MFA Financial, Inc. (MFA) is a real estate investment trust (REIT) that invests in mortgage-backed securities. MFA utilizes leverage to acquire its portfolio of Agency and non-Agency residential mortgage-backed securities. MFA utilizes repurchase agreements (repo), which are low short-term rates, to finance the acquisition of its mortgage-backed securities. MFA generates net income by maintaining a spread between the interest it earns on its investments and the cost of financing such investments.
Agency REITs carry limited credit risk as securities are guaranteed by government sponsored entities. Agency REITs are subject to interest rate and refinance risk. As opposed to agency REITs, hybrid REITs invest in both agency and non-agency securities. Hybrid REIT managers have the flexibility to move between agency and non-agency securities to find the best risk/reward for shareholders.
What Makes MFA Interesting?
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As opposed to peers such as Annaly Capital (NLY) and American Capital Agency (AGNC), MFA management has the flexibility to invest in both agency and non-agency securities. Purchased at the appropriate price, non-agency securities can offer REIT investors attractive risk-adjusted returns and lower the volatility in a REIT portfolio. Non-agency mortgages trade more like equity than credit as when the economy heals, recoveries increase. As the economy heals the market drives interest rates up, which hurts agency securities.
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A key risk for mortgage REITs is prepayment risk. As rates decline, borrowers refinance loans into lower rates, which impact mortgage REIT earnings. After the credit collapse, hybrid mortgage REITs including MFA purchased non-agency mortgages at discounts to par. In the most recent reporting period MFA owned over $4 billion of non-agency MBS at an average cost of $0.73. As refinancing on these securities increases, MFA realizes more than its average cost. The table outlines the increase in yield when speeds increase. MFA management believes the company can generate 6% - 7% loss adjusted annual unlevered yields on non-agency securities.
Conversely, agency mortgage REITs, including Annaly and American Capital Agency, which have an average cost of over $1.00, can experience loss on securities as refinancing increase. If an investor pays $1.04 for a face value security of $1.00 and the security is refinanced the investor will lose $0.04.