MFA Financial, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. This unaudited filing covers the three and nine months ended September 30, 2019. MFA is a leveraged mortgage REIT investing primarily in residential whole loans, mortgage-backed securities (MBS), credit risk transfer securities and mortgage-servicing-rights-related assets. Management’s stated strategy is to focus chiefly on residential whole loans, with selective investments in securities and MSR-related assets.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net income | $95.6 million | $87.1 million | $277.5 million | $240.9 million |
| Net income available to common stock and participating securities | $91.8 million | $83.4 million | $266.2 million | $229.7 million |
| Basic EPS | $0.20 | $0.19 | $0.59 | $0.56 |
| Net interest income | $56.9 million | $58.6 million | $178.7 million | $161.7 million |
| Net interest spread / margin | 1.82% / 2.19% | 2.41% / 2.82% | 1.90% / 2.29% | 2.32% / 2.71% |
| Other income, net | $62.4 million | $48.4 million | $170.5 million | $137.0 million |
| Operating and other expenses | $23.7 million | $19.8 million | $71.7 million | $57.8 million |
- Balance sheet at September 30: assets were $13.10 billion, liabilities $9.70 billion and stockholders’ equity $3.40 billion. Repurchase agreements were $8.57 billion; securitized debt was $605.7 million. The company also reported $230.0 million principal amount of 6.25% Convertible Senior Notes due 2024 and $96.9 million carrying value of 8% Senior Notes due 2042.
- Portfolio and leverage: residential whole loans totaled approximately $6.4 billion, residential MBS and CRT securities $4.59 billion, and MSR-related assets $1.16 billion. Debt-to-equity leverage was 2.8x, compared with 2.6x at year-end 2018. GAAP book value was $7.09 per common share; economic book value, a company-defined non-GAAP measure, was $7.41.
- Liquidity: management estimated more than $234.7 million in available liquidity, including $154.2 million of cash and cash equivalents and estimated financing capacity against unpledged or excess-collateral securities. It also reported $1.1 billion of unencumbered residential whole loans. Restricted cash was $39.0 million and excluded from management’s liquidity estimate.
- Cash flows, nine months: operating activities provided $153.6 million, investing activities used $564.3 million, and financing activities provided $515.2 million. Cash, cash equivalents and restricted cash ended at $193.2 million, up from $88.7 million at the start of the period.
- Distribution: MFA declared common dividends of $0.20 per share each quarter through Q3 and preferred dividends of $0.46875 per share per quarter. The nine-month common dividend payout ratio was reported as 1.02.
Material changes versus comparable periods
- Q3 common earnings and EPS increased year over year, while net interest income declined $1.7 million and net interest spread narrowed 59 basis points. Higher net income reflected higher gains on fair-value whole loans, higher other income and lower unrealized losses on securities measured through earnings; these were partly offset by swap unwind losses and higher expenses.
- For the first nine months, net income and common EPS rose year over year, and net interest income increased $17.0 million. Growth in whole loans, MSR-related assets and RPL/NPL MBS income more than offset lower income from Legacy Non-Agency MBS, CRT securities and Agency MBS.
- Funding costs rose: the effective cost of borrowings was 3.50% in Q3 versus 3.13% a year earlier, and 3.52% for the nine-month period versus 3.03%. The company cited higher average borrowings, higher financing rates and interest on newly issued convertible notes. Loan servicing and other related operating expenses also increased as the loan and REO portfolios expanded.
- Residential whole loans at carrying value grew to $4.97 billion from $3.02 billion at year-end 2018. REO increased to $376.2 million from $249.4 million. During Q3, MFA added $918 million of Purchased Performing Loans and made approximately $100 million of capital contributions to loan-origination partners.
- Core earnings, a non-GAAP measure, were $0.20 per share for Q3 versus $0.21, and $0.57 for nine months versus $0.58. These differed from GAAP EPS of $0.20 and $0.59, respectively.
Outlook, risks and notable items
- Management expected to continue seeking investment opportunities primarily in residential whole loans, and selectively in residential mortgage securities and MSR-related assets, for the remainder of 2019. The filing provides no numerical earnings or dividend guidance.
- Management said it believed resources were adequate for current obligations, margin calls, declared dividends and investment plans. However, repo financing is uncommitted and renewable at lenders’ discretion; asset-value declines, tighter markets, higher haircuts or nonrenewals could increase margin calls, reduce leverage capacity or impair liquidity.
- Net interest income and asset values are exposed to interest rates, yield-curve changes, financing spreads and prepayments. The company’s shock analysis estimated that an immediate 100-basis-point rate increase would reduce projected 12-month net interest income by 4.90% and portfolio value by 1.38%; management cautioned that actual results could differ materially. Estimated net effective duration was 1.14.
- Credit and valuation risks include defaults and recoveries on Non-Agency MBS, CRT securities and whole loans; the growing REO portfolio; and estimates used for Level 3 whole-loan valuations. Management reported no credit-related OTTI losses on Non-Agency MBS in the current or comparable periods, but estimates of future cash flows and collateral values remain judgmental.
- Non-hedging swaps generated net losses of $17.3 million for the nine months, including $17.7 million of realized losses on unwinds; the Q3 net loss was $0.9 million. The filing also notes uncertainty about LIBOR’s expected discontinuation after 2021 and potential U.S. housing-finance reforms affecting Fannie Mae and Freddie Mac.
- MFA reported no material pending legal proceedings, no material unsettled loan repurchase claims and no reserve for such repurchases. It reported compliance with financial covenants through September 30, 2019, effective disclosure controls and no material changes in internal control over financial reporting. No material risk-factor changes from the 2018 Form 10-K were reported.
Important facts for investors to verify
- Whether portfolio growth in whole loans and REO produces returns sufficient to offset rising funding costs, servicing expenses and the continuing decline in net interest spread.
- Liquidity resilience under adverse collateral marks, margin calls, repo nonrenewals or higher haircuts, including the availability and financing value of unencumbered loans.
- Whole-loan delinquency, loss and foreclosure trends, REO dispositions, and the assumptions supporting fair values and loan-loss allowances.
- The quality and repeatability of reported earnings, including fair-value gains, security-sale gains, swap results and the reconciliation of GAAP earnings to Core earnings.
- Dividend coverage against taxable income, cash generation and liquidity, and the effects of leverage and potential share issuance on per-share book value and earnings.