, you know, the type of structures that are that are put together, and it’s less homogeneous. Now, there’s been a decent amount of those issues, though, over the last, like I said, you know, 18 months, and there seems to be developing a little bit of more standardization, is there still more, more room to go there, but, you know, the fact that there is a viper market is obviously a benefit for everyone associated with the BPL space, whether it’s the, you know, the operators on the ground, or the people who are actually doing the work and rehabbing the homes, you know, an originated like Lima, or an hour invested like us, because it does create, to bring liquidity to the space.
Speaker 1
Yeah, it’s, it’s an exciting, I mean, it’s really great to see the rating agencies getting comfortable with it, that that also adds another level of confirmation to the bond markets, that you know, the right processes and controls and all the different components that go with it. And, and it’s the real benefit of kind of seeing us being able, as an originator, that kind of method of kind of cost of funding, cost of financing, as an originator is allowing us to have better rates, better products in the marketplace for our borrowers, and it just kind of snowballs down to, to all the people that get the advantage of an active, safe, important investment that the ultimate bond investors like.
Speaker 2
That’s right. And it’s interesting, you use processes, because many of these things are, I guess, somewhat, you know, mundane and boring in the sense that like to be able to bring a securitization, you know, having good data, having clean data, being able to tell a story that, you know, you service the loans in a certain way, you know, how do you deal with delinquencies? How do you assist borrowers? You know, you know, how do you man it’s, you know, cash flows and funds, all these things that come along with again, this is scale and operational aspect, but, you know, if you can get that done, well, you know, it helps you in terms of, you know, bringing better deals getting lower cost of funds, but this is the thing that we talked about scale, right, you know, doing a few loans, and, you know, making very nice money on a few loans versus scaling it up. If you want to scale up, you got to do all these things, right. Like, you got to do the, the servicing aspect well, and all that data and the operational aspect, but that then brings benefits, which because you can, you can bring securitizations and other things of that nature.
Speaker 1
Yeah. So, yeah, the hot topic in the business purpose space right now is mergers and acquisitions. Obviously, you know, you there’s been a surge of acquisitions, like in via institutions like MFA, you guys acquiring Lima one. I mean, premium just announced they acquired anchor loans in RZ, announced they acquired Genesis PacWest acquired Civic. And then, you know, a year or so ago, Redwood acquired Corvette. So there’s a, you know, the top probably three to five, originator five to seven originators in the space have all gone through some kind of merger, what’s creating the interest in the business purpose lending space to acquire these versus just bought? alongs?
Speaker 2
Well, I think, you know, it’s, it’s a part of, you know, broader trends that we’ve seen, you know, not just this year, last year, but, you know, last, you know, five to six years really like when you look at asset managers, you know, private equity funds, people guys mortgage REITs does anyone who manages a large pool of capital in the, you know, the mortgage space, or even just the broader fixed income markets, you know, with rates coming down, you know, the Fed buying a lot of assets, it does create a competition for assets and access to assets. And so as, as some of the lower yielding spaces are crowded out, it pushes people to look, you know, into other areas or spaces. And, you know, historically the PPL space was fragmented, it was a lot of hard money lending, local lending. And so it was hard for institutional investors to gain foothold in it because it talks about this a little earlier to really accumulate Sighs you had to build a lot of smaller relationships and buy a lot of loans from for many, many participants. So if you are an investor, like myself was used to, you know, buying bonds and size and really just, you know, you have a lean team and you’re good at doing the analysis, but you don’t, you don’t really want to manage hundreds and hundreds of like correspondent relationships. So that perspective, as you look into the space is okay, it’s attractive, I can make good returns here. Anyone who is has a good track record and is sizable, and is has the ability to originate loans across the entire country becomes then an interesting target or of some of these larger players. And so I think that’s really what we’re seeing, we’re seeing the importance of creating the asset of controlling the asset creation, the flow of assets onto your balance sheet. And, and so, you know, it’s also just kind of competitive, I don’t do it, someone else will do it. So you protect your turf. But I think it’s a real vote of confidence in this space that people see real benefit. Nice, nice returns. And it’s, it’s a commitment to the space too, because at least from our perspective, I think it’s really a we’re showing tremendous amount of commitment, we’re gonna be here for the long run, this is not a short term trade, where we’re buying a few loans, we envision this as a, as a business where we can continue to grow it and do more in the future.
