MFA Financial (NYSE:MFA) has more than common stock. The mortgage REIT has two series of preferred stock. In an unusual twist, one of the series has superiority in claims and a mandatory redemption date. Consequently one of the preferred issues is similar to a bond with a call feature that trades on the preferred share markets rather than the bond markets. I find the bond markets to be less attractive than the preferred share markets because I want clearing to be automated and centralized.
For MFA Financial, the two series of preferred stock trade under the terms MFA-B and MFO. The preferred stock that is arguably debt is MFO. The mandatory redemption doesn't come into play for a very long time, so I don't believe investors should treat it as a material part of the analysis. Instead, I would emphasize the call date, which is the date when the stock could be called if the company decides to call it. That is a material risk and it is important to the analysis.
The following chart comes from a weekly series I run for subscribers. In the weekly series I run through all the preferred shares of the different mREITs and establish which shares are trading at attractive prices. Due to poor liquidity, there can be some material shifts in which shares make sense to pursue.
Shares of MFA-B warrant a light green rating. This works in a manner similar to a stop light. Light green means MFA-B is relatively attractive. At a price of $25.26, I think MFA-B is a very reasonable investment. The shares won't be callable for over a year and the resulting "worst cash to call" comes in at a solid $2.78. This metric includes the loss of $.26 in premium that would occur if the shares were called at par value.
While MFO has seniority in claims and a materially higher stripped yield at 7.73%, the large premium to par value is a bit too much for my taste. When shares of MFO are cheap, I find them to be an excellent choice. However, I wouldn't classify $26.35 as "cheap."
Why the Cash to Call Matters So Much
MFA Financial is a very stable mortgage REIT. They should be a consistent contender for titles such as "best of breed." I'm not going to focus on analyzing the common stock pricing for this piece because that is an entirely different animal.
The point I want to make is that both shares of MFA's preferred stock are trading above par value. The MFA-B shares carry an original coupon rate of 7.5% relative to the 8% on MFO. If MFO were called, it would reduce the amount of preferred stock that ranked senior to MFA-B. Consequently, a call on MFO would improve the coverage ratios for MFA-B whether investors were looking at core income to preferred dividends or looking at common equity to preferred equity.
Consequently, it would seem MFA might be able to issue new preferred shares around 7.25%. A difference of .75% doesn't automatically trigger a call of the higher coupon preferred shares, but it would be pretty close. If we saw interest rates trend lower over the next year, it might open up the opportunity to issue at 7.125% or 7%. By 7%, I believe it would be an easy decision for MFA Financial to call MFO and issue a new series of preferred stock.
The following table provides further information on the two series of preferred stock:
I look at leverage with a relatively simple formula. While many investors would choose to use the trailing book value of equity, I've opted to use the market capitalization of common stock. If the market is trading common equity (as represented by the stock) at a substantial discount to book value, I want to represent that in my model. This method also allows a material change during the quarter to be reflected immediately rather than waiting until the company reports.
The coverage ratio here is very strong for a mortgage REIT and reinforces the idea that MFA Financial should be on the radar for investors looking at preferred stock.
Recent Price Change
Only a week ago I was seeing MFA-b at $25.70 and MFO at $25.92. Since then MFA-B fell by $.44 and MFO increased by $.42 cents. Prior to that change, MFO had a much more attractive value for "worst cash to call."
Where Can You Get More Ideas?
My best research all flows through the Mortgage REIT Forum. The first 100 subscribers will be able to lock in their subscription rates at only $240/year. I'm nearing that milestone, but all prior customers will be able to keep their original rate indefinitely. My latest work on preferred shares was published for subscribers on Sunday and includes five issues that I rated above MFA-B based on the most recent prices from Google.
Disclosure: I am/we are long ANH, ZFC, MTGE, AGNCB, AGNCP, NLY-E.
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.
Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. This article is prepared solely for publication on Seeking Alpha and any reproduction of it on other sites is unauthorized. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis. Tipranks: This article is only about preferred shares. No ratings are expressed on the common stock.