MFA Financial portfolio yield continues to drop
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MFA Financial (MFA) is a mortgage Real Estate Investment Trust (REIT) that invests in both agency (government guaranteed) and non-agency (non-guaranteed) mortgage backed securities. Their portfolio is primarily invested in hybrids, adjustable rate mortgages (ARM), and 15 year fixed rate mortgages. They choose to invest in these types of assets in order to minimize interest rate risk. As a REIT, they must distribute 90% of their income to their shareholders and are not subject to income tax at the corporate level. This means they have outsized dividend yields which can be volatile. Over the past 12 months, MFA has paid a dividend yield of 14.7%.
As is typical for a mortgage REIT, MFA uses leverage (borrowed money) to increase returns. They are currently levered 3:1. This amount of leverage is lower than the typical agency REIT that invests in primarily lower-yielding paper. They use repurchase agreements and bond issues to lever their portfolio.
Highlights of the quarter
MFA Financial reported earnings of 21 cents a share, in line with analyst estimates. Revenues came in at $125 million more or less flat with last quarter and up 1.2% from a year ago. They recently paid a 50 cent special dividend.
As a REIT that trades in non-agency paper, the improving housing market definitely helps them. The average loan-to-value ratio on their non-agency mortgages is close to 100%, which means that their non-agency paper is barely fully collateralized. If the borrower defaults, they will bear the risk that the liquidation value of the collateral does not cover the outstanding amount of the loan. The loss is referred to as severity.
Given that they bear credit risk, MFA is careful to minimize its interest rate risk on the agency side. They concentrate on 15 year fixed rate mortgages because they have less prepayment risk than a typical 30 year mortgage – we have seen a lot of people refinance from a 30 year fixed rate mortgage to a 15 year mortgage and keep the same payment. The rest of the agency portfolio is adjustable rate mortgages, which have less interest rate risk than fixed rate mortgages.
Read-across to the other mortgage REITs
The chart above shows how much the net yield on their assets has fallen over the past year. Their net yield has contracted 40 basis points since last year at this time. Given that their starting yield was 4.57% to begin with, that is quite a drop. Most of the decline has been in the agency sector, not the non-agency part of the portfolio. For the agency book the net yield has fallen from 3.15% to 2.42%. The non-agency yield has fallen from 6.95% to 6.8%.
The quick read-across is that non-agency REITs like PennyMac (PMT) and Redwood Trust (RWT) may be in a better position as their portfolio yields may have not dropped as much as the agency REITs. Obviously that depends on how the other non-agency REITs have managed their portfolios, and their results may differ from MFA’s. The non-agency REITs also benefit from increasing home prices in that it lessens the severity of their portfolio when borrowers default. For agency REITs like American Capital (AGNC) or Capstead (CMO), increasing home prices aren’t much of a benefit because (a) they don’t take credit risk to begin with, and (b) increasing home values allow more and more underwater homeowners with high mortgage rates to refinance, which will push up their prepayments. Prepayment risk means that the investor’s highest yielding mortgages are paid off early, and they must re-invest the proceeds in lower yielding mortgages.