Speaker 1
You know, I think that’s an interesting comment. Because I mean, when I first got into the space when Blackstone asked me to help them start BTR finance back in, you know, 2013, I guess it was, you know, there was basically three players in this space, there was BTR there was colony, which is now core best and, and then there was first key, which doesn’t exist anymore. And you know, and from that, at that point, the whole debate, we just finished the IMM single family rental conference in Scottsdale. And, you know, it’s amazing to me that, you know, less than 10 years ago, there were only three people on the stage that had any, any any ability to originate. And as a result, the question was, Is this just a trade? Or is it a true business and industry and it should be real confirming for not only the originators listening to this podcast, but the real estate investors who we all serve through this process, because there is a very consistent national source of financing for their projects, that people like you and others in the space, there should be real continuity and real consistency, which does allow this to be a multi billion dollar industry for years to come.
Speaker 2
I think that’s right. And I do think, you know, the, the space is still maturing. And there’s still plenty of way to go in terms of, you know, bring more maturation more. I think it’s going to be more consolidation, some of the bigger national players will get even bigger, will be mergers that will happen. And I think that’s all good. It’s good in the sense that it brings as the market matures brings tremendous benefits to I think the, again, like the operators on the ground that are doing all the work that are transforming the old housing stock in the United States, which is pretty old, and you’re creating attractive, you know, first time properties or homeownership opportunities for families, you know, which would otherwise not be there.
Speaker 1
Well, I just read an article today actually by Redfin. And, you know, the largest percentage ever of home sales were sold to investors in the third quarter 18% of all home sales in the third quarter went to real estate investors. And it’s not just the big, you know, invitation homes, largest traditional people, it’s really you still in this in this market today. The small three to five to 10 person who owns these properties is the dominant a 92% 94% of these people are those type folks. And so it really does create real optimism as this industry matures, as our processes enhance, as all the different components that go with it. Make a big difference. Well, we’re getting close to wrapping up a couple of you know, it’s getting close to Christmas, it’s around the corner. So you know, I guess to do a little lightning round with you good monitor for some fun. You know, you know, tell us something interesting about yourself that listeners probably wouldn’t just know your the name gives it away that you’re probably not from South lining. But tell us a little bit about yourself and, and maybe, what are you? What’s the big ask of your kids for Christmas this year?
Speaker 2
Wow, that’s a big one. So yeah, I think, yes, but the name probably gives it away. Something for it. So I, I’m born and raised in Iceland’s and, you know, moved here in 2004 to go to college and Cornell is, you know, lived in Chicago for a little bit. And then I’m now in New York. And, you know, people get to know me, they say like, oh, okay, you just like to be where it’s cold. And, you know, I guess it’s not really true, but that’s just how it turned out to be. Um, we, so you know, not me and my wife and I live here. Yes, we got two boys, 10 and 12. And, you know, we like living in New York City. And one of the nice benefits of that is there’s, it’s a melting pot and all kinds of cultures. So that’s fun.
Speaker 2
I can tell you there’s 10 or 12 year old boys. So really, most of the things that they like, has something to do with video games and computers. You know, there’s, you know, gaming this and that and, you know, or some sort of credits for some sort of a, you know, Metaverse thing that no one understands. It’s fascinating. They’re, you know, they’re great kids, but it definitely has something to do with technology and video games. Talk to a friend here in the Carolinas, whose 12-year-old son, like, a year and a half ago, talked him into letting him spend like $500 for cryptocurrency that today is like worth, you know, like, I don’t know, whatever he spent his first like $200,000 and his kids like. So I think I think we had I think our kids are going to teach us not only how to do video games and technology, but how to handle cryptocurrency,
Speaker 2
I liked it; I might steal that idea. But I might tell them there are no presents, they are all in the form of some sort of a cryptocurrency.
Speaker 1
Everybody gets one Bitcoin and then they’ll have to keep up with the logarithm to keep up with it forever. Good monitor. This has been fun. Thank you for taking the time sharing ideas, sharing insights about the market. And what’s going on from the institutional side. Wishing certainly wishing you and your family have a great holiday season. Is that comes upon us. And you know, you’re welcome back anytime actually, you’d probably have a better conversation with Dalton. So next time, we call you and ask you to join the real estate of things. Request the real host Dalton Elliott, and probably even a more fun event but thanks a lot. Appreciate it. And let’s keep lending money.
Speaker 2
Well, thank you, Jeff. I think you’re being too humble. You did a did a pretty good job here. Yeah, no, it was a great conversation. Thanks for inviting me and you know, appreciate the opportunity to talk about the markets and you know our relationship. And yeah, wish everyone Happy Holidays and you know, appreciate it.
The Real Estate of Things 