The mortgage real estate investment trust (mREIT) sector has been a favorite of new investors this year given the extreme volatility we have seen in these stocks. For a time, the stocks appeared cheap, with oversized yields. However, a credit crunch soon became the dominant driver. The entire sector was thrown overboard in the spring as the coronavirus crisis triggered a massive sell-off in mortgage-backed securities.
Several mREITs like MFA Financial (NYSE:MFA) had what could only be called near-death experiences. Even the mREITs the invest in government-guaranteed mortgage backed securities, like AGNC Investment Corp. and Annaly Capital Management, saw the market inflict serious dents in their book value and were forced to cut dividends.
MFA Financial remains popular with day traders -- it's one of the 100 most-owned stocks on the beginner-friendly trading platform Robinhood. But while the Robinhood crowd found MFA's volatility conducive to day trading, the bigger question is whether the company is a suitable long-term investment.
A bloodbath in the sector during the early days of the pandemic
During the spring, as rates were falling, investors began to eschew mortgage assets with credit risk. MFA Financial invests primarily in residential whole loans that are not guaranteed by the U.S. government, and those assets became highly illiquid as forced selling overwhelmed the handful of intrepid investors.
Like most mREITs, MFA financed its assets using repurchase agreements (aka repos), which are secured loans and resemble margin loans. When the value of the underlying assets falls, the bank will demand more cash. Unable to come up with the cash to satisfy margin calls, MFA entered into a forbearance agreement with its repo counterparties and secured a rescue package.
An expensive rescue package
The rescue package was a $500 million 11% term loan from Apollo Management and Athene, which gave MFA the breathing room to negotiate an exit from forbearance and to secure financing on better terms. During the quarter, MFA's activity primarily concerned the liability side of the balance sheet, not the asset side.
In October, MFA conducted two securitizations, which are the ideal financing vehicle since they are non-recourse and non-mark-to-market. This means that if the assets decline in value, the bondholders cannot ask for more capital, and if the value of the underlying collateral is insufficient to satisfy the securitizations, the bondholders cannot go after other MFA assets. MFA used the proceeds from the securitizations to repay the term loan, and to add to its cash balance. The lower interest expense will help bolster earnings.
MFA's residential loans are probably "money good"
As of Sept. 30, MFA held $7.5 billion in assets, which included $5.6 billion in residential whole loans, $250 million in mortgage servicing rights, and about $150 million in mortgage-backed securities. Against this portfolio, MFA had $4.9 billion in debt. Most of the whole loans are either recently originated nonqualified (non-QM) mortgages or non-performing/reperforming loans that MFA bought at deep discounts.
The non-QM portfolio has a typical loan-to-value ratio of 64%, which means the value of the underlying property is more than ample to cover the loan if the borrower defaults. The average credit score is 712, which is strong, and 91% of the portfolio is current. Given that home prices continue to rise, the margin of safety on that portfolio will only continue to rise.
MFA also has a portfolio of nonperforming or reperforming loans it bought at a deep discount and is either working out (getting the borrower current) or foreclosing. The credit-deteriorated loans have an average loan-to-value ration of 79%, which again means that in the event of foreclosure, the loans are probably "money good."
Is the discount to book big enough?
MFA earned $0.17 per share in net income during the quarter and paid a quarterly dividend of $0.05. Book value per share is $4.61, which means that the stock is trading at a 26% discount to book value at Monday morning's prices. The dividend yield is 6%, as well.
The discount to book of 26% sounds large, but when you consider that the big agency REITs (that is, they're focused on mortgages backed by government agencies) like Annaly and AGNC are trading at closer to 12% discounts and have none of the liquidity issues or credit risk that MFA has, it is hard to argue it is excessive. Despite the newly announced $250 million share buyback program, MFA said on the earnings call that the stock didn't trade at a sufficient discount to book value to warrant major buybacks during the quarter. If management isn't all that enticed by the discount, perhaps investors shouldn't be, either.
Robinhood investors and day traders might be seduced by the pre-COVID trading prices around $8 per share. They shouldn't be. MFA is a completely different company now, and has little to no chance of seeing those levels in the near term. Mortgage REITs trade on book value and dividend yields, and building those takes time and patience. MFA is probably a safe long-term investment now, but investors might find the much higher dividend yields of the agency REITs like AGNC and Annaly more appealing.