MFA Financial, Inc. — Third Quarter 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Unaudited consolidated financial statements. Unless stated otherwise, dollar amounts below are in millions.
Business context
MFA is a mortgage REIT that invests primarily in residential Agency and Non-Agency mortgage-backed securities (MBS), using repurchase-agreement borrowings and interest-rate swaps. Its objective is to earn income from the spread between investment returns and financing costs. At quarter-end, its reported MBS portfolio was $7,985.5 million: $6,180.8 million Agency and $1,804.8 million Non-Agency. An additional $545.9 million of Non-Agency MBS was held in linked transactions presented as MBS Forwards.
Financial performance and position
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| MBS interest income | $97.3 | $124.4 | $293.5 | $383.0 |
| Net interest income | $62.0 | $71.6 | $184.1 | $200.9 |
| Net income | $77.2 | $66.8 | $208.2 | $189.6 |
| Net income available to common stock and participating securities | $75.2 | $64.8 | $202.1 | $183.5 |
| Basic and diluted EPS | $0.27 | $0.25 | $0.72 | $0.78 |
| Common dividends declared per share | $0.19 | $0.25 | $0.43 | $0.47 |
- Margins and funding: Q3 net interest spread was 2.56% and net interest margin 3.08%, versus 2.48% and 3.00% a year earlier. Nine-month spread and margin were 2.46% and 3.01%, versus 2.18% and 2.66%. Q3 MBS net yield was 5.10%, down from 5.43%.
- Balance sheet at September 30: Total assets were $8,478.0; total liabilities $6,187.0; stockholders’ equity $2,291.0. Repurchase agreements were $5,995.4, down from $7,195.8 at December 31, 2009. Cash and cash equivalents were $270.9, down from $653.5; restricted cash was $41.2.
- Leverage: GAAP debt-to-equity was 2.6x, versus 3.3x at December 31, 2009. The company’s non-GAAP measure, including borrowings underlying MBS Forwards, was 2.8x versus 3.4x.
- Cash flow, nine months: Operating activities provided $186.8; investing activities provided $970.0; financing activities used $1,539.3. Cash decreased $382.5 to $270.9.
Material changes versus comparable periods
- Q3 net income available to common increased to $75.2 from $64.8, while EPS rose to $0.27 from $0.25. For the nine-month period, common earnings increased to $202.1 from $183.5, but EPS fell to $0.72 from $0.78, reflecting a higher weighted-average share count.
- Net interest income declined in both comparison periods as the Agency MBS portfolio and its yield contracted. Lower borrowing costs and growth in higher-yielding Non-Agency MBS partly offset the decline.
- Other income was materially higher: Q3 included $21.3 of net gains on MBS Forwards. Nine-month other income of $49.3 included $41.3 of MBS Forward gains and $33.7 of MBS sale gains, partly offset by $26.8 of losses terminating repurchase agreements.
- MFA shifted its portfolio toward Non-Agency MBS. During the first nine months it bought approximately $1,009 million of Non-Agency MBS, including securities reported as MBS Forwards, and acquired approximately $1,842 million of Agency MBS after selling $931.9 million of Agency MBS in Q1.
- Credit-related other-than-temporary impairment charges were $5.4 for the first nine months, all recorded in Q2 and relating to six Legacy Non-Agency securities, compared with $9.0 in the prior-year period.
Outlook, commentary, risks and unusual items
- Management said financing remained available at attractive rates and terms, and considered discounted Non-Agency MBS and selected Agency securities attractive. It expected most assets to remain in Agency MBS, while continuing to explore Non-Agency investments and other strategic initiatives. No formal earnings or dividend guidance was provided.
- Management reported $270.9 of cash, $458.9 of unpledged Agency MBS and $75.9 of excess collateral as resources available for potential margin calls. The filing elsewhere labels this cushion “$805.7 billion,” although the listed components and other references indicate an amount in millions; the filing text contains an apparent unit inconsistency.
- Key risks include short-term repo funding against longer-term assets; lender non-renewal or higher collateral requirements; margin calls and forced asset sales; changes in rates, yield curves and prepayments; and credit deterioration in Non-Agency MBS. Swaps had $3,025.1 notional value and a $175.3 fair-value liability. The filing’s modeled +100-basis-point rate shock estimated a 6.34% decline in net interest income and a 0.60% decline in portfolio value; these are scenario estimates, not forecasts.
- Non-Agency MBS credit estimates depend on projected cash flows and assumptions about defaults, prepayments and loss severity. MFA reported $723.1 of purchase discount designated as credit reserve across Non-Agency MBS and securities underlying MBS Forwards; actual losses could exceed estimates.
- On October 8, 2010, MFA completed a resecuritization involving $985.2 face value of Non-Agency MBS, received $246.3 cash from third-party investors’ purchase of senior bonds, and retained mezzanine and subordinate bonds. MFA said the trust would be consolidated and the transaction accounted for as financing, with no gain or loss.
- On October 1, MFA declared a $0.225 common dividend per share, paid October 29. The company reported no material pending legal proceedings and stated that disclosure controls were effective.
Important facts for investors to verify
- Confirm the correct unit for management’s reported $805.7 margin-call cushion; the filing contains an apparent “billion” versus “million” inconsistency.
- Review the quality and performance of Non-Agency MBS, including credit reserves, delinquency trends and the assumptions underlying impairment and discount accretion estimates.
- Assess repo renewal, counterparty concentration, collateral requirements and the company’s capacity to withstand margin calls, especially given the short remaining terms of much of its financing.
- Track the effect of swap costs, prepayments and interest-rate movements on net interest income, book value and dividends; note that scenario analyses rely on assumptions and can differ from actual outcomes.
- Review the October resecuritization’s consolidated financing treatment and its effects on liquidity, leverage and retained credit exposure.