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Section 1: 10-Q (10-Q)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2011

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                   to                  

 

Commission File Number: 1-13991

 

MFA FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

 


 

Maryland
(State or other jurisdiction of
incorporation or organization)

 

13-3974868
(I.R.S. Employer
Identification No.)

 

 

 

350 Park Avenue, 21st Floor, New York, New York

(Address of principal executive offices)

 

10022

(Zip Code)

 

(212) 207-6400

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

 

356,059,031 shares of the registrant’s common stock, $0.01 par value, were outstanding as of April 28, 2011.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

Page

 

 

PART I

 

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Consolidated Balance Sheets as of March 31, 2011
(Unaudited) and December 31, 2010

1

 

 

 

 

Consolidated Statements of Operations (Unaudited) for the
Three Months Ended March 31, 2011 and March 31, 2010

2

 

 

 

 

Consolidated Statements of Comprehensive Income (Unaudited) for the
Three Months Ended March 31, 2011 and March 31, 2010

3

 

 

 

 

Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)
for the Three Months Ended March 31, 2011

4

 

 

 

 

Consolidated Statements of Cash Flows (Unaudited) for the
Three Months Ended March 31, 2011 and March 31, 2010

5

 

 

 

 

Notes to the Unaudited Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

33

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

47

 

 

 

Item 4.

Controls and Procedures

54

 

 

 

 

PART II
OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

55

 

 

 

Item 1A.

Risk Factors

55

 

 

 

Item 6.

Exhibits

55

 

 

 

Signatures

58

 



Table of Contents

 

MFA FINANCIAL, INC.

CONSOLIDATED BALANCE SHEETS

 

 

 

March 31,

 

December 31,

 

(In Thousands, Except Per Share Amounts)

 

2011

 

2010

 

 

 

(Unaudited)

 

 

 

Assets:

 

 

 

 

 

Mortgage-backed securities (“MBS”):

 

 

 

 

 

Agency MBS, at fair value ($6,861,597 and $5,519,879 pledged as collateral, respectively)

 

$

7,374,510

 

$

5,980,623

 

Non-Agency MBS, at fair value ($887,635 and $867,655 pledged as collateral, respectively)

 

1,462,374

 

1,372,383

 

Non-Agency MBS transferred to consolidated variable interest entities (“VIEs”) (1)

 

1,739,466

 

705,704

 

Cash and cash equivalents

 

629,423

 

345,243

 

Restricted cash

 

34,565

 

41,927

 

MBS linked transactions, net (“Linked Transactions”), at fair value

 

103,855

 

179,915

 

Interest receivable

 

43,931

 

38,215

 

Interest rate swap agreements (“Swaps”), at fair value

 

2,862

 

 

Real estate held for sale as of March 31, 2011, net

 

10,656

 

10,732

 

Securities held as collateral, at fair value

 

17,658

 

 

Goodwill

 

7,189

 

7,189

 

Prepaid and other assets

 

9,872

 

5,476

 

Total Assets

 

$

11,436,361

 

$

8,687,407

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Repurchase agreements

 

$

7,652,713

 

$

5,992,269

 

Securitized debt (2)

 

663,367

 

220,933

 

Accrued interest payable

 

8,199

 

8,007

 

Swaps, at fair value

 

116,333

 

139,142

 

Obligations to return securities held as collateral, at fair value

 

17,658

 

 

Dividends and dividend equivalents rights (“DERs”) payable

 

84,692

 

67,040

 

Accrued expenses and other liabilities

 

4,995

 

9,569

 

Total Liabilities

 

$

8,547,957

 

$

6,436,960

 

 

 

 

 

 

 

Commitments and contingencies (Note 9)

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

Preferred stock, $.01 par value; series A 8.50% cumulative redeemable; 5,000 shares authorized; 3,840 shares issued and outstanding ($96,000 aggregate liquidation preference)

 

$

38

 

$

38

 

Common stock, $.01 par value; 370,000 shares authorized; 355,331 and 280,481 issued and outstanding, respectively

 

3,553

 

2,805

 

Additional paid-in capital, in excess of par

 

2,789,872

 

2,184,493

 

Accumulated deficit

 

(194,773

)

(191,569

)

Accumulated other comprehensive income

 

289,714

 

254,680

 

Total Stockholders’ Equity

 

$

2,888,404

 

$

2,250,447

 

Total Liabilities and Stockholders’ Equity

 

$

11,436,361

 

$

8,687,407

 

 


(1)  Non-Agency MBS transferred to consolidated VIEs included in the Consolidated Balance Sheet at March 31, 2011 and December 31, 2010 represent assets of the consolidated VIEs that can be used only to settle the obligations of the VIEs.

