MFA Financial, Inc. — 2010 Form 10-K
Reporting period: Fiscal year ended December 31, 2010; the filing also reports fourth-quarter results. MFA is a mortgage REIT investing primarily in residential Agency and Non-Agency mortgage-backed securities (MBS), using leverage to earn the spread between investment income and borrowing costs.
Financial performance and position
| Metric | 2010 | 2009 |
|---|---|---|
| Interest income | $391.3 million | $505.6 million |
| Net interest income | $246.2 million | $276.2 million |
| Net income | $269.8 million | $268.2 million |
| Net income available to common stock and participating securities | $261.6 million | $260.0 million |
| Basic and diluted EPS | $0.93 | $1.06 |
| Common dividends declared per share | $0.89 | $0.99 |
- Net interest spread increased to 2.47% from 2.31%; net interest margin rose to 3.02% from 2.80%. However, average MBS investment fell 18.6% to $7.65 billion and portfolio net yield declined to 5.11% from 5.37%.
- Interest expense declined 36.7% to $145.1 million, reflecting lower average borrowings and funding costs. Average borrowing cost was 2.31%, versus 2.83% in 2009.
- At year-end, total assets were $8.69 billion, including $8.06 billion of MBS; stockholders’ equity was $2.25 billion. Repurchase agreements were $5.99 billion and securitized debt was $220.9 million. GAAP debt-to-equity leverage was 2.8x, or 3.0x including borrowings in Linked Transactions.
- Cash and cash equivalents were $345.2 million. Management reported $899.4 million of liquidity cushion for potential margin calls, including cash, unpledged Agency MBS and excess collateral. It also held $512.7 million of unpledged Non-Agency MBS.
- Cash flow from operations was $245.9 million; investing activities provided $915.4 million and financing activities used $1.47 billion. Cash declined by $308.2 million to $345.2 million.
- Fourth-quarter net income was $61.6 million; net income available to common stock and participating securities was $59.5 million, or $0.21 per share.
Material changes and notable items
- MFA reduced Agency MBS and expanded Non-Agency MBS exposure. Non-Agency MBS were 25.8% of the reported MBS portfolio at year-end; including securities underlying Linked Transactions, combined Non-Agency MBS fair value was $2.82 billion.
- During 2010, MFA sold $931.9 million of longer-reset Agency MBS, recognizing $33.1 million of gains, and terminated $657.3 million of associated repo borrowings, incurring $26.8 million of losses.
- Agency MBS prepayments accelerated during the year: weighted-average CPR was 29.0%, compared with 16.8% in 2009, partly due to Fannie Mae and Freddie Mac buyouts of seriously delinquent loans. Prepayments and premium amortization eased in the second half.
- MFA recorded $12.3 million of impairment losses through earnings on eight Non-Agency MBS. This included $5.9 million related to clarification of inconsistent transaction-document terms on one security. Management reallocated $106.6 million of Non-Agency purchase discount from credit reserve to accretable discount, subject to continued expected performance.
- An October 2010 resecuritization generated $246.3 million of cash proceeds and $220.9 million of year-end securitized debt. The trust was consolidated; MFA retained substantial exposure to underlying first losses. Certain representations-and-warranties breaches could require asset repurchases.
Outlook, risks and contingencies
- Management expected most assets to remain in Agency MBS, while continuing to view selected Non-Agency MBS and certain Agency securities as opportunities. It cited attractive repo financing conditions at year-end, but noted Non-Agency financing generally has fewer counterparties and higher collateral and borrowing costs. The filing provides no formal earnings or dividend guidance.
- Management expected unrealized losses on swaps to lessen over time as higher-cost swaps amortize or expire. At year-end, swaps had $2.81 billion notional, a 3.74% weighted-average fixed-pay rate and $139.1 million of unrealized losses; $642.6 million of notional was scheduled to expire during 2011.
- Key risks include short-term funding renewals and margin calls, declines in MBS values, rate and yield-curve changes, prepayment variability, and credit losses on Non-Agency MBS. Agency exposure also depends on the future role and support of Fannie Mae and Freddie Mac. Regulatory changes, including implementation of Dodd-Frank, could affect mortgage markets and financing.
- REIT status requires distribution of at least 90% of REIT taxable income. Taxable income can differ materially in timing from GAAP income, and the Board has not set a minimum common dividend. The Series A preferred stock carries an 8.50% cumulative dividend and ranks ahead of common dividends.
- No legal proceedings were reported. Management and Ernst & Young reported effective disclosure controls and internal control over financial reporting; the financial-statement and internal-control audit opinions were unqualified.
Most important facts for investors to verify
- How reported earnings and dividend capacity reconcile to REIT taxable income, particularly given Non-Agency discount accretion and credit-loss timing.
- Current repo renewal terms, counterparty concentration, collateral haircuts and liquidity available under stressed MBS valuations or larger margin calls.
- Actual Non-Agency MBS credit performance versus management’s cash-flow, delinquency, loss-severity and credit-reserve assumptions.
- How Agency prepayments, interest-rate changes and swap expirations affect portfolio yield, funding cost and net interest margin.
- The continuing economic exposure and any repurchase obligations arising from the 2010 resecuritization.