MFA Financial, Inc. — Third-Quarter 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012. The filing was signed November 6, 2012. MFA is a REIT that invests primarily in residential Agency and Non-Agency mortgage-backed securities (MBS), financed largely with repurchase agreements.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Interest income | $125.1m | $130.8m | $374.2m | $372.8m |
| Interest expense | $45.8m | $38.8m | $128.6m | $110.6m |
| Net interest income | $79.3m | $92.0m | $245.6m | $262.2m |
| Net income | $78.1m | $83.7m | $237.6m | $245.9m |
| EPS, basic and diluted | $0.21 | $0.23 | $0.65 | $0.71 |
| Common dividend declared per share | $0.21 | $0.25 | $0.68 | $0.74 |
- Margins: Q3 net interest spread was 2.22% and net interest margin 2.61%, down from 2.83% and 3.20%, respectively, a year earlier. For the nine-month period, spread was 2.40% and margin 2.81%, versus 2.91% and 3.31%.
- Other income and impairments: Q3 other income was $7.5m, including $4.3m of realized MBS sale gains and $3.2m of gains and net interest income from Linked Transactions. No OTTI was recognized in earnings in Q3; nine-month OTTI charges were $1.2m, compared with $6.4m in 2011.
- Comprehensive income: Q3 comprehensive income available to common stock and participating securities was $556.4m, reflecting substantial unrealized MBS gains recorded primarily in other comprehensive income. Nine-month total was $976.7m.
- Balance sheet at September 30: Total assets were $13.735bn, including $12.674bn of MBS and $450.4m of cash and cash equivalents. Total liabilities were $10.496bn and stockholders’ equity was $3.239bn. The MBS portfolio comprised $7.477bn of Agency and $5.197bn of Non-Agency MBS.
- Debt and leverage: Repurchase agreements were $8.832bn, securitized debt $749.5m, and newly issued senior notes $100m. Reported debt-to-equity leverage was 3.2x, down from 3.6x at December 31, 2011; management attributed the Q3 decline primarily to higher Non-Agency MBS market values. The senior notes carry an 8% coupon and mature in 2042.
- Cash flow and liquidity: For nine months, operating activities provided $232.6m, investing activities used $782.3m, and financing activities provided $606.1m. Cash increased $56.4m to $450.4m. Management reported a $1.071bn liquidity “Cushion” for potential margin calls, comprising cash, unpledged Agency MBS and excess Agency collateral.
Material changes versus comparable periods
- Q3 net income available to common stock and participating securities fell to $76.1m from $81.7m; nine-month income declined to $231.5m from $239.7m. Per-share earnings also decreased.
- Lower MBS yields and higher funding costs compressed spreads and margins. Agency MBS income fell as yields declined and prepayments accelerated premium amortization; Non-Agency MBS income increased with portfolio growth, but its yield also declined.
- Q3 interest expense rose 18.2% year over year, while net interest income fell 13.8%. The filing cites greater average borrowings, higher-cost longer-term financing and lower-yielding additions to the portfolio.
- MBS fair value increased to $12.674bn from $10.913bn at year-end 2011. Net unrealized gains on MBS were $764.6m at quarter-end, versus $55.5m at year-end; these gains are not equivalent to realized earnings.
- MFA issued $100m of 8% senior notes in April 2012 and completed a February 2012 resecuritization. It also increased use of longer-term financing for Non-Agency assets.
Outlook, management commentary and risks
- Management intended to continue selectively acquiring Agency and Non-Agency MBS during the remainder of 2012 and expected Agency MBS to remain the majority of assets. It cited available financing and investment opportunities, while noting that funding costs and future interest expense were uncertain.
- Management viewed discounted Non-Agency MBS as offering attractive loss-adjusted returns, but acknowledged uncertainty in housing fundamentals and potential credit losses. At quarter-end, $1.460bn of Non-Agency purchase discount was designated as Credit Reserve and/or OTTI.
- Key exposures include short-term, uncommitted repo funding; margin calls and collateral-value declines; interest-rate and prepayment risk; Non-Agency mortgage credit performance; and counterparty default. Repo borrowings generally reset faster than asset yields, creating exposure to spread changes.
- The filing’s modeled shock analysis estimated that an immediate 100-basis-point rate increase would reduce next-12-month net interest income by 7.44% and portfolio value by 0.31%. These are model estimates based on assumptions, not guidance or guaranteed outcomes.
- The SEC was reviewing interpretations of the Investment Company Act exemption MFA relies on. An adverse change could require restructuring, constrain leverage and financing, or materially affect earnings. Management also cited uncertainty about the implementation and business effects of Dodd-Frank regulations.
- MFA reported no material pending legal proceedings, no material changes to previously disclosed risk factors, and effective disclosure controls as of September 30, 2012. Management stated that it had complied with financial covenants.
Important facts for investors to verify
- Whether net interest spread and margin stabilize, particularly as Agency yields, prepayments and borrowing costs change.
- How Non-Agency MBS credit performance compares with management’s cash-flow assumptions, Credit Reserves and impairment estimates.
- Repo renewal terms, counterparty concentrations, collateral haircuts and the adequacy of liquidity to withstand margin calls.
- The sustainability of dividends relative to earnings, taxable income, liquidity needs and REIT distribution requirements.
- Developments in the SEC’s Investment Company Act review and mortgage/securitization regulation, and their potential effect on MFA’s leverage and operating model.