MFA FINANCIAL, INC. quarterly report, Q1 FY2017

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MFA Financial, Inc. — Q1 2017 Form 10-Q

Business context and period: Unaudited results for the three months ended March 31, 2017. MFA is a REIT investing, on a leveraged basis, in residential mortgage assets. Its portfolio is primarily Agency and Non-Agency mortgage-backed securities (MBS), residential whole loans, and credit risk transfer (CRT) securities.

Financial performance and position

  • Income and earnings: Interest income was $117.3 million, essentially unchanged from $117.4 million a year earlier. Net interest income was $66.9 million, down 4.2% from $69.8 million. Net income was $78.1 million, nearly unchanged year over year; earnings available to common stock and participating securities were $74.3 million, or $0.20 per diluted share. The declared common dividend was also $0.20 per share.
  • Margins: Net interest spread improved to 2.27% from 2.22%, and net interest margin rose to 2.63% from 2.51%. The effective cost of interest-bearing liabilities increased to 2.34% from 2.01%.
  • Other income and expenses: Other income, net increased to $28.0 million from $22.7 million, including $13.8 million of gains on fair-value whole loans and $9.7 million of realized securities-sale gains. Operating and other expense increased to $16.4 million from $14.5 million, including higher whole-loan servicing and related costs.
  • Comprehensive income: Comprehensive income available to common stock and participating securities was $95.3 million, versus a loss of $31.1 million in Q1 2016, largely reflecting the change in MBS and derivative-related other comprehensive income. Q1 2017 included $414,000 of Non-Agency MBS impairment losses recognized in earnings.
  • Cash flow: Operating activities provided $43.5 million; investing activities provided $730.0 million, primarily from principal collections; and financing activities used $612.0 million. Cash and cash equivalents increased $161.5 million to $421.6 million. The investing cash inflow principally reflects portfolio runoff and should not be read as recurring operating cash generation.
  • Balance sheet and leverage: Total assets were $11.9 billion at March 31, down from $12.5 billion at year-end; stockholders’ equity was $3.06 billion, up from $3.03 billion. Repurchase agreements and other advances were $8.14 billion, and the 8% Senior Notes had a $96.7 million carrying value. Debt-to-equity leverage was 2.9x, compared with 3.1x at December 31. Book value per common share increased to $7.66 from $7.62.
  • Liquidity: Management estimated liquidity sources of more than $903.8 million: $421.6 million in cash and estimated financing capacity of $212.4 million from Agency MBS and $269.8 million from Non-Agency MBS. Restricted cash is excluded. The company had no FHLB advances at quarter-end after repaying $215.0 million in January 2017.

Material changes versus Q1 2016 and year-end 2016

  • Net interest income declined as lower average Agency and Legacy Non-Agency MBS balances and higher funding costs outweighed improved yields on Legacy Non-Agency MBS and growth in CRT and whole-loan income.
  • Interest expense rose to $50.3 million from $47.6 million as repurchase financing costs increased; average repurchase-agreement cost was 2.28%, versus 1.94%.
  • The MBS portfolio’s fair value was approximately $9.0 billion, down from $9.6 billion at year-end; residential whole loans totaled approximately $1.3 billion, down from $1.4 billion. MFA reported no Q1 purchases of Agency MBS, Legacy Non-Agency MBS, or residential whole loans, while purchasing $150.0 million of Non-Agency MBS and $87.4 million of CRT securities.
  • In Q1, MFA unwound its remaining resecuritization transaction. It had no GAAP gain or loss, but management estimated approximately $47.1 million of taxable income, or more than $0.13 per common share, from the transaction for tax purposes.

Outlook, commentary, and risks

  • Management expects to continue seeking credit-sensitive, less interest-rate-sensitive assets during 2017, including whole loans, Non-Agency MBS, and CRT securities. It may allow Agency MBS to run off without reinvesting all proceeds. Management cited ample potential supply of credit-sensitive whole loans but did not provide specific earnings guidance.
  • Management estimated Q1 taxable income of approximately $117.0 million and undistributed taxable income of approximately $97.4 million, or $0.26 per share. Taxable income can differ materially from GAAP earnings; the resecuritization unwind is a notable tax-versus-GAAP difference.
  • Funding is heavily reliant on short-term, uncommitted repurchase agreements: the weighted-average remaining time to interest-rate reset was 17 days, and $5.66 billion of repo borrowings were contractually due within 30 days. Non-renewal, higher haircuts, collateral declines, or margin calls could constrain liquidity and leverage.
  • Interest-rate risk remains significant. The filing’s modeled shock table estimates that an immediate 100-basis-point rate increase would reduce next-12-month net interest income by 6.90% and portfolio value by 0.75%; these are scenario estimates, not forecasts. MFA used swaps with $2.85 billion aggregate notional at quarter-end.
  • Credit, valuation, and prepayment risks include performance of Non-Agency MBS and whole loans, foreclosure timelines, property values, and changes in borrower defaults and prepayments. Whole-loan fair values and certain MSR-backed term notes use significant Level 3 inputs. REO increased to $98.7 million from $80.5 million at year-end; 542 properties were held at quarter-end.
  • Management reported compliance with financial covenants and effective disclosure controls. The company reported no material pending legal proceedings and no material changes to the risk factors in its 2016 Form 10-K.

Important facts for investors to verify

  • Whether repo financing remains available on acceptable terms, and how refinancing, margin calls, and collateral haircuts affect liquidity.
  • Actual credit performance, cash-flow assumptions, and reserve adequacy for Non-Agency MBS, whole loans, CRT securities, and REO.
  • How the estimated taxable income from the resecuritization unwind affects required REIT distributions, without treating it as GAAP earnings.
  • Whether higher short-term funding costs, prepayments, and hedge performance alter net interest income and book value versus management’s modeled sensitivities.
  • Whether the $0.20 common dividend remains supported by taxable income, liquidity, and the company’s financial condition.