MFA Financial, Inc. — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010; filed August 3, 2010. MFA is a REIT investing primarily in residential Agency and Non-Agency mortgage-backed securities (MBS), financed mainly with short-term repurchase agreements. Amounts below are U.S. dollars; financial statement figures are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| MBS interest income | $88.5 | $126.5 | $196.2 | $258.6 |
| Interest expense | $35.7 | $58.0 | $74.2 | $130.1 |
| Net interest income | $52.9 | $68.7 | $122.1 | $129.4 |
| Net income | $48.3 | $69.1 | $131.0 | $122.8 |
| Net income available to common stock and participating securities | $46.3 | $67.1 | $126.9 | $118.7 |
| Basic and diluted EPS | $0.16 | $0.30 | $0.45 | $0.53 |
| Common dividends declared per share | $0.24 | $0.22 | $0.24 | $0.22 |
- Q2 net interest spread and margin were 2.08% and 2.64%, respectively, versus 2.31% and 2.75% a year earlier. For the six months, they were 2.41% and 2.96%, compared with 2.04% and 2.50%.
- At June 30, total assets were $8.684 billion and stockholders’ equity was $2.228 billion. MBS at fair value totaled $7.950 billion: $6.386 billion Agency and $1.564 billion Non-Agency. Cash and cash equivalents were $531.5 million; restricted cash was $43.4 million.
- Repurchase agreements were $6.274 billion, down from $7.196 billion at December 31, 2009. GAAP debt-to-equity leverage was 2.8x, compared with 3.3x at year-end; the company’s non-GAAP measure, including repo borrowings in MBS Forwards, was 3.0x.
- For the six months, operating cash flow was $121.3 million, investing cash flow was $844.2 million and financing cash flow was negative $1.087 billion. Cash and cash equivalents declined $121.9 million to $531.5 million.
Material changes and management commentary
- Q2 net income available to common fell 31% year over year, while six-month net income available to common rose about 7%. Six-month EPS nevertheless declined, from $0.53 to $0.45; weighted-average common shares increased from about 222 million to 280 million.
- Q2 MBS interest income declined as the average MBS investment fell 23.2% year over year and Agency MBS yields weakened. Agency MBS yield was 3.61% versus 5.07%; the total MBS portfolio yield was 4.80% versus 5.27%.
- Agency Buyouts of delinquent loans and mortgage refinancing drove higher prepayments. The fair-value-weighted Agency MBS CPR rose to 42.7% in Q2 from 16.1% a year earlier, accelerating premium amortization and reducing Agency yields. Management expected buyout-related prepayments and premium amortization to ease in Q3.
- Funding costs and borrowings fell: Q2 interest expense declined 38.4%, reflecting lower average repos and lower borrowing rates. Swaps moderated exposure to rate increases but kept costs on hedged borrowings from falling as quickly as market rates. At quarter-end, $3.176 billion of $6.274 billion in repo debt was hedged with swaps.
- MFA sold $931.9 million of Agency MBS in Q1 and bought $648.4 million of Non-Agency MBS during the first half at an average 72.2% of par. Non-Agency MBS represented 19.7% of the reported MBS portfolio, or 23.9% including securities underlying linked MBS Forwards. Management cited attractive risk-adjusted opportunities and expected Q3 interest income to increase as prepayments slowed and cash was reinvested; no quantified earnings guidance was provided.
Unusual items, risks and contingencies
- Six-month other income included $33.7 million of MBS sale gains and $20.0 million of gains on MBS Forwards, offset in part by a $26.8 million loss on terminating repo agreements associated with Agency MBS sales.
- MFA recognized $5.4 million of credit-related impairment losses in earnings on six Legacy Non-Agency MBS during the first half. Non-Agency MBS also had $47.6 million of gross unrealized losses at quarter-end, which management attributed primarily to market spreads and liquidity conditions rather than identified credit impairment.
- In June, MFA reclassified $81.0 million of MFR MBS purchase discount from credit reserve to accretable discount, expected to flow into interest income over the assets’ lives. This depends on actual collateral performance and estimates of future cash flows.
- Liquidity and financing are exposed to short-term repo renewals, counterparty decisions, collateral values and margin calls. Management reported a $929.6 million liquidity cushion, consisting of cash, unpledged Agency MBS and excess collateral, and said all margin calls had been met to date without forced asset sales. A sudden MBS value decline could still trigger significant calls or impair financing access.
- Other material risks include Non-Agency borrower credit losses, prepayment and reinvestment risk, interest-rate and yield-curve movements, swap counterparty exposure, and changes in regulation. The Dodd-Frank Act had been enacted, but management said its effects were not yet clear. Repo financing generally was not guaranteed to roll over.
- MFA reported compliance with swap financial covenants, no material pending legal proceedings, no material off-balance-sheet arrangements, and effective disclosure controls. It stated that it intended to maintain REIT status and its exemption from Investment Company Act registration.
Important facts for investors to verify
- Whether Agency prepayments and premium amortization eased as management expected, and how reinvestment affected yields and earnings.
- Subsequent performance of MFR and Legacy Non-Agency MBS, underlying delinquency and loss trends, and whether credit reserves and cash-flow assumptions remain adequate.
- Availability and renewal terms of repo funding, collateral requirements, margin-call activity and the composition of the reported $929.6 million liquidity cushion.
- Interest-rate sensitivity, swap costs and maturities, including the effect of short-term funding repricing and any changes in hedge coverage.
- Whether MBS Forward-linked transactions remain linked and how changes in valuation, accounting presentation or market liquidity affect reported results.
- The Q2 common dividend of $0.19 per share was declared July 1, 2010 and paid July 30; confirm future distributions against earnings, REIT taxable income and liquidity needs.