Business context and reporting period
MFA Financial, Inc. is a REIT investing primarily, on a leveraged basis, in residential Agency and Non-Agency mortgage-backed securities (MBS). This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2013; comparisons are to the corresponding 2012 periods unless stated otherwise. Amounts below are in millions of dollars, except per-share data and ratios.
Financial results and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Interest income | $118.5 | $125.1 | $361.9 | $374.2 |
| Interest expense | $42.0 | $45.8 | $120.6 | $128.6 |
| Net interest income | $76.5 | $79.3 | $241.3 | $245.6 |
| Other income, net | $5.6 | $7.5 | $12.9 | $18.7 |
| Operating and other expense | $10.8 | $8.7 | $30.1 | $25.4 |
| Net income | $71.3 | $78.1 | $224.2 | $237.6 |
| Basic and diluted EPS | $0.19 | $0.21 | $0.58 | $0.65 |
- Q3 net interest spread was 2.24% and net interest margin 2.63%, versus 2.22% and 2.61% a year earlier. For the nine months, spread was 2.32% and margin 2.68%, versus 2.40% and 2.81%.
- At September 30, total assets were $12,598.6, including MBS at fair value of $11,671.1; total liabilities were $9,525.0 and stockholders’ equity was $3,073.5. Book value per common share was $7.85.
- Repurchase agreements were $8,568.2; securitized debt was $419.7; and 8% Senior Notes were $100.0. Reported debt-to-equity leverage was 3.0x (3.1x on the company’s non-GAAP measure).
- Cash and cash equivalents were $503.9, with another $59.3 of restricted cash. Management reported a $966.6 liquidity “Cushion” for potential margin calls, including cash, unpledged Agency MBS and excess Agency collateral.
- For the nine months, operating activities provided $227.1; investing activities provided $1,191.9; financing activities used $1,316.4; and cash increased $102.6.
- Common dividends declared were $0.50 per share in Q3, including a $0.28 special dividend; the regular Q3 dividend was $0.22. Nine-month declared dividends totaled $1.44 per share, including special dividends of $0.50 and $0.28.
Material changes versus the prior comparable period
- Q3 net income declined $6.8 and EPS fell from $0.21 to $0.19; nine-month net income declined $13.5 and EPS fell from $0.65 to $0.58.
- Agency MBS yields weakened: Q3 Agency net yield was 2.13%, down from 2.66%; nine-month yield was 2.25%, down from 2.91%. Non-Agency MBS net yields improved to 7.33% from 6.65% in Q3 and 7.09% from 6.78% for the nine months.
- Net interest income decreased by $2.8 in Q3 and $4.3 for the nine months. Lower Agency asset yields were partly offset by lower Agency funding costs and stronger Non-Agency yields; Non-Agency funding costs increased.
- Other income was affected by $8.7 of unrealized TBA short-position losses in 2013. This was partly offset by MBS sale gains of $13.7 in Q3 and $19.7 for the nine months. Linked Transaction gains and income were also lower than in 2012.
- Operating and other expense included a $2.0 impairment charge for resecuritization-related costs in Q3, plus a $2.0 excise-tax and interest accrual for the nine months. The nine-month common earnings calculation also included $3.9 of costs associated with redeeming Series A preferred stock.
- The company issued $200.0 of Series B preferred stock, netting approximately $193.3, and redeemed Series A preferred stock for approximately $97.0. The MBS portfolio’s fair value declined from $12,607.6 at year-end 2012 to $11,671.1 at September 30, 2013.
Outlook, commentary, risks and unusual items
- Management said it intended to continue selectively acquiring Agency and Non-Agency MBS for the remainder of 2013, with most assets expected to remain Agency MBS. It cited $503.9 of cash and $415.0 of unpledged Agency MBS as resources for investment opportunities. No quantified earnings or dividend guidance was provided.
- Management attributed improved Non-Agency MBS credit expectations to home-price appreciation, lower estimated loan-to-value ratios, declining delinquency transitions and higher voluntary prepayments. It transferred $71.0 from Credit Reserve to accretable discount in Q3, and $160.3 during the nine months. These estimates depend on assumptions about future collateral performance and may change.
- Interest-rate, prepayment and reinvestment risks are significant. The company relies heavily on short-term, uncommitted repurchase financing; counterparties may decline to renew, raise haircuts or make margin calls. A modeled 100-basis-point rate increase indicated a 1.02% decline in projected net interest income and a 0.90% decline in portfolio value; actual outcomes may differ materially.
- Non-Agency MBS expose the company to mortgage credit losses. Management noted geographic concentrations, including Southern California (28.1%) and Northern California (17.3%) of underlying mortgage exposure, and stated that 67% of current face had no remaining credit enhancement.
- Counterparty default, collateral recovery, market liquidity and the availability and cost of financing are risks. Changes in regulation, including Dodd-Frank implementation and SEC review of the Investment Company Act exemption on which the company relies, could raise costs or require significant business restructuring.
- The company estimated 2013 taxable income of approximately $297.0 through September 30 and said it had distributed approximately $236.0 of dividends not allocated to prior years. It filed its 2012 tax return reporting approximately $476.0 of REIT taxable income as fully distributed. The filing describes a prior taxable-income calculation control material weakness: new controls were operating, but remediation was ongoing and disclosure controls remained ineffective as of September 30.
- The company reported no material pending legal proceedings, no material changes to the risk factors in its 2012 Form 10-K, and no material off-balance-sheet arrangements. Results for the nine months should not be taken as indicative of full-year results.
Important facts for investors to verify
- Whether updated collateral performance supports the $1,119.0 Non-Agency Credit Reserve and the $71.0 Q3 release to accretable discount.
- How Agency and Non-Agency yields, prepayments, funding costs and hedges affect future net interest income and book value.
- Repurchase financing renewal terms, margin-call capacity, collateral haircuts and exposure to concentrated counterparties.
- Final 2013 REIT taxable income, required distributions and the sustainability of dividends relative to earnings and available liquidity.
- Whether the revised taxable-income controls operate effectively long enough for management to conclude the material weakness has been remediated.
- Potential effects of regulatory developments on the company’s financing, investment strategy and Investment Company Act exemption.