MFA FINANCIAL, INC. annual report, FY2017

MFA Financial, Inc. — 2017 Form 10-K Summary

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017; fourth-quarter figures are noted where relevant. MFA is a leveraged residential mortgage REIT investing in Agency and Non-Agency mortgage-backed securities (MBS), residential whole loans, credit risk transfer (CRT) securities and mortgage servicing rights (MSR)-related assets. Its strategy increasingly emphasizes credit-sensitive assets, particularly residential whole loans.

Financial performance and position

Metric	2017	2016
Interest income	$433.4 million	$457.5 million
Net interest income	$236.3 million	$264.1 million
Net interest spread / margin	2.09% / 2.55%	2.12% / 2.45%
Net income	$322.4 million	$312.7 million
Net income available to common stock and participating securities	$307.4 million	$297.7 million
Basic and diluted EPS	$0.79	$0.80
Common dividends declared per share	$0.80	$0.80
Operating and other expense	$71.9 million	$60.0 million

Fourth quarter: net income was $100.6 million and common EPS was $0.24, versus $72.6 million and $0.18 in Q4 2016. Net interest income was $52.4 million.
Year-end balance sheet: total assets were $11.0 billion, total stockholders’ equity $3.26 billion, and book value per common share $7.70, versus $7.62 a year earlier. Cash and cash equivalents were $449.8 million; restricted cash was $13.3 million.
Portfolio: residential mortgage assets were approximately $9.7 billion. MBS fair value was $6.36 billion; residential whole loans totaled $2.23 billion, including $908.5 million at carrying value and $1.33 billion at fair value. CRT securities were $664.4 million and MSR-related assets $492.1 million.
Debt and leverage: repurchase agreements and other advances were $6.61 billion; securitized debt was $363.9 million; and $100 million principal amount of 8% Senior Notes due 2042 remained outstanding. Debt-to-equity leverage was 2.3x, down from 3.1x at year-end 2016. Repo financing is generally short-term, uncommitted and renewable at lenders’ discretion.
Liquidity and cash flow: management estimated available liquidity above $1.1 billion, including cash and estimated financing capacity from unpledged or excess-collateral MBS and CRT securities. Operating cash flow was $176.1 million; investing activities provided $1.82 billion; financing activities used $1.80 billion. Cash increased $189.6 million during the year.

Material changes versus the prior period

Net interest income fell $27.8 million (10.5%) as lower average Agency and Non-Agency MBS balances and higher funding costs outweighed growth in whole loans, CRT and MSR-related assets. Borrowing costs rose: the effective rate on interest-bearing liabilities increased to 2.58% from 2.13%.
Other income increased to $159.0 million from $109.0 million, including $90.0 million of net gains on whole loans held at fair value, $39.6 million of net gains on securities sales and $27.7 million of unrealized CRT gains.
Assets shifted toward whole loans and other credit-focused investments, while MBS holdings contracted. Whole loans grew to about 20.4% of total assets; the company purchased approximately $1.0 billion of whole loans during 2017.
Operating and other expense rose to $71.9 million, including $22.3 million of whole-loan servicing and related costs. Management cited higher servicing costs and non-recurring expenses associated with accelerated vesting of awards and a death benefit for the estate of its former CEO.
MFA issued 23 million common shares in a May 2017 public offering for gross proceeds of approximately $180.6 million, and issued additional shares through its dividend reinvestment/direct purchase plan. Management said increased share issuance contributed to lower annual EPS despite higher net income available to common holders.
Residential real estate owned (REO) increased to $152.4 million across 709 properties from $80.5 million across 447 properties. Management recorded $11.0 million of downward REO valuation adjustments during 2017.

Outlook, commentary, risks and unusual items

Management expects to continue investing in residential mortgage assets during 2018, with a primary focus on residential whole loans, RPL/NPL MBS and MSR-related assets. It described market pricing as high and attractive risk/reward opportunities as difficult to find. No quantitative earnings or dividend guidance was provided.
Management expects whole-loan investment growth to continue and REO balances may rise in the short to medium term. Further RPL/NPL MBS runoff is possible if issuers call securities.
Rising short-term rates may increase repo costs faster than asset yields reset; the filing’s year-end sensitivity analysis estimated that an immediate 100-basis-point increase would reduce 12-month net interest income by 2.83% and portfolio value by 0.95%. These are model-based estimates, not forecasts.
Key risks include leverage and margin calls, non-renewal or repricing of repo financing, counterparty concentration, credit losses and valuation uncertainty in whole loans and Non-Agency MBS, servicing and foreclosure delays, geographic concentration, prepayment risk, and changes to Fannie Mae/Freddie Mac or mortgage regulation. The portfolio has significant California exposure, including 42.4% of Legacy Non-Agency MBS unpaid principal balance and 20.4% of whole-loan interest-bearing unpaid principal balance.
Fair-value movements affect reported earnings: $1.33 billion of whole loans were carried at fair value, and management identified fair-value accounting as a source of quarterly earnings volatility. A $50.8 million transfer from Legacy Non-Agency MBS credit reserve to accretable discount reflected improved expected cash flows; the remaining credit reserve and OTTI totaled $593.2 million.
Estimated 2017 REIT taxable income was $331.4 million, with approximately $57.9 million, or $0.15 per share, undistributed based on dividends paid or declared. The first-quarter unwind of an MBS resecuritization was estimated to generate about $53.3 million ($0.13 per common share) in taxable income but no GAAP gain. Taxable income and GAAP earnings may differ materially.
The company completed two whole-loan securitizations, issuing $382.8 million face amount of third-party bonds and retaining certificates. The consolidated securitization vehicles’ debt is non-recourse to MFA’s general credit, subject to specified loan representation-and-warranty repurchase obligations; no reserve for repurchases was recorded at year-end.
The board declared $0.80 per common share in 2017 dividends. The filing states there is no minimum common dividend and future payments remain at the board’s discretion; REIT status generally requires distribution of at least 90% of REIT taxable income. The auditor issued an unqualified opinion, and management and the auditor reported effective internal control over financial reporting.

Important facts for investors to verify

Whether net interest income and margins can withstand further increases in short-term funding costs, and how the $2.6 billion swap hedge portfolio changes over time.
The quality, valuation assumptions, servicing performance and ultimate recoveries of whole loans; monitor past-due balances, foreclosure progress, REO growth and realized losses.
Whether Non-Agency MBS credit assumptions, the $593.2 million credit reserve and the $50.8 million reserve release remain appropriate as collateral performance evolves.
Actual liquidity under stressed collateral values and repo renewals, including potential margin calls, counterparty exposure and financing availability.
REIT taxable income, tax effects of securitizations and the resecuritization unwind, and whether taxable income supports the common dividend despite GAAP EPS of $0.79 versus $0.80 declared dividends per share.
The impact of common-share issuance and any future equity raises on per-share earnings and book value, as well as the sustainability of the $0.80 annual common dividend.