MFA Financial, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. MFA is a REIT investing primarily in residential Agency and Non-Agency mortgage-backed securities (MBS), financed largely with repurchase agreements and securitized debt.
Financial performance and position
- Third quarter: Net income was $83.7 million, up from $77.2 million a year earlier. Income available to common stock and participating securities was $81.7 million, or $0.23 per diluted share, versus $75.2 million, or $0.27 per share. The lower per-share result reflects substantially more shares outstanding following the March 2011 offering.
- First nine months: Net income was $245.9 million versus $208.2 million. Income available to common stock and participating securities was $239.7 million, or $0.71 per diluted share, compared with $202.1 million, or $0.72 per share.
- Net interest income: Q3 was $92.0 million versus $62.0 million; nine-month income was $262.2 million versus $184.1 million. Q3 net interest spread and margin were 2.83% and 3.20%, respectively, compared with 2.56% and 3.08% a year earlier.
- Interest and funding yields: Q3 net yield on MBS was 4.75%, down from 5.10%. The Non-Agency MBS net yield declined to 7.25% from 9.92%, while its portfolio grew significantly. Q3 effective borrowing cost declined to 1.70% from 2.26%.
- Other income and expenses: Q3 other income, net, was $4.4 million, including $4.2 million gain on Agency MBS sales. Operating and other expense rose to $8.7 million from $6.4 million, mainly due to staffing and investment-analysis and data-system costs.
- Comprehensive results: Q3 comprehensive loss available to common stock and participating securities was $26.4 million, versus income of $115.6 million a year earlier, reflecting a $109.3 million unrealized loss on Non-Agency MBS. Nine-month comprehensive income available to common was $45.0 million versus $241.3 million.
- Balance sheet at September 30: Total assets were $12.0 billion, including $11.4 billion of MBS; cash and cash equivalents were $421.0 million. Total liabilities were $9.4 billion and stockholders’ equity was $2.64 billion. Repurchase agreements were $8.02 billion and securitized debt was $958.4 million. GAAP debt-to-equity leverage was 3.4x (3.5x on the company’s non-GAAP measure), compared with 2.8x and 3.0x, respectively, at year-end 2010.
- Cash flow and liquidity: Nine-month operating cash flow was $245.1 million; investing activities used $2.67 billion and financing activities provided $2.50 billion. Cash increased $75.8 million to $421.0 million. Management reported a $1.109 billion liquidity cushion, including cash, unpledged Agency MBS and excess collateral, plus $361.2 million of unpledged Non-Agency MBS.
- Dividends and equity: Common dividends declared were $0.25 per share for Q3; the nine-month declared total was $0.74 per share. A March public offering issued 74.75 million shares and generated approximately $605.0 million net proceeds.
Material changes and unusual items
- The MBS portfolio expanded substantially: Agency MBS were $7.52 billion and Non-Agency MBS were $3.89 billion at quarter-end. The Non-Agency portfolio’s growth reflected purchases, resecuritizations and equity proceeds.
- Two 2011 resecuritizations raised cash through third-party senior bonds. Because MFA consolidated the trusts, the transactions were reported as financings, not sales; quarter-end securitized debt was $958.4 million. Investors in the bonds generally have no recourse to MFA’s general credit, although MFA retains first-loss economic exposure to the underlying assets and certain repurchase obligations for breaches of representations and warranties.
- Q3 Non-Agency MBS market value declined by $105.3 million, according to management. The company recorded $4.0 million of credit-related impairment in earnings for the quarter and $6.4 million for the nine months. It also reported $180.2 million of gross unrealized losses on Non-Agency MBS, which it characterized as non-credit-related and temporary.
- Accumulated other comprehensive income fell to $59.9 million from $254.7 million at year-end 2010, mainly because of Non-Agency MBS unrealized losses. Agency MBS had $207.8 million of net unrealized gains at quarter-end.
- Repurchase borrowings rose from $5.99 billion at year-end 2010 to $8.02 billion. Management cited lower market values of Non-Agency MBS as a contributor to the increase in leverage during Q3.
Outlook, commentary and principal risks
- No quantitative earnings or dividend guidance is provided. Management said it continued to invest opportunistically in Agency and Non-Agency MBS, expected most assets to remain in Agency MBS, and viewed loss-adjusted returns on discounted Non-Agency MBS as attractive. It also pursued diversified and longer-term funding, including resecuritizations and a three-year Non-Agency repurchase facility.
- Management said funding remained available from multiple counterparties and that it believed resources were adequate for current obligations and investment plans. It cautioned that falling collateral values or tighter markets could trigger larger margin calls, higher haircuts or reduced leverage, and that repo renewals are at lenders’ discretion.
- Key exposures include interest-rate and spread movements, prepayment and reinvestment risk, Non-Agency mortgage credit performance, counterparty and collateral risk, and the mismatch between longer-lived assets and short-term financing. Management’s shock analysis estimated a 9.57% decline in next-12-month net interest income under an immediate 100-basis-point rate increase; the filing cautions that assumptions and actual results may differ materially.
- The SEC’s August 2011 concept release on the Investment Company Act exemption relied upon by MFA could require significant restructuring if the interpretation changes, potentially reducing leverage and financing options. Dodd-Frank implementation may also raise industry and compliance costs. Maintaining REIT status requires distributing at least 90% of annual REIT taxable income.
- Management stated that disclosure controls were effective at September 30, 2011 and that no material changes in internal control over financial reporting occurred during the quarter. The filing reports no material pending legal proceedings.
Important facts for investors to verify
- Whether Non-Agency MBS cash-flow, impairment and fair-value assumptions remain supportable as mortgage delinquencies, defaults and loss severities evolve.
- Repo renewal terms, counterparty concentration, collateral requirements and the sufficiency of the reported liquidity cushion under adverse market conditions.
- How the SEC’s review of the Section 3(c)(5)(C) exemption and evolving regulation could affect MFA’s portfolio, leverage and business model.
- Whether higher leverage and the expanded share count translate into durable per-share earnings and sustainable common dividends.
- The economic risks retained in consolidated resecuritization trusts, including first-loss exposure and contingent repurchase obligations.