MFA Financial, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. MFA is a REIT investing, on a leveraged basis, in residential mortgage assets. This unaudited filing covers the quarter and six months ended June 30, 2018; comparisons below are with the corresponding 2017 periods unless stated otherwise. At quarter-end, total assets were $10.64 billion. Residential whole loans and REO continued to expand as a share of the portfolio.
Financial performance and position
- Q2 earnings: Net income was $70.4 million, compared with $79.9 million. Net income available to common stock and participating securities was $66.6 million, or $0.17 per diluted share, versus $76.2 million, or $0.20. For the first half, those common earnings were $146.3 million, or $0.36 per share, versus $150.5 million, or $0.39.
- Interest income and margins: Q2 interest income was $101.7 million versus $110.2 million; net interest income was $49.9 million versus $61.1 million. The net interest spread improved to 2.30% from 2.10%, and net interest margin to 2.66% from 2.58%. For the first half, net interest income fell to $103.1 million from $128.0 million, while spread rose to 2.28% from 2.19% and margin to 2.65% from 2.61%.
- Other income and expenses: Q2 other income, net, rose to $41.0 million from $36.9 million, including $32.4 million of net gains on whole loans held at fair value. Operating and other expense increased to $20.5 million from $17.5 million, largely reflecting higher loan servicing and related costs. First-half other income, net, was $88.7 million versus $64.9 million.
- Portfolio and equity: Residential whole loans were $3.41 billion at quarter-end, up from $2.23 billion at December 31, 2017; MBS were $5.61 billion, down from $6.36 billion. Stockholders’ equity was $3.21 billion. Book value per common share was $7.54, down from $7.62 at March 31, 2018 and $7.76 a year earlier. Q2 comprehensive income available to common stock and participating securities was $48.6 million, versus $113.9 million, including a $18.0 million other comprehensive loss.
- Debt and leverage: Repurchase agreements totaled $5.89 billion, down from $6.61 billion at year-end; securitized debt was $518.7 million, up from $363.9 million. Senior Notes had a $96.8 million carrying value and $100 million principal amount. Reported debt-to-equity leverage was 2.3 times.
- Liquidity and cash flows: Cash and cash equivalents were $54.9 million and restricted cash $3.3 million. Management estimated liquidity sources exceeding $606.4 million, excluding restricted cash, plus $877.1 million of unencumbered residential whole loans. For the first half, operating cash flow was $43.8 million, investing cash flow was positive $266.6 million, and financing cash flow was negative $715.3 million; cash, cash equivalents and restricted cash declined $404.9 million to $58.2 million.
- Dividends: Common dividends declared were $0.20 per share in Q2; the first-half declared dividend was $0.40 per share. The Q2 dividend payout ratio was 1.18 times reported earnings per share.
Material changes versus comparable periods
- Earnings per common share declined in Q2 and the first half. Management attributed the decline mainly to lower MBS net interest income and lower unrealized gains on fair-value CRT securities, partly offset by growth in whole-loan income and gains.
- MBS interest income fell as average MBS balances contracted; higher yields did not offset the reduction in invested balances and higher funding costs. In contrast, first-half interest income on whole loans held at carrying value rose to $32.3 million from $17.2 million, reflecting portfolio growth.
- Whole loans and REO increased substantially. During Q2, MFA acquired approximately $898 million of residential whole loans and REO, while total residential mortgage assets were $10.16 billion versus $10.02 billion at March 31, 2018.
- First-half interest expense increased to $102.4 million from $99.4 million as funding rates rose, despite lower average repurchase borrowings. The effective borrowing rate was 2.97% versus 2.42%.
Outlook, commentary, and risks
- Management said it would continue seeking residential mortgage investments during 2018, focusing primarily on whole loans, with RPL/NPL MBS and MSR-related assets as opportunities arise. The filing provides no numerical earnings or dividend guidance.
- Management cited improving collateral performance and home-price appreciation in the legacy Non-Agency MBS portfolio. It transferred $8.0 million of credit reserve to accretable discount in Q2, which it expects to contribute to interest income over time. A one-time $12.1 million cash settlement relating to certain mortgage securitization litigation also affected the period’s discount/yield accounting.
- Interest-rate sensitivity remains material: the filing’s modeled instantaneous +100 basis-point shock estimated a 3.80% decline in net interest income over 12 months and a 1.20% decline in portfolio value; results depend on assumptions and are not forecasts.
- Key risks include short-term, uncommitted repurchase funding; potential nonrenewals, higher haircuts and margin calls; rising funding costs; asset valuation, credit, prepayment and foreclosure risks; and dependence on market access for securitizations. At June 30, MFA reported compliance with its financial covenants. Six whole loans totaling about $2.1 million were on non-accrual; management recorded no related loan-loss allowance.
- MFA reported no material changes to the risk factors in its 2017 Form 10-K, no material pending legal proceedings, and effective disclosure controls as of June 30, 2018.
Important facts for investors to verify
- Whether growth in whole loans can offset continued MBS runoff, lower MBS interest income, and higher financing costs.
- The composition, availability, and assumptions underlying the estimated $606.4 million of liquidity, and the financing capacity of the $877.1 million of unencumbered loans.
- Loan portfolio credit quality, delinquency and foreclosure progression, servicing costs, REO liquidation outcomes, and management’s cash-flow and valuation assumptions.
- Whether the $8.0 million credit-reserve release and the litigation settlement benefit recur; both should be distinguished from recurring investment income.
- The sustainability of the $0.20 quarterly common dividend given reported Q2 earnings per share of $0.17 and a payout ratio above 1.0 times.
- How rate movements, prepayments, collateral values, repurchase-agreement renewals and margin requirements affect book value, earnings and liquidity.