In recent articles, we discussed the merits of a large Agency-focused mortgage REIT American Capital Agency (A Deeper Look at American Capital Agency Corp and Its 18.4% Dividend Yield), and outlined metrics comparing a number of large U.S. mortgage REITs (Comparing the 8 Largest Mortgage REITs).
In this article, we are highlighting MFA Financial, Inc. (MFA), a real estate investment trust ("REIT") which invests in a portfolio of both Agency and non-Agency residential mortgage-backed securities.
Agency REITs are more interest rate sensitive, whereas non-Agency REITs are rate and credit sensitive. MFA invests in a blend of Agency (65% of assets) and Non-Agency (31% of assets) to take advantage of specific market conditions. In 2009, MFA took advantage of dislocations in the markets to acquire non-Agency MBS at prices below par value (highlighted by the change in mix of Agency and non-Agency between 2008 and 2009 - see financial summary below).
We remain positive on the REIT segment due to the underlying challenges to the U.S. economy and the likelihood of a sustained low interest rate policy as well as the attractive dividend yields offered by mortgage REITs. Investors interested in the segment should consider building a portfolio of mortgage REITs to help manage the risks inherent in each model. We advocate adding MFA to a portfolio due to its tenure of management and proven ability to manage various interest rate cycles, size, and composition of balance sheet.
Below we outline the metrics we believe MFA investors should focus on and monitor. Simply put, MFA makes money by maintaining a positive spread between the interest and other income it earns on its investments and the cost of financing such investments and its operating costs. As with other mortgage REITs the Company uses leverage to amplify returns.
MFA Financial, Inc. is a real estate investment trust primarily engaged in the business of investment, on a leveraged basis, in a portfolio of hybrid and adjustable-rate mortgage-backed securities issued or guaranteed by an agency of the U.S. government, such as the Government National Mortgage Association, or a federally chartered corporation, such as the Federal Home Loan Mortgage Corporation or Fannie Mae, and, to a lesser extent, high quality hybrid and adjustable-rate mortgage-backed securities rated in one of the two highest rating categories by at least one nationally recognized rating agency.
The mortgage-backed securities that MFA acquires are primarily secured by pools of hybrid and adjustable-rate mortgage loans on single family residences. Hybrid mortgage loans have interest rates that are fixed for a specified period and, thereafter, generally adjust annually to an increment over a pre-determined interest rate index. Interest rates on the hybrid and adjustable-rate mortgage loans collateralizing MFA's mortgage-backed securities are based on an index rate, such as the one-year constant maturity Treasury rate, the London Interbank Offered Rate or the 11th District Cost of Funds Index.
MFA utilizes repurchase agreements, which typically bear interest rates reflective of the short-term London Interbank Offered Rate, to finance the acquisition of its hybrid and adjustable-rate mortgage-backed securities and other assets. MFA primarily generates net income by maintaining a positive spread between the interest and other income it earns on its investments and the cost of financing such investments and its operating costs. Unlike more traditional financial institutions, such as savings and loans and banks, MFA avoids the expense of a costly infrastructure and, due to its REIT status, corporate level taxation.
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Portfolio Composition (as of 3/31/11):
Historical Price-to-Book Value:
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Historical Dividend Yield:
As shown in the table above, MFA is the only REIT in this class trading below book value and we believe that this is a great buying opportunity for MFA. The whole sector has traded down recently due to overall softness in the equity market. MFA and Annaly Capital Management (NLY) remain our two main REIT holdings due to their strong management teams. However, we also have a small position in American Capital Agency Corp. (AGNC).
We continue to believe that the best strategy for investing in this space is to own a portfolio of mortgage REITs to diversify your risk. That said, the following REITs are currently on our watchlist and we are following them very closely: Chimera Investment Corp. (CIM), Anworth Mortgage Asset Corp. (ANH), Hatteras Financial Corp. (HTS), and Capstead Mortgage Corp (CMO).