MFA Financial Is Outperforming In The Mortgage REIT Sector.

 |  About: MFA Financial, Inc. (MFA), Includes: AGNC, HTS
by: David White

MFA Financial Inc. (NYSE:MFA) is an REIT. It invests in Agency and non-Agency MBS. It is internally managed. It pays a hefty 11.96% dividend, and that is without considering any special dividends. MFA declared a special dividend of $0.50 per common share in March 2013 (payable April 10, 2013). It declared another special dividend in Q3 2013 of $0.28 per common share. If you consider this as part of the annual dividend for MFA for 2013, then the annual dividend for FY2013 would be $1.66 per common share (or 22.6%), assuming a continuation of the $0.22 quarterly dividend in Q4 2013.

The above is a bit misleading. MFA's book value was $8.99 as of December 31, 2013. The book value was $7.85 per common share as of September 30, 2013. The special dividends amount to $0.78 in total. This in turn accounts for most of the book value loss. With the special dividend monies still in the company, the book value would be +$0.78 higher or $8.63 per common share. The special dividends were done because MFA wanted to payout all of its taxable monies from 2012 and years earlier before the September 15, 2013 deadline.

Admittedly the -$0.36 per common share loss of book value (-4%) is still a negative. However, it represents outperformance in the mortgage REIT sector this year. For instance, American Capital Agency Corp. (NASDAQ:AGNC) saw its book value fall from $31.64 per common share on December 31, 2012 to $25.27 per common share on September 30, 2013. This amounted to a -20.1% loss in book value. AGNC is a primarily Agency fixed rate mortgage REIT. Hatteras Financial Corp. (NYSE:HTS), which has substantial ARMs, did no better. Its book value on December 31, 2012 was $28.19 per common share. By September 30, 2013 the book value had dropped to $21.31 per common share. This was a -24.4% drop in book value. Neither the drop in book value by AGNC nor that by HTS was due to paying out taxable income in special dividends. Neither AGNC nor HTS paid a special dividend in 2013. Hence MFA's -4% book value loss compares very favorably to AGNC's -20.1% book value loss and HTS's -24.4% book value loss for the first nine months of 2013. Considering that both Q2 and to a lesser extent Q3 were abnormally volatile quarters, MFA's performance might be termed excellent. In fact investors are firmly in the black with regard to total economic return (book value gain/loss and dividend payout) from MFA for the first nine months of 2013.

For a while it looked like the recent volatility was abating. However, the 10 year US Treasury Note yield, which fell from 2.99% to 2.50%, has popped back up to 2.75% as of November 10, 2013; and it may continue to go up. The US GDP growth for Q3 of 2.8% reported November 7, 2013 was much higher than the expected 2.0% growth. The NonFarm Payrolls figure of +204K for October 2013 was much higher than the expected 125K. Plus previous months figures were raised by a combined 60K. These hugely more positive than expected data are making many believe that the Fed may start tapering sooner than many had believed before this data. Plus a faster growing economy in itself tends to make interest rates rise. This may be very bad for primarily fixed rate mortgage REITs. The good news is that it should not be terribly bad for MFA, which has proved earlier this year that it can withstand rapidly rising interest rates well.

Further MFA decreased its duration risk from approximately 1.70 as of June 30, 2013 to approximately 0.65 as of September 30, 2013. Duration risk is the risk that a bond's price will decline with increasing interest rates. The higher the duration is the greater the decline will be with increasing interest rates. Hence MFA has positioned itself well for increasing interest rates with its Q3 duration moves. As part of this decrease, MFA added $1,750,000 in notional value of 5-10 year swap hedges, while only $358,000 in notional value expired. All of the duration moves should position MFA well for a rising interest rate environment. The table below summarizes MFA's holdings as of September 30, 2013. The numbers are in millions.

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The net duration figure tells you that the portfolio should be relatively safe with regard to the risk of rising interest rates.

Another factor that has been lending stability to MFA's book value has been the gains in the housing market. The table below shows some of the gains in some of MFA's biggest markets as of August 2013 (CoreLogic data).

MFA's average non-Agency portfolio's loan to value ratio has dropped by over 20 points since the beginning of 2013 (see chart below).

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This means fewer loans are likely to default; and more of the prepayments made will be for the full amount of the loan. Since MFA bought its non-Agency loans at an approximate 27% discount to their face value; it will pocket a sizeable sum for each loan that is prepaid at 100% of face value. In fact over the last two quarters this has been a significant factor in its out performance versus other mortgage REITs in Q2 and Q3 of 2013 with regard to book value.

The table below shows MFA's major earnings and costs that contributed to book value in Q3 2013.

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I like my full year description better; but the above data gives investors a good idea of the specific money flows.

In sum, the special dividends paid this year ($0.78) have accounted for most of the decrease in book value. For the stockholder, they have not resulted in a loss though. The stockholder has gotten the special dividend payouts in exchange for book value. This seems a good trade. It would have been nice for MFA to simply keep these monies. However, it could not do so without having to pay tax on them. Hence it made the extra dividend payouts. Very little book value has been lost other than that "exchanged" by these special dividends. In a very tough year MFA has done exceptionally well. If it loses no more book value in 2013, investors will effectively glean a 7.96% dividend with no book value loss (an 11.96% annual dividend minus the 4% book value loss not attributable to the special dividend payouts). MFA is a buy in this troubled time for the stock market and for the mortgage REIT market.

The two year chart of MFA provides some technical direction for this trade.

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The slow stochastic sub chart shows that MFA is near oversold territory. The main chart shows that MFA has been in a downtrend for most of 2013. However, it appears to have bottomed in August 2013. It appears to be headed back upward. Its Q3 earnings report should do nothing to derail this recovery. With a book value of $7.85 as of September 30, 2013, MFA is trading at a 6.66% discount to book value. Since MFA lost only an average of -1.33% in book value per quarter during Q1 - Q3 in 2013, which were very tough quarters for most mortgage REITs, it seems unlikely to lose appreciably more in the one quarter remaining in 2013.

Further the chart shows that MFA's stock price has gained +8.88% over the last two years. Meanwhile it has paid out a great dividend (11.96% as of November 10, 2013). Investors are getting the dividend plus an appreciation in the stock price; and the stock price for MFA is undervalued on a value basis currently. This means they may get a still bigger total return. The dividend return itself is probably enough to attract most investors.

By comparison AGNC's stock price has lost -24.58% over the same two year period. HTS' stock price has lost -33.42% over the same two year period. MFA has been a much better investment; and it seems likely that it will continue to be in the likely longer term, rising interest rate environment. MFA is a buy. It has an analysts' mean recommendation of 2.2 (a buy). It has a CAPS rating of five stars (a strong buy).

Investors should feel good about a long term investment in MFA. In the shorter term, the recent rapid rise in interest rates on the positive US economic news is pushing mortgage REIT stocks downward. MFA seems to be falling along with its sector. This is probably an undeserved fall; and it should correct itself in MFA's case. Investors may wish to average in with this mini-trend in play.

NOTE: Some of the above fundamental and technical financial data is from Yahoo Finance.

Good Luck Trading.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MFA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.