This year has been a wild one for mortgage REITs (mREITs). The COVID-19 crisis created a credit crunch that swept through the entire sector, causing big declines in book value and sizable dividend cuts. For the most part, the sector's crisis is over, provided we don't enter another economic shutdown like we had beginning in March. For many of these stocks, it is time to start looking for value.
MFA Financial (NYSE:MFA) had what amounts to a corporate near-death experience. Is it worth an investment now?
Margin calls almost killed the company
After beginning the year at $7.64 per share, MFA dropped to a low of $0.32 in late March during the worst of the sector's liquidity problems. Most mREITs rely on borrowing to increase the returns on their portfolios of mortgage-backed securities. This is usually fine. But the market chaos in late March and early April meant mREITs needed to come up with more cash to back their debt just as cash became much harder to come by. MFA couldn't, and so it entered into forbearance with its creditors.
MFA suspended the dividend on its common and preferred shares and finally obtained a strategic investment from Apollo Global Management and affiliated insurance company Athene, which was able to settle all of the outstanding margin calls. MFA recently announced that it has exited forbearance with its creditors. Its leverage ratio stands at 1.9 to 1, a sizable drop from the 3-to-1 ratio at the end of 2019. This means the company is run much more conservatively now.
The March 30 book value was close to the bottom of the market
As of March 30, book value was $4.34 per share compared to $7.04 at the end of 2019. The end of March, when book value was reported, was the vortex of the forced selling in the mortgage asset markets. It couldn't have been a worse time to mark the book.
On a conference call, CEO Craig Knutson described assets that had been steady as a rock for years suddenly falling 20% to 50%. The Federal Reserve stepped in and began buying mortgage-backed securities, which stabilized things. Since then, most assets in the mortgage ecosystem have rebounded.
A lot of activity in the second quarter
MFA has continued to de-leverage its portfolio since the quarter ended. After MFA completed its deal with Apollo and Athene, it gave a snapshot of the portfolio. Residential whole loans and real estate owned are now $6 billion (down from $7 billion as of March 31), the agency mortgage-backed securities portfolio is gone, and the servicing portfolio has fallen from $738 million to $235 million. MFA also reported that book value per share had increased about 2% to 3% from the end of March.
There remain $31.7 million in margin calls, but MFA has reduced its reliance on short-term financing via repurchase agreements. MFA has also reinstated its dividend on its preferred shares, although it's still suspended on the common stock.
Delinquencies and marks
The number I am most interested in is the delinquency rate on MFA's mortgage book. As of March 30, 97.5% of MFA's nongovernment book was current, and the typical loan-to-value ratio was 66%. We have seen delinquencies tick up across the board, especially in Federal Housing Administration (FHA) and Veterans Affairs (VA) loans. With such low loan-to-value ratios, homeowners will have enough equity to trade down if they cannot afford the current payments. Which means these loans are almost assuredly "money good."
Still, delinquencies will affect cash flows and could cause some strain on income. The other number I want to understand is the mark on these loans as a percentage of amortized value, which would be similar to the percentage of face value. This would represent the unrealized value that is currently held on the balance sheet. If the loans are marked at, say, 80% of amortized value, then that would imply an embedded return in addition to the current discount to book. The company should be pulled up toward book value, which is steadily increasing. We still don't have enough information to really make an investment decision on MFA, but the second-quarter earnings should bring some clarity.