MFA Financial, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. MFA is a leveraged residential mortgage REIT investing in residential whole loans, mortgage-backed securities (MBS), credit risk transfer securities and MSR-related assets.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 |
|---|---|---|
| Interest income | $144.9 million | $101.7 million |
| Interest expense | $85.0 million | $51.8 million |
| Net interest income | $59.9 million | $49.9 million |
| Other income, net | $56.9 million | $41.0 million |
| Net income | $93.0 million | $70.4 million |
| Net income available to common stock and participating securities | $89.3 million | $66.6 million |
| Basic and diluted EPS | $0.20 | $0.17 |
| Net interest spread / margin | 1.90% / 2.29% | 2.30% / 2.66% |
For the six months, net income was $181.9 million and basic/diluted EPS was $0.39/$0.38, versus $153.8 million and $0.36/$0.36 a year earlier. Net interest income increased 18.1% to $121.8 million, while the six-month spread and margin narrowed to 1.94% and 2.35%, from 2.28% and 2.65%.
At June 30, total assets were $13.2 billion, including $5.9 billion of residential whole loans, $5.4 billion of MBS and CRT securities, and $1.2 billion of MSR-related assets. Repurchase agreements were $8.6 billion; additional liabilities included $627.5 million of securitized debt, $223.4 million of convertible notes and $96.8 million of senior notes. Stockholders’ equity was $3.40 billion. Book value per common share was $7.11, unchanged from March 31 and down from $7.54 a year earlier. Leverage was 2.8 times, versus 2.6 times at year-end 2018.
Six-month operating cash flow was $85.9 million, investing cash outflow was $738.4 million, and financing cash inflow was $683.4 million. Cash, cash equivalents and restricted cash totaled $119.7 million at period-end. Management estimated available liquidity above $243.1 million, excluding restricted cash, and separately reported $1.4 billion of unencumbered residential whole loans.
Material changes versus comparable periods
- Q2 net income rose year over year, supported by higher net interest income from the expanded whole-loan portfolio and higher gains on whole loans measured at fair value.
- Growth in whole loans and MSR-related assets lifted income, but higher financing costs, larger average borrowings and interest on newly issued convertible notes drove interest expense up 64.1% in Q2.
- Net interest spread compressed year over year as funding costs rose. The company reported a Q2 portfolio spread of 1.90%, compared with 2.30%.
- Q2 other income included $51.5 million of gains on fair-value whole loans and $7.4 million of losses on swaps not designated as accounting hedges. Six-month swap losses were $16.3 million.
- Operating and other expense increased to $23.7 million in Q2, including higher loan servicing and REO-related costs. REO carrying value grew to $334.1 million from $249.4 million at year-end.
- During the first half, MFA issued $230 million principal amount of 6.25% convertible senior notes due 2024, receiving approximately $223.3 million net proceeds.
Outlook, commentary and risks
- Management said it expected to continue pursuing residential whole-loan investments, with selective investment in MBS and MSR-related assets as opportunities arise. No quantified earnings or financial guidance was provided.
- Management described book value as relatively stable and reported estimated net effective duration of 1.11. Its sensitivity analysis estimated that an immediate 100-basis-point rate increase would reduce portfolio value by 1.37% and net interest income over the next 12 months by 4.84%; these are model estimates, not forecasts.
- Key exposures include short-term, renewable repurchase funding against longer-duration assets, margin calls, counterparty concentration, interest-rate and spread changes, prepayments, credit losses, foreclosure timelines, and valuation uncertainty. Management warned that falling collateral values or tighter financing markets could materially impair liquidity and leverage capacity.
- Credit-sensitive assets include non-Agency MBS, CRT securities and whole loans. At June 30, non-Agency MBS included $479.6 million of credit reserve and previously recognized impairment discounts. No credit-related OTTI loss was recorded on non-Agency MBS in Q2 or the first half.
- Commitments included $100.4 million of unfunded rehabilitation-loan commitments, a $36.2 million undrawn portion of a $100 million corporate loan commitment, and $87.0 million of unsettled whole-loan purchases. MFA reported no material unsettled securitization repurchase claims and no related reserve.
- The company estimated $175.0 million of REIT taxable income for the first half and $22.3 million of undistributed taxable income. Taxable income can differ materially from GAAP income and is subject to estimates.
- Management stated that controls were effective, there were no material changes to previously disclosed risk factors, and no material pending legal proceedings.
Important facts for investors to verify
- Whether net interest spread and margin stabilize as funding costs and portfolio mix change.
- Performance, delinquency and loss severity in the rapidly expanded whole-loan portfolio, alongside the rising REO balance and associated expenses.
- Availability, renewal terms and haircuts on repurchase financing, plus the adequacy of liquidity under adverse collateral or market conditions.
- Assumptions underlying fair values and credit reserves, including the Level 3 whole-loan and MSR-note valuations.
- Potential dilution from the convertible notes, convertible at an initial price of approximately $7.95 per share, and the sustainability of dividends relative to taxable income and cash generation.
- Expected transition effects from the credit-loss accounting standard, which the company was evaluating for adoption in 2020.