MFA Financial, Inc. — Q2 2012 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2012. MFA is a REIT investing on a leveraged basis in residential Agency and Non-Agency mortgage-backed securities (MBS), primarily using repurchase-agreement financing. MBS represented $11.691 billion, or 90.7%, of total assets at quarter-end.
Financial performance and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Interest income | $125.5 million | $132.1 million | $249.1 million | $242.0 million |
| Net interest income | $82.8 million | $94.9 million | $166.2 million | $170.1 million |
| Net income | $74.8 million | $79.3 million | $159.5 million | $162.2 million |
| EPS, basic and diluted | $0.20 | $0.22 | $0.43 | $0.48 |
| Net interest spread / margin | 2.45% / 2.87% | 3.05% / 3.46% | 2.50% / 2.91% | 2.97% / 3.40% |
- Balance sheet at June 30: Assets were $12.892 billion; liabilities $10.136 billion; stockholders’ equity $2.756 billion. Cash and cash equivalents were $593.4 million, in addition to $9.0 million of restricted cash.
- Debt and leverage: Repurchase agreements were $8.368 billion, securitized debt $861.3 million, and 8% Senior Notes $100 million. Reported debt-to-equity leverage was 3.6x. The Senior Notes were issued in April, mature in 2042, and generated approximately $96.6 million of net proceeds.
- Cash flow, first half: Operating activities provided $160.7 million; investing activities used $309.7 million; financing activities provided $348.4 million. Cash increased $199.4 million to $593.4 million.
- Dividends: Common dividends declared were $0.23 per share in Q2, versus $0.25 in Q2 2011. Preferred dividends were $2.04 million for the quarter.
Material changes versus comparable periods
- Q2 net income available to common stock and participating securities fell to $72.7 million from $77.2 million; first-half earnings fell to $155.4 million from $158.1 million. Per-share earnings also declined.
- Management attributed weaker earnings and spreads principally to lower yields on Agency and Non-Agency MBS, higher Agency prepayments and premium amortization, newly acquired lower-yielding assets, and more expensive longer-term Non-Agency financing.
- Q2 Agency MBS interest income decreased 24.9% to $49.6 million, while Non-Agency MBS interest income increased to $76.0 million as the portfolio expanded. The Non-Agency portfolio’s Q2 net yield nevertheless declined to 6.77% from 7.84%.
- Total MBS fair value increased to $11.691 billion from $10.913 billion at year-end 2011. Non-Agency MBS fair value rose to $4.676 billion from $3.775 billion.
- Other comprehensive income was $264.9 million for the first half, mainly reflecting unrealized MBS gains; comprehensive income available to common stock and participating securities was $420.3 million, versus $71.4 million in the prior-year period. This non-cash valuation movement contrasts with the modest decline in net income.
- The company added $100 million of Senior Notes, expanded longer-term collateralized financing, and completed a February 2012 resecuritization. These transactions diversified financing but increased the cost of some funding.
Outlook, commentary, and principal risks
- Management planned to continue selectively acquiring Agency MBS and discounted Non-Agency MBS during the remainder of 2012, and expected most assets to remain Agency MBS. It cited accommodative monetary policy, available financing, and attractive opportunities, but issued no specific earnings or dividend guidance.
- Management said the company had a $1.302 billion liquidity “Cushion” for potential margin calls, including cash, unpledged Agency MBS, and excess collateral. It believed resources were adequate for current obligations, while warning that falling MBS values or tighter markets could trigger margin calls, higher haircuts, reduced leverage, or difficulty renewing financing.
- Repo borrowings are generally uncommitted and renewable at lenders’ discretion. The short-term funding of longer-lived assets creates liquidity and refinancing risk; rising rates may raise funding costs faster than asset yields. The filing’s modeled +100-basis-point shock showed a 5.78% decline in projected net interest income and a 0.62% decline in portfolio value; these are estimates based on assumptions, not forecasts.
- Non-Agency MBS carry credit risk, including possible losses exceeding purchase discounts and credit reserves. At June 30, gross unrealized losses on these securities were $124.6 million; management considered them non-credit-related and did not expect to be forced to sell. Credit-related impairment charges were $0.3 million in Q2 and $1.2 million for the first half.
- Other risks include counterparty exposure, concentrated mortgage geography, prepayment and reinvestment effects, changing mortgage regulation, and uncertainty over the SEC’s interpretation of the Investment Company Act exemption. An adverse interpretation could require restructuring and reduce leverage or financing access. The filing also identifies proposed eminent-domain actions involving underwater mortgages as a potential risk to affected Non-Agency MBS.
- The company reported no material pending legal proceedings and stated that disclosure controls were effective as of June 30, 2012. Management cautioned that interim results are not necessarily indicative of full-year results.
Key facts for investors to verify
- Whether net interest spreads and portfolio yields continue to compress, and how financing costs change as swaps mature and higher-cost term funding grows.
- Repo renewal terms, collateral haircuts, margin-call capacity, and the concentration of counterparty exposure; Credit Suisse represented 19.1% of stockholders’ equity at risk.
- Non-Agency MBS credit performance, assumptions underlying expected cash flows and reserves, and the effect of mortgage delinquencies, defaults, and regional concentrations.
- The sustainability of dividends relative to earnings, cash generation, and REIT taxable income; GAAP income and taxable income may differ materially.
- Developments in SEC interpretation of the Investment Company Act exemption and mortgage/securitization regulation.