(2)  Securitized Debt included in the Consolidated Balance Sheet at March 31, 2011 and December 31, 2010, represents third-party liabilities of consolidated VIEs and excludes liabilities of the VIEs acquired by the Company that eliminate on consolidation.  The third-party beneficial interest holders in the VIEs have no recourse to the general credit of the Company.  (See Notes 9 and 14 for further discussion.)

 

The accompanying notes are an integral part of the consolidated financial statements.

 

1



Table of Contents

 

MFA FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In Thousands, Except Per Share Amounts)

 

2011

 

2010

 

Interest Income:

 

 

 

 

 

Agency MBS

 

$

60,175

 

$

78,679

 

Non-Agency MBS

 

22,894

 

28,965

 

Non-Agency MBS transferred to consolidated VIEs

 

26,755

 

 

Cash and cash equivalent investments

 

54

 

53

 

Interest Income

 

$

109,878

 

$

107,697

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

Repurchase agreements

 

$

33,054

 

$

38,451

 

Securitized debt

 

1,599

 

 

Total Interest Expense

 

$

34,653

 

$

38,451

 

 

 

 

 

 

 

Net Interest Income

 

$

75,225

 

$

69,246

 

 

 

 

 

 

 

Other Income/(Loss):

 

 

 

 

 

Unrealized net gains and net interest income from Linked Transactions

 

$

14,850

 

$

12,800

 

Gain on sales of MBS

 

 

33,739

 

Revenue from operations of real estate held-for-sale

 

381

 

374

 

Loss on termination of repurchase agreements

 

 

(26,815

)

Other Income, net

 

$

15,231

 

$

20,098

 

 

 

 

 

 

 

Operating and Other Expense:

 

 

 

 

 

Compensation and benefits

 

$

5,123

 

$

4,368

 

Other general and administrative expense

 

2,161

 

1,853

 

Real estate held-for-sale operating expense and mortgage interest

 

307

 

446

 

Operating and Other Expense

 

$

7,591

 

$

6,667

 

 

 

 

 

 

 

Net Income

 

$

82,865

 

$

82,677

 

Less: Preferred Stock Dividends

 

2,040

 

2,040

 

Net Income Available to Common Stock and Participating Securities

 

$

80,825

 

$

80,637

 

 

 

 

 

 

 

Earnings per Common Share - Basic and Diluted

 

$

0.27

 

$

0.29

 

 

 

 

 

 

 

Dividends Declared on Common Stock

 

$

0.235

 

$

(1)

 


(1)  A dividend of $0.24 per share for the quarter ended March 31, 2010 was declared on April 1, 2010.  See Note 10.

 

The accompanying notes are an integral part of the consolidated financial statements.

 

2



Table of Contents

 

MFA FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In Thousands)

 

2011

 

2010

 

Net income

 

$

82,865

 

$

82,677

 

Other Comprehensive Income:

 

 

 

 

 

Unrealized gain on MBS, net

 

9,363

 

38,059

 

Reclassification adjustment for MBS sales

 

 

(41,459

)

Unrealized gain/(loss) on Swaps, net

 

25,671

 

(1,287

)

Comprehensive income before preferred stock dividends

 

$

117,899

 

$

77,990

 

Dividends declared on preferred stock

 

(2,040

)

(2,040

)

Comprehensive Income Available to Common Stock and Participating Securities

 

$

115,859

 

$

75,950

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

3



Table of Contents

 

MFA FINANCIAL, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

 

 

 

Three Months Ended

 

 

 

March 31, 2011

 

(In Thousands, Except Per Share Amounts)

 

Dollars

 

Shares

 

 

 

 

 

 

 

Preferred Stock, Series A 8.50% Cumulative Redeemable — Liquidation Preference $25.00 per Share:

 

 

 

 

 

 

 

 

 

 

 

Balance at March 31, 2011 and December 31, 2010

 

$

38

 

3,840

 

 

 

 

 

 

 

Common Stock, Par Value $.01:

 

 

 

 

 

Balance at December 31, 2010

 

2,805

 

280,481

 

Issuance of common stock

 

748

 

74,850

 

Balance at March 31, 2011

 

3,553 

 

355,331

 

 

 

 

 

 

 

Additional Paid-in Capital, in excess of Par:

 

 

 

 

 

Balance at December 31, 2010

 

2,184,493

 

 

 

Issuance of common stock, net of expenses

 

604,447

 

 

 

Equity-based compensation expense

 

932

 

 

 

Balance at March 31, 2011

 

2,789,872

 

 

 

 

 

 

 

 

