MFA Financial, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; balance-sheet comparisons are to December 31, 2017. MFA is a REIT investing on a leveraged basis in residential mortgage assets, including mortgage-backed securities (MBS), whole loans, credit risk transfer securities and mortgage-servicing-rights-related assets.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Interest income | $117.4m | $105.1m | $322.9m | $332.5m |
| Net interest income | $58.6m | $55.9m | $161.7m | $183.9m |
| Other income, net | $48.4m | $29.1m | $137.0m | $93.0m |
| Net income | $87.1m | $63.8m | $240.9m | $221.8m |
| EPS, basic and diluted | $0.19 | $0.15 | $0.56 | $0.54 |
| Common dividend declared per share | $0.20 | $0.20 | $0.60 | $0.60 |
| Net interest spread / margin | 2.41% / 2.82% | 2.02% / 2.54% | 2.32% / 2.71% | 2.15% / 2.59% |
Balance sheet at September 30: Assets were $11.78bn, liabilities $8.23bn and stockholders’ equity $3.55bn. Repurchase agreements totaled $7.28bn; securitized debt was $714.2m and senior notes had a carrying value of $96.8m. Management reported leverage of 2.3 times debt to equity. Cash and cash equivalents were $104.2m, with a further $6.5m of restricted cash.
Cash flow, nine months: Operating activities provided $90.3m; investing activities used $1.61bn; financing activities provided $1.17bn. Cash, cash equivalents and restricted cash declined $352.4m to $110.7m. The filing’s cash-flow statement reports investing cash as used; its MD&A narrative describes investing cash inconsistently, so investors should check the underlying statement.
Portfolio and liquidity: Residential whole loans were approximately $3.9bn, or about 33% of assets; MBS were about $6.2bn. Management estimated available liquidity above $412.1m, excluding restricted cash, and also reported $1.1bn of unencumbered residential whole loans. Book value per common share was $7.46, versus $7.54 at June 30 and $7.70 at December 31, 2017.
Material changes versus comparable periods
- Q3 net income available to common stock and participating securities rose to $83.4m from $60.1m; EPS increased to $0.19 from $0.15. Higher gains on fair-value whole loans and increased whole-loan interest income were key contributors. Lower prior-year compensation expense comparisons also reflected non-recurring costs related to the former CEO and accelerated vesting of awards.
- For the first nine months, net income available to common stock and participating securities increased to $229.7m from $210.5m, while net interest income fell 12.1% to $161.7m. Growth in whole-loan income and fair-value loan gains offset declines in MBS interest income and higher financing costs.
- Whole loans and REO expanded materially: residential whole loans rose from $2.2bn at year-end to about $3.9bn; REO carrying value rose from $152.4m to $223.1m. MFA acquired or committed to acquire substantial newly or previously originated performing loans and completed two 2018 loan securitizations.
- The company issued approximately 50.9m common shares in a public offering in Q3, generating about $389.4m net proceeds. Common shares outstanding were 449.5m at September 30, compared with 397.8m at year-end 2017.
- Other comprehensive loss was $38.3m in Q3 and $82.9m for the nine-month period, primarily reflecting unrealized MBS losses. AOCI declined to $526.4m from $609.2m at year-end.
Outlook, commentary and risks
- Management said it expected to continue seeking investment opportunities, particularly in residential whole loans, RPL/NPL MBS and MSR-related assets. No specific earnings or dividend guidance was provided.
- Management attributed improved Legacy Non-Agency MBS yields to better collateral performance, faster voluntary prepayments and credit-reserve releases. It transferred $10.2m from credit reserve to accretable discount in Q3; this is expected to increase interest income over time, with most impact anticipated over the next ten years. This depends on estimates of future loan cash flows and credit performance.
- Funding costs increased: the effective borrowing rate was 3.13% in Q3 versus 2.66% a year earlier. Most repo borrowings reset within 30 days, and repo financing is uncommitted and renewable at lenders’ discretion. Margin calls, collateral-value declines, higher haircuts or loss of funding could materially affect liquidity and leverage.
- Management’s modeled +100 basis-point rate shock estimated a 2.98% decline in net interest income and a 1.25% decline in portfolio value; a -100 basis-point shock estimated a 0.20% decline in net interest income and a 1.21% increase in portfolio value. These are estimates based on assumptions, not forecasts.
- Credit, prepayment, valuation and servicing risks remain significant, particularly for Non-Agency MBS, whole loans and REO. Fair values for whole loans and MSR-related term notes include Level 3 estimates and unobservable assumptions. Regulatory changes affecting mortgage lending, servicing, securitization, REIT status or GSEs could also affect the business.
- MFA reported compliance with financial covenants, no material pending legal proceedings, and no reserve for loan-securitization repurchase claims; it was unaware of material unsettled claims. The filing reported no material changes to the risk factors in its 2017 Form 10-K.
Key facts for investors to verify
- Whether whole-loan growth and fair-value gains can persist, and how much Q3 earnings depended on valuation changes or other non-cash items.
- The sustainability of the $0.20 quarterly common dividend relative to earnings, taxable income, cash generation and the reported payout ratio above 1.0.
- Repo renewal, counterparty concentration, collateral haircuts and liquidity adequacy under adverse market or margin-call conditions.
- Loan delinquency, foreclosure, REO liquidation and loss trends, and the assumptions supporting Level 3 valuations and credit-reserve releases.
- The effects of the 50.9m-share offering on per-share value and returns, alongside growth in securitized debt and total leverage.
- The discrepancy between the cash-flow statement’s investing cash outflow and the MD&A wording describing investing cash as provided.