MFA Financial, Inc. — Q2 2014 Form 10-Q
Business context and reporting period. MFA is a residential mortgage REIT investing primarily in Agency and Non-Agency mortgage-backed securities (MBS), using leverage to earn the spread between investment income and financing costs. This unaudited filing covers the quarter and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Interest income | $118.6 million | $120.7 million | $239.8 million | $243.4 million |
| Net interest income | $78.1 million | $82.2 million | $158.3 million | $164.8 million |
| Net income | $78.7 million | $75.5 million | $154.9 million | $152.8 million |
| Net income available to common stock and participating securities | $75.0 million | $67.3 million | $147.4 million | $142.6 million |
| Basic and diluted EPS | $0.20 | $0.19 | $0.40 | $0.39 |
| Common dividend declared per share | $0.20 | $0.22 | $0.40 | $0.94* |
Margins. Q2 net interest spread was 2.42% and net interest margin was 2.80%, versus 2.38% and 2.73% a year earlier. For the first half, spread was 2.43% and margin 2.82%, versus 2.35% and 2.71%. *The 2013 six-month dividend included a $0.50 special dividend.
Balance sheet and liquidity. At June 30, total assets were $12.65 billion, including $11.55 billion of MBS at fair value ($6.55 billion Agency and $5.00 billion Non-Agency). Stockholders’ equity was $3.28 billion and book value was $8.37 per common share, up from $8.06 at year-end. Cash and cash equivalents were $343.7 million; restricted cash was $54.4 million. Management reported a $789.3 million liquidity “Cushion,” including cash, unpledged Agency MBS and excess Agency collateral.
Debt and leverage. Repurchase agreements totaled $8.38 billion, securitized debt $214.0 million, and 8% Senior Notes $100.0 million. Reported debt-to-equity leverage was 2.8x (2.9x on the company’s non-GAAP measure). Repo borrowings had a 0.69% weighted-average interest rate and a 28-day weighted-average remaining term to rate reset; including swaps, the effective repricing period was 24 months.
Cash flow. In the first half, operating activities provided $115.0 million and investing activities provided $21.2 million; financing activities used $357.9 million. Cash and cash equivalents declined $221.7 million to $343.7 million. Cash dividends paid on common stock and dividend-equivalent rights were $146.8 million, with $7.5 million paid on preferred stock.
Material changes versus prior periods
- Q2 net interest income fell 5.0% year over year, and first-half net interest income fell 3.9%, despite higher reported spread and margin. Management attributed the declines mainly to lower average MBS balances and higher Non-Agency financing costs, including swap costs.
- Net income available to common holders rose in Q2 and the first half. Higher gains on MBS sales and improved Linked Transaction results contributed; 2013 comparisons also included a $3.9 million charge for costs associated with redeeming Series A preferred stock.
- Non-Agency MBS yield increased to 7.71% in Q2 from 7.15% a year earlier. Management cited improving credit estimates and discount accretion; $24.5 million of Credit Reserve was reallocated to accretable discount in Q2.
- Net unrealized MBS gains increased: accumulated other comprehensive income was $851.0 million at June 30, versus $737.7 million at year-end. The quarter’s comprehensive income available to common holders was $133.8 million.
- The portfolio expanded into re-performing/non-performing loan securitizations and residential whole loans. Whole loans had a $59.7 million carrying value at quarter-end; Q2 income from them was approximately $650,000.
Outlook, commentary, and risks
- No formal earnings or dividend guidance was provided. Management said it expected to continue selectively acquiring Agency MBS, Non-Agency MBS and residential whole loans during the rest of 2014, and believed it had adequate resources for current obligations and planned investments.
- Management reported a $133 million estimate of first-half REIT taxable income and approximately $39 million, or $0.11 per share, of undistributed taxable income. The filing notes that taxable income can differ materially from GAAP earnings; distributions remain at the Board’s discretion and are subject to REIT requirements.
- Key exposures include interest-rate and spread movements, prepayments and reinvestment, Non-Agency credit losses, and reliance on short-term, uncommitted repo financing. Declines in collateral values can trigger margin calls; lenders may decline to renew or may increase haircuts. Non-Agency financing typically carries higher costs and collateral requirements.
- At June 30, $3.93 billion of swaps was designated as hedging, with $54.7 million of net unrealized losses. The company was in compliance with financial covenants. Its modeled rate shock estimated that a 100-basis-point increase would reduce portfolio value 0.83% while increasing next-12-month net interest income 1.47%; a 100-basis-point decrease was modeled to increase portfolio value 0.49% and reduce net interest income 10.76%. These are estimates based on assumptions, not forecasts.
- Management recognized no credit-related OTTI charges on MBS in the quarter or first half. This assessment depends on estimates of future Non-Agency mortgage cash flows and could change. A $66 million Non-Agency MBS purchase commitment was outstanding at quarter-end.
- Regulatory uncertainties include potential changes to the GSE housing-finance system, mortgage and securitization rules, and SEC interpretation of the Investment Company Act exclusion used by the company and certain subsidiaries. An adverse interpretation could require restructuring, constrain financing or asset choices, and reduce net interest income.
- The filing reported no material pending legal proceedings, no material change in the risk factors from the 2013 Form 10-K, and no material off-balance-sheet arrangements. Management stated disclosure controls were effective as of June 30, 2014.
Most important facts for investors to verify
- Whether Non-Agency MBS credit assumptions, reserve releases and expected cash flows remain supported by underlying loan performance; $986.8 million of Credit Reserve and OTTI remained at quarter-end.
- How repo renewal terms, collateral haircuts, margin calls and counterparty exposures evolve; assess the reported $789.3 million Cushion against potential market stress.
- Whether higher funding costs or interest-rate moves pressure net interest income, book value and the common dividend; compare the modeled sensitivities with actual portfolio behavior.
- How REIT taxable income, undistributed taxable income and future distributions develop, given differences between taxable income and GAAP net income.
- Whether growth in RPL/NPL MBS and residential whole loans delivers the returns assumed without increasing credit, financing or liquidity risk.