MFA Financial, Inc. — Q2 2013 Form 10-Q
Business context and reporting period. MFA is a REIT investing primarily in residential Agency and Non-Agency mortgage-backed securities (MBS), financed largely with repurchase agreements. This unaudited filing covers the quarter and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods unless stated otherwise.
Financial performance and position
| Metric | Q2 2013 / June 30, 2013 | Comparison |
|---|---|---|
| Interest income | $120.7 million | $125.5 million in Q2 2012 |
| Net interest income | $82.2 million | $82.8 million in Q2 2012 |
| Net income | $75.5 million | $74.8 million in Q2 2012 |
| Net income available to common stock and participating securities | $67.3 million; diluted EPS $0.19 | $72.7 million; $0.20 per share in Q2 2012 |
| Net interest spread / margin | 2.38% / 2.73% | 2.45% / 2.87% in Q2 2012 |
| Total assets / stockholders’ equity | $13.197 billion / $3.165 billion | $13.518 billion / $3.311 billion at December 31, 2012 |
| MBS portfolio at fair value | $12.234 billion: $6.938 billion Agency and $5.296 billion Non-Agency | $12.608 billion at December 31, 2012 |
| Cash and cash equivalents | $448.3 million | $401.3 million at December 31, 2012 |
| Repurchase agreements / securitized debt / Senior Notes | $8.909 billion / $443.7 million / $100 million | Repurchase agreements $8.752 billion and securitized debt $646.8 million at December 31, 2012; Senior Notes unchanged |
| Book value per common share | $8.19 | $8.84 at March 31, 2013; $8.99 at December 31, 2012 |
For the six months, net interest income was $164.8 million versus $166.2 million; net income was $152.8 million versus $159.5 million; and diluted EPS was $0.39 versus $0.43. Net cash provided by operations was $141.2 million, investing activities provided $447.7 million, and financing activities used $542.0 million. Cash increased $47.0 million to $448.3 million.
Q2 comprehensive loss was $148.0 million before preferred dividends and redemption costs, principally reflecting $223.5 million of other comprehensive loss as MBS valuations fell. Net unrealized MBS gains nevertheless remained $700.9 million at quarter-end. The company recorded no credit-related impairment charges through earnings in the first half of 2013.
Material changes and capital actions
- Q2 MBS fair value declined, primarily from market price declines amid greater uncertainty about the pace and scale of Federal Reserve asset purchases. The portfolio fell by $374 million from year-end, while principal repayments exceeded additions during Q2.
- Agency MBS net yield fell to 2.19% in Q2 from 2.95% a year earlier; Non-Agency MBS net yield increased to 7.15% from 6.77%. Q2 total net interest income was slightly lower as Agency spread pressure offset stronger Non-Agency income and lower funding costs.
- In April, MFA issued $200 million of 7.50% Series B preferred stock, receiving approximately $193.3 million net, and redeemed all Series A preferred stock for approximately $97 million in May. The redemption resulted in a $3.9 million charge against earnings available to common shareholders for the original Series A offering costs.
- Common dividends declared in the first half totaled $0.94 per share, including the $0.50 special dividend declared in March. The regular Q2 dividend was $0.22 per share.
- Management released $54.8 million from Non-Agency MBS credit reserves into accretable discount in Q2, citing improved estimated collateral cash flows. This is expected to increase interest income over time, not immediately.
Outlook, risks and unusual items
- Outlook: No quantified earnings or return guidance is provided. Management said it intended to selectively acquire Agency and Non-Agency MBS during the rest of 2013, expected most assets to remain Agency MBS, and considered available funding and investment capacity adequate at quarter-end. It cautioned that funding costs and results are uncertain.
- Interest-rate exposure: Management’s modeled shock estimated that an immediate 100-basis-point rate increase would reduce next-12-month net interest income by 5.92% and portfolio value by 1.91%; a 100-basis-point decrease was modeled to reduce net interest income by 6.85% while increasing portfolio value by 1.60%. These are estimates based on assumptions, not forecasts.
- Leverage and liquidity: Debt-to-equity was 3.1x. Repurchase funding is uncommitted and renewable at lenders’ discretion; declining collateral values or tighter markets could trigger margin calls, higher haircuts, reduced leverage, or difficulty refinancing. Management reported a $961.1 million liquidity “Cushion” at quarter-end, in addition to other excess or unpledged Non-Agency collateral.
- Credit and valuation: Non-Agency MBS are exposed to mortgage defaults and loss severities; 59% of their current face amount had no remaining credit enhancement. Estimated cash flows, fair values, and credit reserves rely on management assumptions and may change. Agency and Non-Agency MBS fair values may be affected by interest rates, prepayments, housing conditions, and market liquidity.
- Controls and tax: Management concluded disclosure controls were ineffective as of June 30, 2013 because remediation of a material weakness in calculating taxable income for MBS remained in progress. The weakness had contributed to underreported taxable income for prior years. MFA recorded a $2.0 million accrual for estimated excise tax and interest related to undistributed taxable income.
- Regulatory and other matters: Changes to REIT requirements, mortgage/securitization regulation, or the SEC’s interpretation of the Investment Company Act exemption could affect operations and financing. The filing reports no material pending legal proceedings and no material changes to the prior annual report’s risk factors.
- After quarter-end: On August 1, 2013, the Board declared a $0.28-per-share special common dividend, payable August 30. MFA also entered into $950 million of additional swaps after June 30; reported swap notional at July 31 was $3.452 billion.
Important facts for investors to verify
- Progress and effectiveness of remediation for the material weakness in taxable-income calculations and disclosure controls.
- Actual REIT taxable income, tax-return filings, and whether declared distributions satisfy distribution and excise-tax requirements.
- Quarter-end book value and portfolio marks, and the assumptions supporting the $54.8 million credit-reserve release and future discount accretion.
- Repurchase agreement renewal terms, collateral haircuts, margin-call capacity, counterparty exposures, and the impact of the additional post-quarter swaps.
- Cash available after declared dividends and the sustainability of earnings and distributions amid lower Agency yields, changing rates, prepayments, and Non-Agency credit performance.