MFA Financial: Strong Yield But Negative Total Return (NYSE:MFA)

MFA Financial, Inc. (NYSE:MFA) is a specialty finance company that invests in and finances residential mortgage assets. The company selectively invests in residential mortgage assets with a focus on credit analysis, projected prepayment rates, interest rate sensitivity and expected return. The company is an internally managed real estate investment trust (REIT). Some months back, the company went for a reverse stock split, the impact of which has not been very positive.

Its portfolio of assets includes 43 percent of non-qualified mortgage (non-QM) loans, and 23 percent of business purpose loans. MFA Financial Inc. has been successful in generating a strong and steady yield. However, the price performance has been disappointing. Investors are hesitant about MFA despite its record dividend yield and the company’s share buyback program.

Dividend and Price Performance

MFA Financial Inc. has been paying steady quarterly dividends since 1998. Baring a few years, the average yield was consistently in double digits till the Four-year average dividend yield came to 13.4 percent. Thus, this mREIT becomes a good option for income seeking investors. MFA’s yield generating capacity got a further boost through its acquisition of Lima One, an US based premier lender for residential real estate investors. During the first quarter of 2022, MFA was able to get hold of high-yielding, high quality business purpose loans through this acquisition. The current origination pipeline has now a weighted average coupon of approximately 8 percent. On the back of this, MFA has been able to record a trailing twelve month (TTM) yield of 14.17 percent.

Price growth, however, has been extremely disappointing, and negative overall. The degree of price loss is so extreme that such a high yield too failed to generate a positive total return. In order to pull up its stock price, MFA Financial Inc. completed a 1-for-4 reverse stock split of its common stock in April 2022. As a result of the split, every four issued and outstanding shares of the company’s common stock were converted into 1 share. Thus the number of outstanding shares was reduced from 420 million to about 105 million. The most probable reason behind this reverse share split was to enhance the value per share beyond a certain point in order to be considered by closed-ended mutual funds (CEFs), Exchange traded funds (ETFs), etc.

Net Interest Income and Risk Factors

During the covid-19 pandemic in 2020, stock price fell to as low as $1, and was never able to cross the $5 mark during those two years. Thus, it made sense for MFA Financial Inc. to go for this reverse stock split. As a result of this reverse split, the price per share became $15. However, the stock had recorded a huge price fall since the reverse stock split. It seems that the reverse stock split made investors wary of investing in MFA for the time being. The company is buying back its shares in order to enhance the price. Still, considering the current price to book value (P/B) of 0.58, this stock looks undervalued.

This Mortgage real estate investment trust is also facing issues with non-performing loans and in an increasing interest rate environment, there are much higher chances of default. The company however has something positive to show in the form of growth in net interest income over the past two years, which means that the company has been able to recover from the pandemic shock. However, the second quarter of 2022 has seen the trend reversed. Unfortunately, the future market scenario will be somewhat detrimental for MFA, as an increase in interest rate and tighter Fed policy will result in growing interest expense.

Permanence in Q2 2022 Shows Some Positivity

The US financial markets had a very challenging 2022. The S&P 500 Index dropped by more than 16 percent and posted its worst first half of the year in more than 50 years. Bond markets continued to sell off and bond indices also went down. Mortgage spreads widened materially as did credit spreads, with high yield corporates widened up to 3 percent. Despite difficult market conditions, MFA Financial Inc. continued to execute securitizations, finance its loan portfolio and generate more liquidity. However, new investment activity in non-qualified mortgage loans slowed down due to the uncertainty over interest rates and credit spreads.

Commenting on the second quarter, Craig Knutson, MFA’s CEO and President said,

Mortgage REIT book values are down substantially since the beginning of 2022, and while MFA has certainly not been immune to these forces, our book value performance has been better than most in the peer group. We proactively addressed these market challenges beginning late last year in an effort to hedge our exposure to interest rate risk and marshal liquidity. Our interest rate swap position, which was $900 million at the beginning of 2022, is now $3.2 billion as we actively managed our hedge position through the rate cycle, and the floating receive leg of these swaps now exceeds the fixed pay leg by over 50 basis points.

Investment Thesis

MFA’s principal business objective is to deliver shareholder value through generation of distributable income and through asset performance linked to residential mortgage credit fundamentals. This REIT has been successful in generating a strong and steady yield. However, the price performance has been disappointing. Investors are hesitant about MFA despite its record dividend yield and the company’s share buyback program. As the stock price is now in double digit, probably the bigger institutions are considering MFA, but otherwise investors are a bit worried about investing in MFA. The price loss has been so severe that it failed to generate a positive total return despite such strong yield. This makes this stock too risky to invest.

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