MFA Financial, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017; 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 (CRT) securities.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Interest income | $110.2 million | $114.5 million | $227.4 million | $231.9 million |
| Interest expense | $49.0 million | $47.7 million | $99.4 million | $95.3 million |
| Net interest income | $61.1 million | $66.8 million | $128.0 million | $136.6 million |
| Other income, net | $36.9 million | $27.0 million | $64.9 million | $49.7 million |
| Net income | $79.9 million | $79.0 million | $158.0 million | $157.0 million |
| EPS, basic and diluted | $0.20 | $0.20 | $0.39 | $0.40 |
| Common dividend declared per share | $0.20 | $0.20 | $0.40 | $0.40 |
Q2 net interest spread was 2.10% and net interest margin 2.58%, versus 2.14% and 2.46% a year earlier. For the first half, spread was 2.19% and margin 2.61%, versus 2.18% and 2.50%. Q2 return on average equity was 10.01%; book value per common share was $7.76 at June 30, up from $7.66 at March 31.
At June 30, total assets were $11.54 billion, liabilities $8.26 billion and stockholders’ equity $3.27 billion. Cash and cash equivalents were $745.5 million; restricted cash was $11.8 million. Repurchase agreements and other advances were $7.04 billion, alongside $143.7 million of securitized debt and $96.8 million carrying value of 8% Senior Notes. Management reported a 2.5x debt-to-equity leverage multiple, down from 2.9x at year-end 2016.
For the six months, operating cash flow was $96.1 million, investing cash flow provided $1.85 billion and financing cash flow used $1.46 billion. Cash increased $485.4 million to $745.5 million. Management estimated liquidity above $1.3 billion, including cash and estimated borrowing capacity against unpledged or excess Agency and Non-Agency MBS. Restricted cash is excluded from that estimate.
Material changes and drivers
- Q2 net interest income fell 8.5% year over year, primarily as lower average Agency and Non-Agency MBS and 3 Year Step-up holdings and higher funding costs outweighed growth in CRT and whole-loan income. Average borrowing cost rose to 2.51% from 2.05%.
- Other income increased, reflecting gains on fair-value whole loans and CRT securities, as well as realized securities-sale gains. Q2 included $16.2 million of whole-loan gains, including $4.3 million of unrealized gains, and $13.8 million of unrealized CRT gains.
- The MBS portfolio declined to $7.8 billion from $9.6 billion at December 31, 2016; residential whole loans rose to approximately $1.6 billion from $1.4 billion. MFA said principal runoff and issuer calls/refinancing reduced 3 Year Step-up holdings, despite substantial purchases and commitments.
- MFA issued 23.0 million common shares in May for approximately $178.3 million net proceeds, increasing outstanding shares. The common dividend remained $0.20 per share per quarter.
- In June, MFA completed its first residential whole-loan securitization. Third parties bought $147.8 million face amount of bonds at a weighted average fixed rate of 2.753%; MFA retained credit-support certificates. The trust is consolidated, so the transaction did not remove the underlying loans from the consolidated balance sheet.
Outlook, risks and unusual items
No specific earnings or dividend guidance was provided. Management said it expected to continue pursuing more credit-sensitive, less interest-rate-sensitive assets—including whole loans, Non-Agency MBS and CRT securities—for the remainder of 2017. It cautioned that funding costs depend on interest rates, borrowing levels, hedging and future structured financings and cannot be predicted with certainty.
- Funding and liquidity: Repurchase agreements are generally short-term, uncommitted and renewable at lenders’ discretion. Falling collateral values can trigger margin calls; reduced lender capacity or tighter market liquidity could impair financing. At quarter-end, $5.2 billion of repo borrowings were contractually due within 30 days.
- Interest-rate and prepayment exposure: Management’s rate-shock analysis estimated that an immediate +100 basis-point move would reduce 12-month net interest income 1.47% and portfolio value 0.81%; a −100 basis-point move would reduce net interest income 1.78% while increasing portfolio value 0.70%. These are model estimates, not forecasts.
- Credit and valuation risk: Non-Agency MBS, CRT securities and whole loans are exposed to borrower defaults and collateral values. MFA recognized $0.6 million of Non-Agency MBS impairment in Q2 and $1.0 million for the first half. Its $626.5 million Non-Agency credit reserve and OTTI balance relies on management cash-flow estimates. Whole-loan fair values and certain MSR-backed term notes use significant Level 3 inputs.
- Whole-loan servicing and foreclosure: REO increased to 564 properties valued at $104.4 million. Formal foreclosure proceedings involved loans with $468.7 million aggregate value. REO write-downs were $2.4 million in Q2 and $4.2 million for the first half.
- Tax and distribution: Management estimated first-half taxable income of $191.0 million and undistributed taxable income of $86.0 million, or $0.22 per share. Unwinding a prior MBS resecuritization generated estimated taxable income of $47.1 million, or $0.12 per common share, without GAAP income; the new loan securitization was also estimated to generate taxable income exceeding $0.01 per share. Taxable income and GAAP income can differ materially.
- Contingencies and controls: The new securitization includes loan repurchase obligations for certain breaches of representations and warranties; no reserve or known repurchase claim was reported at June 30. The filing reported no material pending litigation, no material change in risk factors, and effective disclosure controls.
Key facts investors should verify
- Whether net interest income can stabilize as funding costs rise and portfolio balances change, and how new asset yields compare with financing costs.
- Whether the reported $1.3 billion-plus liquidity estimate remains available after collateral haircuts, margin requirements and repo renewals.
- Performance of Non-Agency MBS and whole loans relative to the cash-flow, credit-loss and prepayment assumptions supporting yields, reserves and fair values.
- Effects of the loan securitization, including retained credit exposure, representations-and-warranties risk and tax-versus-GAAP accounting.
- How share issuance, dividends and estimated undistributed REIT taxable income affect per-share book value, earnings and future distributions.