MFA Financial Has Returned 25% In 1H 2014 - This 9.5% Dividend Payer Is Still Attractive

Jun.18.14 | About: MFA Financial, (MFA)


MFA has returned 25% in dividends and stock price increases so far in 2014.

Its portfolio of non-Agency RMBS, Agency ARMs, and 15 year fixed rate Agency RMBS is about as safe a portfolio as investors will find.

The continually decreasing LTV ratio of MFA's non-Agency RMBS (now about 82%) makes it ever safer.

In a bullish economy, it is set up to excel. In a mediocre one, it should hold its own. In a weak one, it should perform better than most.

MFA Financial Inc. (NYSE:MFA) is a mortgage REIT. It invests in Agency and non-Agency MBS. It is internally managed. It pays a great 9.5% dividend, and that is without considering special dividends. In 2013 MFA paid $0.78 in special dividends and $0.86 in regular dividends for a total of $1.64. Simultaneously, it lost -$0.93 in book value over the year. The special dividends were payouts of MFA's taxable monies (not really dividends at all). Thus MFA really only lost -$0.15 per common share (-1.67%) in book value; and it paid out $0.86 in regular dividends for a still great return. This left the total economic return at $0.71 per share (or +7.9% for FY2013). That was in one of the worst years for mortgage REITs in recent history. MFA has a long track record of delivering attractive shareholder returns (see chart below).

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It is hard to argue with success.

Q1 2014 was another quarter of great performance. MFA gained +$0.14 per common share in book value ($8.06 to $8.20 as of March 31, 2014). This was due to an increase in the value of its Agency MBS by $0.05 and an increase in value of its non-Agency MBS of +$0.13 per common share. It lost -$0.04 on its hedging and derivatives instruments. On top of that MFA earned $0.20 per common share in net income during Q1 2014; and it paid this out as a dividend. Together, the book value increase and the dividend amounted to a 4.22% total economic return for Q1 2014 (or 16.9% annualized).

If you invested in the stock in 2014, you did even better. The stock has gone up 19.49% year to date. Plus MFA has paid a $0.20 Q1 dividend; and has said it will pay another $0.20 per common share for Q2 2014. If the quarter ended at the June 16, 2014 closing stock price of $8.46 per share, investors would have realized a total stock price and dividend return rate of 25.14% in just six months. Don't you wish you could find that every day, especially in a relatively low risk stock.

Of course on January 1, 2014, the book value was $8.06 per share and the stock price was $7.08 per share. On July 1, 2014, the book value will likely be about $8.35 per share; and the stock price, if it stays at its current level, will be $8.46 per share. MFA will likely be trading at a premium to book value, although not a large one. Still the 9.5% dividend is still attractive by itself; and there is still the possibility of an increase in book value in Q3 2014. A total economic return of 15% to 20% for FY2014 is still a very attractive prospect. Long term the stock price will roughly parallel the book value.

For Q1 2014 the net interest rate spread was 2.44%. The leverage was 2.9x overall. Home price appreciation and mortgage amortization keep decreasing the loan to value ratio for many of the mortgages in MFA's non-Agency portfolio. This has led to lower estimates of future losses. As a consequence, $35.9 million was transferred from credit reserve to accretable discount. $243.8 million has been transferred in just the last five quarters. The accretable discount monies are expected to increase the interest income realized over the remaining life of MFA's non-Agency MBS.

The following table describes MFA's investments and their performance in Q1 2014.

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The most important statistic is the "Total". The leverage for this is 3.01x and the net interest rate spread is 2.46%. This leads to an overall yield of 7.4%. This is below the current dividend, and that is worrisome. However, MFA has been earning monies in other areas too. Therefore it was still able to garner $72.4 million in net income (or $0.20 per common share) in Q1 2014. This supported the dividend nicely.

MFA has been doing particularly well with its non-Agency MBS portfolio. As of March 31, 2014 that portfolio had a face value of $5.742B with an amortized cost of $4.258B and a net purchase discount of $1.484B. The discount consists of $1.042B credit reserve and other temporary impairments and a $441.6 million net accretable discount. This will significantly increase the net interest yield of these assets over the life of the loans.

As for safety, MFA between its investments and its hedges (swaps) has a net duration risk of 0.83 for its entire portfolio. Anything under 1.0 is thought to be safe. Further the loan to value ratio on MFA's non-Agency MBS has been in continuous decline. This is a good thing. It indicates that MFA, with a total non-Agency portfolio LTV of about 82%, should be able to easily recoup losses from defaults. At the least MFA should have very limited downside exposure; and MFA might in some cases be able to profit from defaults. The chart of LTV ratios is below.

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Again this shows that MFA is relatively safe, even though it has a significant amount of non-Agency loans in its overall portfolio. For those who like to see the everything themselves, the overall portfolio is below.

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Investors should notice that much of the Agency portfolio is ARMs. These have limited exposure to interest rate rises. They reset with time. Even the fixed rate Agency RMBS are 15 year fixed rate Agency RMBS. These have much less extension risk than do 30 year fixed rate Agency RMBS. Both the repos and the hedge swaps for these are cheaper.

Overall MFA seems to have a safe portfolio that is set up to perform well in a rising rate environment. It should perform well if rates don't rise too. MFA presents a case with a great dividend and upside book value potential. In the case of another real estate crash, it might have some troubles, but it should still be able to perform. It should be a safe buy that pays a great 9.5% dividend.

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

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The slow stochastic sub chart shows that MFA is at overbought levels. The main chart shows that MFA is in a strong uptrend. The results of Q2 2014 should help it to continue this uptrend. However, with a $8.20 book value as of March 31, 2014, it has limited stock price upside. The stock price as of the close on June 16, 2014 was $8.46 per share. The book value might go up another $0.10-$0.20 per share in Q2 2014, but that would only bring the book value to $8.30-$8.40 per share. That would not provide upward impetus. However, it could get further book value increases in 2H 2014. Still the 9.5% dividend looks very attractive, especially if the stock is considered "safe"; and MFA has proved that is about as safe as investors can get. Its Beta of 0.38 substantiates this. MFA is still a buy, although less of a bargain than it was at the beginning of 2014. CAPS rates it five stars (a strong buy).

NOTE: Some of the fundamental financial information above is from Yahoo Finance.

Good Luck Trading.

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