MFA Financial, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; unaudited. MFA is a REIT investing on a leveraged basis in residential mortgage assets, including Agency and Non-Agency MBS, residential whole loans, and credit risk transfer securities.
Financial results and position
- Third-quarter earnings: Interest income was $112.7 million and net interest income was $64.5 million. Net income was $83.0 million; income available to common stock and participating securities was $79.3 million, or $0.21 per diluted share. Common dividends declared were $0.20 per share.
- Nine-month results: Interest income was $344.6 million, net interest income was $201.2 million, and net income was $240.0 million. Common income was $228.8 million, or $0.61 per diluted share; common dividends declared were $0.60 per share.
- Margins: Q3 net interest spread and margin were 2.13% and 2.46%, respectively. Nine-month spread and margin were 2.16% and 2.49%.
- Assets and equity: At September 30, total assets were $12.75 billion and stockholders’ equity was $3.03 billion. MBS were $9.93 billion; residential whole loans were approximately $1.35 billion, excluding purchases not yet closed.
- Debt and leverage: Repurchase agreements and other advances totaled $8.70 billion, including $8.48 billion of repurchase agreements and $215 million of FHLB advances. Senior Notes were $96.7 million. Reported leverage was 3.1x.
- Liquidity and cash flow: Cash and cash equivalents were $288.7 million; restricted cash was $122.7 million and unavailable for general corporate purposes. Management estimated liquidity sources above $635.6 million, excluding restricted cash. Nine-month operating cash flow was $98.8 million, investing cash flow was $1.02 billion, financing cash flow was negative $997.2 million, and cash increased $123.7 million.
- Book value: Book value per common share was $7.64, up from $7.41 at June 30, 2016, but below $7.70 at September 30, 2015.
Changes versus comparable periods
- Q3 net income available to common and participating securities increased to $79.3 million from $75.8 million; diluted EPS rose to $0.21 from $0.20. The increase chiefly reflected higher gains on fair-value whole loans and CRT securities, partly offset by lower MBS net interest income and lower MBS sale gains.
- Q3 net interest income declined 15.1% from $76.0 million a year earlier. Net interest spread narrowed from 2.24% to 2.13%, while borrowing costs rose and average Agency and Legacy Non-Agency MBS balances fell.
- For the first nine months, common earnings and diluted EPS were broadly flat versus 2015. Net interest income fell 17.3%, while other income rose to $83.6 million from $35.4 million, including larger fair-value loan gains and MBS sale gains.
- Compared with December 31, 2015, total assets declined to $12.75 billion from $13.16 billion, while MBS declined to $9.93 billion from $11.17 billion. Residential whole loans increased to approximately $1.35 billion from $895 million. Repurchase agreements and other advances declined to $8.70 billion from $9.39 billion, and FHLB advances fell from $1.5 billion to $215 million.
Outlook, commentary, and material risks
- Management expected to continue selectively acquiring MBS and residential whole loans during the remainder of 2016, with an emphasis on more credit-sensitive, less interest-rate-sensitive assets; Agency MBS could continue to run off without reinvestment. The filing gives no specific earnings or dividend guidance.
- Management reported estimated nine-month REIT taxable income of $288.5 million and undistributed taxable income of approximately $58.5 million, or $0.16 per share. A completed resecuritization unwind was estimated to create about $70.9 million, or $0.19 per share, of taxable income but no GAAP gain. Management anticipated unwinding the remaining resecuritization in Q1 2017, with taxable income expected to exceed $0.10 per share.
- MFA had to terminate its FHLB membership and repay outstanding advances by February 19, 2017; the remaining balance was $215 million at quarter-end. Repurchase funding is generally short-term, uncommitted, and subject to renewal, collateral haircuts, and margin calls.
- Interest-rate sensitivity analysis estimated that an immediate 100-basis-point rise would reduce projected 12-month net interest income by 7.49% and portfolio value by 0.67%; results depend on assumptions and are not forecasts. Risks also include prepayments, credit losses, collateral values, counterparty performance, and access to financing.
- Credit and valuation judgments are significant. Management reported $715.0 million of Non-Agency MBS credit reserve and OTTI discounts, and $485,000 of impairment losses recognized in earnings in Q3. Fair-value whole-loan gains included $10.9 million of unrealized gains; their valuation uses significant unobservable inputs.
- REO increased to 393 properties with a carrying value of $73.2 million, from 182 properties and $28.0 million at year-end 2015. Management recorded a $1.7 million Q3 downward valuation adjustment to REO.
- The filing reported no material change to the risk factors in the 2015 Form 10-K, no material pending legal proceedings, and effective disclosure controls as of September 30, 2016.
Investor verification priorities
- Confirm the sustainability of net interest income and margins amid rising funding costs and shrinking Agency and Legacy MBS balances.
- Assess liquidity quality and repo renewal, maturity, haircut, and margin-call exposure; verify progress toward the February 2017 FHLB repayment deadline.
- Review whole-loan fair-value assumptions, loan delinquencies and foreclosure activity, REO growth, and servicing costs.
- Evaluate the assumptions supporting Non-Agency MBS credit reserves, reserve releases, and expected cash flows, as well as the one-time Countrywide settlement effect on yields.
- Verify the timing and tax consequences of the remaining resecuritization unwind and whether taxable income may require distributions beyond GAAP earnings.
- Monitor common dividends relative to taxable income, liquidity, leverage, and the REIT distribution requirements.