MFA Financial, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; balance-sheet comparisons are with December 31, 2011. MFA is a REIT investing primarily, on a leveraged basis, in residential Agency and Non-Agency mortgage-backed securities (MBS). Financial amounts below are in U.S. dollars.
Key financial results
| Metric | Q1 2012 | Q1 2011 or prior date |
|---|---|---|
| Interest income | $123.5 million | $109.9 million |
| Interest expense | $40.1 million | $34.7 million |
| Net interest income | $83.4 million | $75.2 million |
| Net income | $84.7 million | $82.9 million |
| Net income available to common stock and participating securities | $82.7 million; $0.23 per diluted share | $80.8 million; $0.27 per diluted share |
| Net interest spread / margin | 2.54% / 2.96% | 2.87% / 3.31% |
| Operating cash flow | $79.9 million | $62.1 million |
| Cash and cash equivalents at period end | $374.6 million | $394.0 million at Dec. 31, 2011 |
| Total assets | $12.452 billion | $11.751 billion at Dec. 31, 2011 |
| Stockholders’ equity | $2.765 billion | $2.498 billion at Dec. 31, 2011 |
Q1 comprehensive income available to common stock and participating securities was $352.2 million, including $269.6 million of other comprehensive income, mainly from unrealized Non-Agency MBS gains. Book value per common share increased to $7.49 from $6.74 at year-end. The common dividend declared was $0.24 per share, versus $0.235 in Q1 2011; the preferred dividend was $2.04 million.
Portfolio, debt and liquidity
- At March 31, the MBS portfolio had a fair value of $11.475 billion: $7.060 billion Agency and $4.415 billion Non-Agency. Non-Agency MBS were 38.5% of the portfolio. The filing reports a further $104.7 million of Non-Agency MBS within Linked Transactions.
- Repurchase agreements were $7.909 billion and securitized debt was $967.4 million. GAAP debt-to-equity leverage was 3.4x, down from 3.6x at year-end; management’s non-GAAP measure was 3.5x. Repurchase borrowings were generally short-term and subject to renewal and margin requirements.
- Cash declined $19.4 million during the quarter. Investing activities used $108.5 million; financing activities provided $9.1 million. The filing reports a $1.078 billion liquidity “Cushion” of cash, unpledged Agency MBS and excess collateral, plus $1.127 billion of unpledged Non-Agency MBS.
- Net unrealized gains on MBS were $313.0 million at quarter-end, compared with $55.5 million at year-end. MFA recorded $0.9 million of OTTI losses, net of reclassification, in earnings on five Non-Agency securities; it reported no OTTI loss in Q1 2011.
Material changes and management commentary
- Net interest income rose 10.9% year over year, principally reflecting a larger, higher-yielding Non-Agency portfolio. Interest expense increased 15.8% as average borrowings grew, despite lower average funding costs. Lower yields on both Agency and Non-Agency MBS contributed to narrower net interest spread and margin.
- Common earnings per share fell from $0.27 to $0.23 despite higher total common earnings; management attributed the per-share decline primarily to a larger share count. The filing reports average diluted shares of 356.2 million versus 297.9 million.
- MFA bought approximately $419.3 million of Agency MBS and $391.3 million of Non-Agency MBS during Q1, and sold Agency MBS for $71.1 million, realizing $3.0 million in gains. Its February resecuritization transferred $433.3 million principal value of Non-Agency MBS and issued $186.7 million face amount of senior bonds to third parties.
- Management planned to selectively acquire Agency MBS and discounted Non-Agency MBS, pursue diversified and longer-term financing, and continue targeting double-digit returns on equity over time. This is an objective, not earnings guidance; no quantitative earnings or dividend guidance was provided.
- On April 11, 2012, after quarter-end, MFA issued $100 million of 8.00% Senior Notes due 2042, receiving approximately $96.5 million net proceeds for investment and working capital, potentially including repayment of repo borrowings. Management said multi-year financing provides greater term certainty but costs about 100–150 basis points more than short-term repo financing for the affected assets, reducing their future net interest spread.
Risks, contingencies and unusual items
- Interest-rate, spread, prepayment and credit risks affect portfolio values, income, funding costs and collateral calls. Management’s modeled +100 basis-point shock estimated a 10.19% decline in net interest income and a 0.76% decline in portfolio value over the modeled period; the filing cautions that results depend on assumptions and actual outcomes may differ.
- Repo financing is uncommitted and renewable at lenders’ discretion. Falling collateral values, higher haircuts or reduced market liquidity could trigger margin calls, constrain leverage or force asset sales. Management reported compliance with financial covenants and believed liquidity was adequate, while noting that adverse markets could materially weaken liquidity.
- Non-Agency MBS carry mortgage-credit exposure. At March 31, the portfolio had $114.9 million of gross unrealized losses; management considered losses without recognized OTTI to be temporary, based on its cash-flow assessments. Those estimates depend on assumptions about defaults, loss severity, prepayments and collateral performance.
- The SEC was reviewing interpretations of the Investment Company Act exemption MFA relies on. An adverse change could require restructuring, asset sales or limits on leverage and could materially harm net interest income. The outcome and timetable were described as unclear.
- Resecuritization representations and warranties may require MFA to repurchase assets from VIEs under specified circumstances. Holders of VIE senior bonds otherwise have no recourse to MFA’s general credit. The filing reported no material pending legal proceedings and no material change to the prior annual report’s risk factors.
- Management stated that disclosure controls were effective as of March 31, 2012 and reported no material quarter-end change in internal control over financial reporting.
Important facts for investors to verify
- Whether Non-Agency MBS cash-flow assumptions, credit reserves and unrealized valuations remain supported by actual loan and security performance.
- Repo renewals, counterparties, collateral haircuts and available liquidity under stressed market conditions.
- How the April 2012 note issuance and higher-cost multi-year financing affect leverage, interest expense and spreads.
- Developments in SEC interpretation of the Investment Company Act exemption and related potential effects on MFA’s business model.
- Future per-share earnings, dividends and book value, particularly given the share-count increase, market-value volatility and absence of quantitative guidance.