MFA Financial, Inc. (NYSE:MFA) is clearly trading with a "best-of-breed" tag attached to its name. Since I haven't been able to find many compelling investment opportunities in the mREIT space over the last month or so, I started spending more time on expanding my coverage universe. One of the mREITs that I've hardly covered (about 5 articles) is MFA Financial, but seeing the company's exceptionally low discount to book value is enough to encourage me to look into the name.
Specifically, I want to see what helps MFA trade at smaller discounts than other mREITs, so I can recognize those characteristics in smaller mREITs with less coverage. With a market capitalization of $2.54 billion, MFA Financial is less likely to deviate dramatically from comparable values with other large peers, but that can also be a favorable factor for casual investors that don't want to spend as much time digging. I also want to see if the company has unique advantages that would be difficult for competitors to duplicate. The typical agency MBS strategy wouldn't be too hard to replicate, but MFA uses a huge position in non-agency MBS. The first comparison that comes to mind is Two Harbors (NYSE:TWO).
Why Two Harbors?
Both mREITs use dramatically less leverage than normal for the sector, and both are using non-agency MBS to generate materially higher yields on their assets to offset the lower level of leverage. While I'm concerned about junk bonds in the current economy (weak oil prices), I believe housing values are likely to be maintained due to the low interest rates supporting higher purchase prices on homes. High home values discourage defaults by providing the homeowner with greater equity in the home.
Rather than using a debt -to-equity ratio around 3 or 4, most mREITs would run with this value around 6 to 9.
The Smaller Discount
When I ran the discounts to the end of Q4 values for the mREIT sector, the quick and dirty numbers suggested MFA was trading at a mere 8.43% discount to its Q4 book value. There were only a handful of mREITs that could claim a discount of less than 10% to their Q4 values, so my interest was drawn to this company.
Assessing the Strengths
The first strength for MFA is simply that it put together a very solid presentation that is easy to read and provides at least a rough understanding of the business. While there are clearly areas where I will want to dive much deeper as an analyst, the company does a great job of conveying some of the information.
The following chart demonstrates management's presentation of some key statistics:
That chart may seem huge in my article, but it is also huge in the presentation. These are small factors, but it demonstrates that MFA intends to communicate clearly and puts an emphasis on providing some of the first things many investors would want to see.
The fairly low level of leverage should be very favorable for the mREIT, given the way interest rates moved in the first quarter. The rates clearly moved down by a significant margin, and many investors might think, at a glance, that a decline in rates would favor the heavily leveraged mREITs. That isn't always the case. The heavily leveraged mREITs were generally running with a substantial amount of swap exposure, and LIBOR swaps created substantial fair value losses for most mREITs. By running a portfolio that was light on leverage and keeping the yields stronger through credit-sensitive assets, MFA Financial was able to stay very light on LIBOR swaps. While the company didn't go overboard on duration exposure, the portfolio came in with a net duration of .59.
When Rates Fall
The challenge that can occur for book value when rates fall is that the prepayment risk reduces the gains for the fair value of agency MBS. The problem isn't just lower prices, though. When prepayment risk leads to actual prepayments, it results in the agency MBS being paid off at par value, when the fair value was materially higher (usually within a range of 2-8%).
For an mREIT taking on substantial credit risk with RMBS, there is always a concern about the performance of the non-agency loans. This is another area where MFA appears to be doing well on two fronts. The first is that the company is communicating to shareholders about some of the risk factors and the fundamentals of the business. The second is that it appears to be running the business quite well. Dealing with these non-agency RMBS can involve doing materially more than "trading paper."
The Acquisitions in the mREIT Space
MFA trades at values that are exceptionally close to book value. This should make the company a very strong contender for acquiring smaller mREITs that trade at substantial discounts. When an mREIT is making acquisitions, it usually wants to expand its equity base by a material amount. As a result, it wants to structure the transaction in a way that involves issuing equity in addition to any cash paid to shareholders. Because MFA trades at a much smaller discounts than peers, it is in a better position to issue new shares as part of a buyout, while making the transaction immediately accretive to existing shareholders.
MFA Financial is doing quite a bit right. Their exceptionally small discount to book value prevents the company from being a viable target for acquisitions, but it could certainly be in the market to buy smaller mREITs at larger discounts. MFA does an excellent job of preparing presentations for shareholders that simplify the operations. I believe the company's excellent ability to communicate with shareholders is one of the reasons the stock is trading at a small discount.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.
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