MFA Financial, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet comparisons are with December 31, 2013. MFA is a REIT that invests primarily in residential Agency and Non-Agency mortgage-backed securities (MBS), financed largely with repurchase agreements. Figures below are in U.S. dollars; financial statement amounts are rounded to millions.
Key financial results and position
| Metric | Q1 2014 / March 31, 2014 | Comparable period / prior date |
|---|---|---|
| Interest income | $121.2 million | $122.7 million in Q1 2013 |
| Interest expense | $40.9 million | $40.2 million in Q1 2013 |
| Net interest income | $80.3 million | $82.6 million in Q1 2013 |
| Net interest spread / margin | 2.44% / 2.84% | 2.32% / 2.69% in Q1 2013 |
| Net income | $76.2 million | $77.4 million in Q1 2013 |
| Net income available to common stock and participating securities; diluted EPS | $72.4 million; $0.20 | $75.3 million; $0.21 in Q1 2013 |
| Other income, net | $6.4 million | $3.2 million in Q1 2013 |
| Operating and other expense | $10.5 million | $8.5 million in Q1 2013 |
| Comprehensive income available to common stock and participating securities | $126.9 million | $205.7 million in Q1 2013 |
| Operating cash flow | $48.3 million | $71.2 million in Q1 2013 |
| Cash and cash equivalents | $274.7 million | $565.4 million at December 31, 2013 |
| Total assets / stockholders’ equity | $12.793 billion / $3.205 billion | $12.472 billion / $3.142 billion at December 31, 2013 |
| Repurchase agreements / securitized debt / Senior Notes | $8.606 billion / $292.5 million / $100.0 million | Repo $8.339 billion / securitized debt $366.2 million / Notes $100.0 million at December 31, 2013 |
| Debt-to-equity leverage | 2.9x | 2.9x at December 31, 2013 |
| Book value per common share | $8.20 | $8.06 at December 31, 2013 |
Business, portfolio and material changes
- MBS fair value totaled $11.886 billion: $6.841 billion Agency and $5.045 billion Non-Agency. The combined portfolio, including MBS accounted for as Linked Transactions, was approximately $12.152 billion, up from $11.502 billion at year-end.
- During the quarter MFA acquired approximately $599.3 million of Agency MBS and $282.1 million of Non-Agency MBS, in addition to purchases accounted for as Linked Transactions. Portfolio growth reflected purchases and appreciation, partly offset by principal repayments.
- Net interest income declined 2.8% year over year as lower average MBS balances and higher Non-Agency funding costs more than offset improved Non-Agency yields. Net interest spread and margin nevertheless improved. Non-Agency MBS net yield rose to 7.80% from 6.80%; Agency MBS net yield eased to 2.39% from 2.42%.
- Management attributed higher Non-Agency yields partly to improved estimated credit performance and discount accretion. It transferred $35.9 million from Credit Reserve to accretable discount during the quarter. No credit-related OTTI losses were recognized through earnings in Q1 2014 or Q1 2013.
- Net unrealized gains on MBS increased stockholders’ equity: other comprehensive income was $54.5 million in Q1 2014, versus $130.4 million in Q1 2013. This helped lift book value per share from $8.06 at year-end.
- Other income included $3.6 million of gains on MBS sales and $3.3 million of gains and net interest income from Linked Transactions. Expense growth reflected compensation, equity awards, personnel and business-development costs.
- Common dividends declared were $0.20 per share in Q1 2014 versus $0.72 in Q1 2013; the 2013 amount included a $0.50 special dividend. Preferred dividends were $3.75 million in Q1 2014, up from $2.04 million, following the Series B preferred issuance in 2013.
Cash flow, liquidity and financing
- Cash decreased $290.7 million in Q1 2014: operating activities provided $48.3 million, investing activities used $434.5 million, and financing activities provided $95.6 million. Investing outflow primarily reflected MBS purchases.
- Management reported a $737.0 million liquidity cushion for potential margin calls, comprising $274.7 million cash and cash equivalents, $434.7 million unpledged Agency MBS and $27.6 million of excess Agency collateral. It also reported unpledged Non-Agency MBS of $273.9 million and $290.9 million of Non-Agency MBS pledged in excess of contractual requirements.
- Repo borrowings were with 26 counterparties; their weighted-average interest rate was 0.70%, and weighted-average remaining term to rate reset was 29 days. Funding is uncommitted and renewable at lender discretion. Non-Agency repo financing generally requires higher collateralization and costs more than Agency financing.
- At quarter-end, $4.078 billion of repo borrowings was hedged with Swaps. The company reported compliance with financial covenants. Restricted cash of $26.1 million was pledged as collateral and unavailable for general corporate purposes.
Outlook, commentary and risks
- MFA said it intended to selectively acquire Agency and Non-Agency MBS during the remainder of 2014 and believed it had resources to pursue investment opportunities. It described funding as available from multiple counterparties under then-current market conditions. The filing provides no earnings or dividend guidance.
- Management stated that borrowing costs for the rest of 2014 would depend on market rates, borrowing levels, hedging and structured financing; costs could not be predicted with certainty. It cautioned that results for the quarter should not be viewed as indicative of full-year results.
- Interest-rate, spread, prepayment and extension risks can affect asset values, funding costs and income. The filing’s modeled shock analysis estimated portfolio value would decline 0.98% for a 100-basis-point rate increase, while net interest income would rise 0.51%; a 100-basis-point decrease was modeled to reduce net interest income 9.65% and increase portfolio value 0.69%. These are estimates based on assumptions, not forecasts.
- Liquidity risks include margin calls, tighter repo markets, increased haircuts and nonrenewal of short-term borrowings. Counterparty defaults could impair recovery of pledged assets or collateral. Non-Agency MBS are exposed to mortgage defaults and losses beyond management’s estimates; credit assumptions and fair values require significant judgment.
- Potential regulatory changes—including the SEC’s review of the Investment Company Act exclusion used by certain subsidiaries and possible housing-finance reform—could require restructuring, restrict eligible investments or reduce access to leverage and financing. Management said the implications remained uncertain.
- The company reported no material pending legal proceedings and no material changes to the risk factors in its 2013 Form 10-K. Management concluded disclosure controls were effective as of March 31, 2014, and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether Non-Agency collateral performance supports the $35.9 million reserve release and management’s expected future cash flows; compare realized losses and updated assumptions with the $1.042 billion Credit Reserve and OTTI balance.
- How repo availability, renewal terms, haircuts and margin requirements evolve, particularly given the short reset period, $737.0 million reported cushion and 2.9x leverage.
- Whether interest-rate and prepayment experience differs from the filing’s modeled scenarios and CPR assumptions, and how this affects spread, book value and distributable income.
- How much of reported earnings and future income depends on discount accretion, fair-value changes and Linked Transactions, rather than recurring net interest income.
- Whether REIT taxable income and distributions remain aligned: management estimated approximately $66 million of Q1 taxable income and $50 million, or $0.14 per share, of undistributed taxable income.
- Whether regulatory developments affect the company’s Investment Company Act exclusions, investment strategy or financing access.