MFA FINANCIAL, INC. annual report, FY2019

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MFA Financial, Inc. — 2019 Form 10-K Summary

Business and period: MFA is an internally managed mortgage REIT that invests with leverage in residential whole loans, mortgage-backed securities, CRT securities and MSR-related assets. This annual filing covers the year ended December 31, 2019; it also reports fourth-quarter results. The audited financial statements received an unqualified opinion.

Financial and operating performance

  • Income and earnings: Interest income was $581.7 million, up from $455.7 million in 2018. Net interest income increased 11.6% to $249.4 million. Net income was $378.1 million versus $301.8 million; income available to common stock and participating securities was $363.1 million, or $0.80 basic EPS and $0.79 diluted EPS, compared with $286.8 million and $0.68 per share in 2018.
  • Profit quality and margins: Core earnings, a non-GAAP measure, were $0.78 per common share, unchanged from 2018. Net interest spread fell to 1.96% from 2.23%, and net interest margin to 2.35% from 2.64%. Higher net interest income reflected growth in loans and MSR-related assets; reported earnings also benefited from fair-value gains and a reversal of prior-period unrealized losses.
  • Expenses: Operating and other expense rose to $97.1 million from $79.7 million, including $44.5 million of loan servicing and related costs, up from $33.6 million. Management cited portfolio growth, REO-related costs, staffing, incentive compensation and technology expenses.
  • Cash flow: Operating activities provided $215.8 million; investing activities used $1.135 billion; financing activities provided $964.9 million. Cash, cash equivalents and restricted cash increased $46.0 million to $134.7 million. Cash and cash equivalents alone were $70.6 million.
  • Balance sheet and leverage: Total assets were $13.57 billion and stockholders’ equity was $3.38 billion. Repurchase agreements totaled $9.14 billion; securitized debt was $571.0 million. The company also had $230 million principal amount of 6.25% convertible notes issued in 2019 and $100 million principal amount of 8.00% senior notes. Debt-to-equity leverage was 3.0x, up from 2.6x.
  • Liquidity: Management estimated available liquidity above $114.2 million, including cash and financing capacity against unpledged or excess-collateral MBS. It also reported $1.1 billion of unencumbered residential whole loans. These amounts do not include restricted cash.
  • Book value and distributions: GAAP book value per common share was $7.04, down from $7.15; economic book value, a non-GAAP measure, was $7.44, up from $7.35. Common dividends were $0.80 per share for the year, matching basic EPS. Preferred dividends were $15.0 million.

Material changes versus 2018

  • The portfolio shifted further toward whole loans: residential whole loans and REO were about 55% of total assets at year-end, while residential mortgage securities were below 40%. The residential mortgage asset portfolio grew to $13.1 billion from $12.1 billion.
  • Residential whole loans and REO increased to $7.9 billion from $4.9 billion, reflecting $4.3 billion of whole-loan acquisitions. MSR-related assets increased to $1.2 billion from $612 million.
  • Agency MBS declined to $1.7 billion from $2.7 billion; CRT securities declined to $255 million from $493 million; Legacy Non-Agency MBS declined to $1.4 billion from $1.9 billion. The company sold securities and used proceeds in part to expand loan investments.
  • Interest expense rose 43.1% to $332.4 million, reflecting higher average borrowings, financing costs and the new convertible notes. Average borrowing cost rose to 3.52% from 3.14%.
  • REO properties increased to 1,652 from 1,093, with carrying value rising to $411.7 million from $249.4 million.

Outlook, risks and notable items

  • Outlook: Management expected to continue prioritizing residential whole loans in 2020, with selective investments in mortgage securities and MSR-related assets, and anticipated a moderate increase in leverage through repo financing and securitization. The filing provides no specific earnings or return guidance.
  • Credit and valuation: The business is exposed to borrower defaults, collateral and home-price changes, servicing performance, foreclosure delays and uncertain valuations. Whole loans are less liquid than many securities; California, Florida, New York, New Jersey and Maryland are notable geographic concentrations.
  • Funding and market risk: Short-term, uncommitted repurchase agreements expose MFA to refinancing risk, margin calls, higher haircuts and forced asset sales. At year-end, repurchase agreements were with 28 lenders; several counterparties each represented more than 5% of stockholders’ equity at risk. Interest-rate, spread, prepayment and hedge risks can affect earnings, asset values and liquidity.
  • Interest-rate sensitivity: The company estimated that an immediate 100-basis-point rate increase would reduce next-12-month net interest income by 3.63% and portfolio value by 1.66%; these are model estimates, not forecasts. LIBOR transition after 2021 was an identified uncertainty.
  • Accounting and unusual items: Adoption of the expected-credit-loss standard on January 1, 2020 increased the allowance on Purchased Performing Loans by approximately $8.3 million. Year-end 2019 allowance for Purchased Performing and Purchased Credit Impaired loans was $3.0 million. The filing identifies significant estimation risk in whole-loan valuations, accretable yield on credit-impaired loans and effective-yield income on Non-Agency MBS.
  • Other items: Estimated 2019 REIT taxable income was $362.6 million, with approximately $22.7 million undistributed based on dividends paid or declared during 2019. No material legal proceedings or material unsettled loan repurchase claims were reported. Management expected to relocate its headquarters in the fourth quarter of 2020; the new lease was estimated at about $4.6 million annual rent before escalations.
  • Timing: The filing was signed February 21, 2020 and describes conditions and plans as of that filing period; it does not provide a later update on subsequent market developments.

Important facts for investors to verify

  1. How loan credit performance, delinquencies, defaults, REO dispositions and collateral values evolve, especially given the rapid growth and geographic concentration of the whole-loan portfolio.
  2. Whether repo funding, margin requirements and counterparties remain stable, and how MFA finances its $1.1 billion of unencumbered whole loans.
  3. Whether net interest spreads and core earnings can support the $0.80 annual common dividend as borrowing costs, prepayments and portfolio mix change.
  4. The assumptions behind fair values and yields for loans, Non-Agency MBS and MSR-related assets, including the effects of the new expected-credit-loss accounting standard.
  5. Actual leverage, liquidity, taxable income and dividend capacity, distinguishing GAAP results from management’s non-GAAP core earnings and economic book value.