MFA FINANCIAL, INC. annual report, FY2016

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MFA Financial, Inc. — 2016 Form 10-K

Reporting period: Fiscal year ended December 31, 2016. This is an annual report, not a standalone fourth-quarter filing; quarterly results are noted where useful. MFA is a mortgage REIT investing on a leveraged basis in residential mortgage securities, whole loans and credit risk transfer securities.

Financial performance and position

  • Income: Interest income was $457.2 million, down 7.1% from $492.1 million in 2015. Net interest income fell 16.3% to $263.8 million from $315.2 million; net interest spread declined to 2.11% from 2.33%, and net interest margin to 2.45% from 2.65%.
  • Profit: Net income was $312.7 million, compared with $313.2 million in 2015. Net income available to common stock and participating securities was $297.7 million, or $0.80 per diluted share, essentially unchanged from 2015. Fourth-quarter common earnings were $68.9 million, or $0.18 per share, versus $69.7 million, or $0.19, in fourth-quarter 2015.
  • Other income and unusual items: Other income, net rose to $109.3 million from $51.2 million, including a $59.7 million gain on whole loans held at fair value, $35.8 million of gains on MBS sales, and $13.0 million of unrealized CRT gains. Litigation settlements generated approximately $68.8 million in cash proceeds and contributed to higher Legacy Non-Agency MBS yields and credit-reserve releases.
  • Cash flow: Operating activities provided $85.5 million, investing activities provided $1.027 billion, and financing activities used $1.017 billion. Cash and cash equivalents increased $95.1 million to $260.1 million; restricted cash was another $58.5 million.
  • Balance sheet and leverage: Total assets were $12.484 billion and stockholders’ equity was $3.034 billion at year-end. Repurchase agreements and other advances were $8.687 billion; senior notes had a $100 million principal balance and $96.7 million carrying value. Debt-to-equity leverage was 3.1x, down from 3.4x a year earlier. Book value per common share increased to $7.62 from $7.47.
  • Liquidity: Management estimated more than $684.5 million of available liquidity, comprising $260.1 million cash and estimated financing capacity of $221.1 million from Agency MBS and $203.3 million from unpledged Non-Agency MBS. The company reported no material off-balance-sheet arrangements.
  • Dividends: Common dividends were $0.80 per share for 2016, matching reported EPS; the annual payout ratio was 1.00. Series B preferred dividends were $15.0 million. The board has not set a minimum common dividend.

Material changes versus 2015

  • Net interest income declined as average Agency and Legacy Non-Agency MBS balances fell and financing costs increased. Interest expense rose 9.3% to $193.4 million; the effective borrowing rate increased to 2.13% from 1.81%.
  • MFA continued shifting toward credit-sensitive assets: residential whole loans grew to approximately $1.4 billion from $895.1 million, while the MBS portfolio declined to approximately $9.6 billion from $11.2 billion. Agency MBS fell to $3.7 billion from $4.8 billion.
  • Residential whole loans at fair value generated $59.7 million of net gains, up from $17.7 million. REO increased to $80.5 million across 447 properties from $28.0 million across 182 properties.
  • CRT securities increased to $404.9 million fair value from $183.6 million. The company bought $194.9 million of CRT securities during the year.
  • Operating and other expenses rose to $60.0 million from $52.4 million, reflecting higher compensation, servicing costs and expenses associated with the growing whole-loan portfolio.
  • FHLB advances fell to $215 million from $1.5 billion. Regulatory changes barred new or renewed advances, and the remaining balance was repaid in January 2017. Securitized debt was also fully repaid during 2016.

Outlook, risks and contingencies

  • Outlook: Management expected to continue seeking credit-sensitive, less interest-rate-sensitive assets in 2017, including residential whole loans, Non-Agency MBS and CRT securities; Agency MBS could continue to run off without reinvestment. No earnings or dividend guidance was provided.
  • Management commentary: MFA attributed improved Legacy Non-Agency MBS expectations to home-price appreciation, lower estimated loan-to-value ratios and faster voluntary prepayments. It released $37.7 million from Credit Reserve into accretable discount in 2016. Management estimated average Legacy Non-Agency MBS LTV had declined to about 65%, and estimated only 3% of non-delinquent underlying loans remained underwater.
  • Interest-rate sensitivity: The company’s shock analysis estimated that an immediate 100-basis-point rate increase would reduce projected 12-month net interest income by 8.94% and portfolio value by 0.77%. These are model estimates, not forecasts; a 50-basis-point decrease was estimated to increase net interest income by 1.24% and portfolio value by 0.34%.
  • Funding and liquidity risks: Short-term, uncommitted repurchase agreements fund longer-term assets and may not be renewed. Falling collateral values can trigger margin calls or forced sales. MFA had 31 repo lenders; five counterparties individually represented more than 5% of stockholders’ equity at risk.
  • Credit, valuation and operational risks: Non-Agency MBS and whole loans face borrower-default, loss-severity, geographic concentration, servicing, foreclosure and REO-liquidity risks. Whole-loan fair values rely on Level 3 estimates; actual recoveries may differ. Interest-rate, prepayment, counterparty, regulatory, REIT-qualification and Investment Company Act exemption risks are also material.
  • Tax and unusual items: Management estimated 2016 REIT taxable income of $366.9 million and undistributed taxable income of $58.8 million, or $0.16 per share, based on dividends paid or declared during 2016. The 2016 unwind of a resecuritization produced an estimated $70.9 million of taxable income without GAAP income; management also anticipated a further unwind-related taxable-income item in 2017. Taxable income and GAAP earnings can differ materially.
  • Audit and controls: KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management also assessed disclosure controls as effective. No material legal proceedings were reported.

Important facts for investors to verify

  • Reconcile the decline in net interest income and margin with higher funding costs, portfolio run-off and growth in credit-sensitive assets.
  • Assess whether the $59.7 million whole-loan gain and litigation settlement proceeds are repeatable, and how much reported income depends on fair-value estimates.
  • Review whole-loan delinquencies, foreclosure and REO trends, servicing performance, credit-loss assumptions and geographic concentrations.
  • Test liquidity and refinancing capacity under repo non-renewal, higher haircuts, margin calls and the loss of FHLB funding; confirm the post-year-end repayment was completed.
  • Evaluate dividend sustainability against REIT taxable income, GAAP earnings, cash generation and the 1.00 annual payout ratio; the board has not guaranteed future distributions.
  • Review the tax effects and timing of the resecuritization unwind, including the difference between taxable income and GAAP income.