Portfolio composition strategies among mortgage REITs (mREITs) continue to diverge, which will increase return dispersion among companies. MFA Financial (NYSE:MFA) has an attractive and diverse portfolio composition with growing credit asset exposure, which will strengthen its future earnings. MFA has been increasing its exposure to reperforming/nonperforming loan (RPL/NPL) assets, along with whole loans, which will allow the company to generate high returns in coming quarters. Also, the growing credit exposure will lower the company's portfolio and book value sensitivity to overall movements in interest rates. Also, MFA has the flexibility to strategically and opportunistically deploy capital in the residential mortgage market. Moreover, dividends offered by the company are safe and backed by its core EPS; the stock offers a yield of 10.2%, which makes it a good investment opportunity for income-hunting investors. In addition, as the company will continue to grow its credit exposure, its stock valuation will expand.
Attractive Portfolio Composition Will Support Core EPS
The company's impressive portfolio composition will continue to strengthen its core EPS. MFA delivered a strong performance for 1Q2015; reported EPS of $0.21 beat consensus of $0.19. The company's portfolio spread for 1Q2015 was 2.44%, up from 2.41% in 4Q2014; the portfolio spread for the quarter was positively affected by a 0.05% drop in borrowing costs. Also, the book value increased by $0.01 to $8.13 in 1Q2015. Also, $2.6 million of recognized gains in NPL's whole loan portfolio and $6.4 million of realized gains from the sale of legacy non-agency MBS positively affect the 1Q2015 earnings; I think the company's realized gains will stay a core part of its earnings, and it has been realizing gains over the last three years. Going forward, the company has the potential to realize further gains, as it has more than $750 million in unrealized gains in the legacy non-agency assets. The company's future performance will stay strong, driven by its diverse and attractive portfolio strategy.
In the recent past, MFA positioned as a holding company, which offers its flexibility to grow its credit sensitive portfolio exposure. The company has been consistently increasing its credit portfolio. In 1Q2015, MFA's RPL and NPL pool loans portfolio increased to $2.3 billion, up from $2 billion in 4Q2014. In 1Q2015, the company invested $500 million in RPL and NPL pool loans, replacing run-off of $200 million. Separately, the company has been expanding its residential whole loan portfolio. By the end of 1Q2015, MFA's residential whole loan portfolio grew to $387 million, up from $351 million in 4Q2014. MFA's credit sensitive assets comprise almost 21% of its total assets, in comparison to 18% in 4Q2014.
I expect the company's credit exposure to continue to grow, which will bode well for its earnings outlook and stock price. The increasing non-agency and credit exposure will augur well for its EPS because RPL/NPL, residential whole loans and non-agency MBS have higher average coupons of 3.54%, 5.3% and 5.81%, versus agency MBS' yield of almost 3%. The table below displays asset allocation and the corresponding average coupons.
Source: Investors Presentation
Furthermore, the company's credit fundamentals of the non-agency portfolio continue to improve as the LTV ratio decreased for several loans backing its non-agency mortgages. And as a result, it lowered its future loss estimates and transferred almost $22 million to accretable discounts, which will strengthen its interest income realized over the remaining life of its non-agency MBS. Also, the company's portfolio composition strategy will allow it to benefit from acceleration in prepayment speed, given the higher relative discount accretion on its credit securities versus premium amortization of agency securities.
Dividends and Valuation
MFA offers a quarterly dividend of $0.20 per share, which is backed by its 1Q2015 EPS of $0.21; the stock offers a yield of 10.2%. The company will continue to maintain its dividends, as its dividend security will improve in future, as it has been increasing its credit exposure, which will strengthen its EPS.
The stock is currently trading at a 9% discount to its book value; it has a price-to-book value of 0.91x. As the company will continue to grow its credit portfolio, which will strengthen its earnings, I think the stock price multiple will expand, which will result in price appreciation. The following graph shows the price-to-book value historical trend for the company.
MFA has an impressive and diverse portfolio composition strategy. The company's growing credit portfolio exposure will strengthen its future earning and allow the company to maintain its dividends. As the stock offers an attractive yield of 10.2%, it stays a good investment opportunity for income-seeking investors. Also, the company's portfolio strategy will allow it to benefit from acceleration in prepayment speed. Moreover, as the company will continue to expand its credit portfolio, the stock valuation will expand; the stock is currently trading at a 9% discount to its book value.
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