~ by Snehasish Chaudhuri, MBA (Finance)
MFA Financial, Inc. (NYSE:MFA) is an internally managed real estate investment trust that finances and invests in residential mortgage backed securities (MBS). The last time I covered this mortgage REIT almost a year back, MFA went for a reverse stock split, the impact of which was not quite positive. Historically, the company had been quite successful in generating a steady double-digit yield and the same trend has continued since my last coverage.
The price performance had been disappointing. Investors were hesitant about MFA Financial, Inc., despite its record dividend yield and the company’s share buyback program. Investors are still skeptical about this stock. However, macro conditions have slowly shifted in MFA’s favor, as interest rate is on the verge of being stabilized. This must have made MFA attractive to its investors.
Over the years, MFA Has Been Successful in Generating Exceptionally High Yield
MFA Financial, along with its subsidiaries, invests in residential MBS, including non-agency MBS, agency MBS, credit risk transfer securities; and residential whole loans, including non-performing loans and purchased performing loans. Its principal objective is delivering shareholder’s value through creation of current income and through asset performance linked to residential mortgage credits. While investing in residential MBS, MFA focuses on credit analysis, projected prepayment rates, interest rate sensitivity and expected total return.
Over the years, MFA Financial has been successful in generating exceptionally high yield (15 percent during 2023), despite a dividend cut by 20 percent during December 2022. Annual average MFA Financial, Inc. dividend yield since 2020 (when the covid-19 pandemic started disrupting the market) has been 14.75 percent. However, over the past year, the price loss has been so severe that it was able to generate a total return of only 6 percent, despite such strong yield. This makes MFA a bit risky to invest in. The good news is that during 2023, MFA has been able to generate a total return of 13.5 percent on the back of a 6 percent price growth. This return is somewhat close to the returns generated by S&P 500.
Since the Reverse Stock Split 70 Weeks Ago, MFA’s Price Fell by Almost 35%
Since the reverse stock split more than 70 weeks ago, its price fell by almost 35 percent and the management cut its dividend by 20 percent in the fourth quarter of 2022. Despite this dividend cut the company was able to deliver a double-digit yield. MFA Financial is also facing issues with non-performing loans and in a high 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 covid-19 pandemic market shock.
A Rising Interest Rate Increases Borrowing Costs Faster Than the Interest Earnings
MFA Financial heavily relies on borrowings under repurchase agreements to raise funds for the purpose of acquiring residential mortgage assets, which exposes it to the risk of volatile interest rates. Interest rates may fluctuate due to various factors, such as fiscal and monetary policies, and the rates are also highly dependent on the macroeconomic and political environment. Rising interest rates are detrimental for mREITs, as it increases borrowing cost more rapidly than their interest earnings. This further contracts their profit margins.
Last time, when the dividend was cut by 20 percent, the market seemed to be prepared for it, as it hardly impacted its price. Rather the reverse stock-split had an adverse effect on the price of MFA. The management described this pay-out reduction to be an earnings issue rather than a liquidity problem. So, there lies a possibility of a further cut in the payout. If the earnings are not good enough the management might further cut the dividend as there is no clear sign of earning growth in the immediate quarter. MFA is generating a 15 percent yield and even if there is a 20 percent (which is highly unlikely) cut it will still be generating a 12 percent yield. That will not be bad either. However, it will raise concerns among the investors due to its too frequent dividend cut.
A Steady Interest Rate Will Enable MFA’s NII to Increase and Ensure High Yield
Mortgage REITs like MFA employ a higher degree of leverage, which makes them sensitive to interest rate movements. However, investors invest in MFA Financial due to its income generating capacity. As the Federal Reserve has lowered the frequency of raising the base rate, inflation and mortgage rates are likely to be under control. Steady interest rate will enable MFA’s net interest income (NII) to increase in a gradual manner. There has also been a growth in yields generated out of the purchased performing loan portfolio of MFA, which is likely to further expand its interest rate spread. Thus, this stock is in a great position to satisfy the needs of income-seeking investors over the long term.
Investment Thesis
MFA Financial is a mortgage real estate investment trust. It is exposed to the risk of fluctuation in interest rates which can contract its profit margins. Market volatility has caused harm to MFA despite some of its well-performing portfolios. However, the market conditions are expected to normalize in the coming year and interest rate is expected to stabilize. In fact, it is showing signs of stability as Fed made only a 0.5 percent rate hike during the past five months, as compared to 4.75 percent hike within twelve months prior to that.
I expect the market conditions to be favorable in the future and mortgage REITs like MFA to benefit out of increasing demand for mortgage-backed securities and loans. In addition to all these, a double-digit yield makes the company a decent investment opportunity for yield-focused investors. However, the current uncertainty surrounding its income, pay-out and price growth stops me from suggesting that an investor should accumulate fresh units of MFA Financial, Inc.
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