MFA Financial’s post-COVID restructuring largely complete

The past year has been difficult for the financial sector. Banks have faced high delinquencies, especially in commercial real estate, and real estate investment fund (REITs), particularly shopping center REITs and apartment REITs, have struggled with tenant delinquencies. It has been a particularly difficult year for mortgage REITs, and many have struggled to survive.

MFA Financial (NYSE: MFA) was one of those REITs. However, the company has largely weathered the crisis and is now looking to the future.

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Mortgage REITs have a different business model

A mortgage REIT is a different animal from the typical REIT. Most REITs use an owner / tenant model, in which the REIT builds properties such as shopping malls, office towers, and apartment buildings and then leases the units to tenants. It’s a relatively easy-to-understand business model. Mortgage REITs, on the other hand, don’t buy buildings – they buy real estate debt.

MFA Financial specializes in the government unsecured sector of the mortgage universe. While large real estate investment firms like AGNC investment focuses on government guaranteed mortgages and uses a lot of leverage to create returns, MFA focuses on taking credit risk. This allows MFA to operate with a significantly lower leverage ratio than agency REITs.

The early days of COVID were brutal for mortgage REITs

In the early days of the COVID-19 crisis, interest rates collapsed and liquidity dried up in the mortgage market. Nervous banks demanded that mortgage REITs post more cash flow against falling securities, and many of the more esoteric assets simply went without a bid. MFA ultimately entered into a forbearance with its creditor banks as it sought a bailout. Eventually, the MFA negotiated a bailout with funds managed by Global management of Apollo and Athens, which consisted of high-interest loans and warrants to buy MFA shares. During the third and fourth quarters, MFA was able to repay the loans and eliminate the excess warrants.

MFA has also spent the last two quarters replacing mark-to-market debt (the source of margin calls) with longer-term debt and more sustainable and less risky securitizations. This will go a long way in reducing interest charges in the future. MFA’s cost of funds fell 140 basis points to 3.1% from June 30, 2020 to December 31, 2020, and fell to 2.9% after year-end as the company called an issue of high rate debt.

MFA focuses on taking credit risk

MFA’s largest asset class consists of mortgages that are unsecured by the US government as they do not fall under Qualified Mortgage (QM) rules. These loans have a weighted average interest rate of 6.15%, which is much higher than the typical agency loan, which earns less than 3%. These are also quite conservative, with an average loan-to-value (LTV) ratio of 64%. This means that if a borrower defaults and the AMF has to foreclose, the loan is more than largely covered by the value of the underlying collateral. As of December 31, 89% of the non-QM portfolio was up to date.

MFA also has a large portfolio of non-performing loans. He buys them for less than face value and then works with borrowers to secure outstanding loans or take possession of properties after foreclosure. Rising house prices have been a positive wind here, and MFA has sold about $ 270 million worth of properties above their book value on the balance sheet. MFA’s reproductive loan portfolio has seen an increase in defaults due to COVID, but 81% of the book is less than 60 days past due.

Low rates mean a shortage of cheap investment assets

MFA characterized the investment climate as one with very few cheap assets. Despite the recent increase in interest rates, they are still extremely low by historical standards and credit spreads are very tight. When rates are very low, the greatest value can be found by managing the passive side of the ledger, and MFA has significantly reduced its cost of funds. Fortunately, the non-QM origination activity is starting to wake up, as the rate hike has eliminated some of the low-hold refinancing activity for originators. In the future, this activity is expected to continue to grow and the securitization market is back.

MFA Financial pays $ 0.075 per share quarterly dividend, which corresponds to a dividend yield of 7.5%. The company is also trading at a substantial discount from its book value of $ 4.54 per share. As the COVID-19 pandemic wears off economically, mortgage assets exposed to credit are expected to outperform government guaranteed assets as rates rise. That said, MFA’s dividend yield is lower than that of large REITs like AGNC Investment (8.9% yield) and Annaly Capital (10.5% yield). On the other hand, his discount for booking is more important. The AMF is probably quite valued at this point, but the worst is definitely over.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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