 

Accumulated Deficit:

 

 

 

 

 

Balance at December 31, 2010

 

(191,569

)

 

 

Net income

 

82,865

 

 

 

Dividends declared on common stock

 

(83,674

)

 

 

Dividends declared on preferred stock

 

(2,040

)

 

 

Dividends attributable to DERs

 

(355

)

 

 

Balance at March 31, 2011

 

(194,773

)

 

 

 

 

 

 

 

 

Accumulated Other Comprehensive Income:

 

 

 

 

 

Balance at December 31, 2010

 

254,680 

 

 

 

Change in unrealized gains on MBS, net

 

9,363

 

 

 

Change in unrealized losses on Swaps

 

25,671

 

 

 

Balance at March 31, 2011

 

289,714

 

 

 

 

 

 

 

 

 

Total Stockholders’ Equity at March 31, 2011

 

$

2,888,404

 

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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Table of Contents

 

MFA FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

 

 

Three Months Ended

 

 

 

March 31,

 

(In Thousands)

 

2011

 

2010

 

 

 

 

 

 

 

Cash Flows From Operating Activities:

 

 

 

 

 

Net income

 

$

82,865

 

$

82,677

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Gain on sales of MBS

 

 

(33,739

)

Losses on termination of repurchase agreements

 

 

26,815

 

Net accretion of purchase premiums and discount amortization on MBS

 

(2,580

)

(485

)

(Increase)/decrease in interest receivable

 

(5,716

)

6,676

 

Depreciation and amortization

 

521

 

163

 

Unrealized gain and other on Linked Transactions

 

(8,933

)

(9,084

)

Increase in prepaid and other assets and other

 

(625

)

(664

)

Decrease in accrued expenses and other liabilities

 

(4,574

)

(7,676

)

Increase/(decrease) in accrued interest payable

 

192

 

(5,011

)

Equity-based compensation expense

 

932

 

722

 

Net cash provided by operating activities

 

$

62,082

 

$

60,394

 

 

 

 

 

 

 

Cash Flows From Investing Activities:

 

 

 

 

 

Principal payments on MBS

 

$

521,796

 

$

596,246

 

Proceeds from sale of MBS

 

 

939,119

 

Purchases of MBS

 

(2,595,914

)

(193,851

)

Net additions to leasehold improvements, furniture, fixtures and real estate investment

 

(511

)

(210

)

Net cash (used in)/provided by investing activities

 

$

(2,074,629

)

$

1,341,304

 

 

 

 

 

 

 

Cash Flows From Financing Activities:

 

 

 

 

 

Principal payments on repurchase agreements

 

$

(12,249,066

)

$

(13,998,897

)

Proceeds from borrowings under repurchase agreements

 

13,862,812

 

12,816,945

 

Proceeds from issuance of securitized debt

 

488,389

 

 

Principal payments on securitized debt

 

(45,955

)

 

Payments to terminate repurchase agreements

 

 

(26,815

)

Payments made for resecuritization related costs

 

(3,724

)

 

Cash disbursements on financial instruments underlying Linked Transactions

 

(828,973

)

(346,435

)

Cash received from financial instruments underlying Linked Transactions

 

529,084

 

318,426

 

Payments made for margin calls on repurchase agreements and Swaps

 

(650

)

(259,286

)

Proceeds from reverse margin calls on repurchase agreements and Swaps

 

8,033

 

287,416

 

Proceeds from issuances of common stock

 

605,195

 

125

 

Dividends paid on preferred stock

 

(2,040

)

(2,040

)

Dividends paid on common stock and DERs

 

(66,378

)

(75,899

)

Principal amortization on mortgage loan

 

 

(42

)

Net cash provided by/(used in) financing activities

 

$

2,296,727

 

$

(1,286,502

)

Net increase in cash and cash equivalents

 

$

284,180

 

$

115,196

 

Cash and cash equivalents at beginning of period

 

$

345,243

 

$

653,460

 

Cash and cash equivalents at end of period

 

$

629,423

 

$

768,656

 

 

 

 

 

 

 

Non-cash Investing and Financing Activities:

 

 

 

 

 

MBS recorded upon de-linking of Linked Transactions

 

$

431,580

 

$

21,448

 

Repurchase agreements recorded upon de-linking of Linked Transactions

 

$

46,698

 

$

 

Dividends and DERs declared and unpaid

 

$

84,692

 

$

387

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

5



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

1.                   Organization

 

MFA Financial, Inc. (the “Company”) was incorporated in Maryland on July 24, 1997 and began operations on April 10, 1998.  The Company has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes.  In order to maintain its qualification as a REIT, the Company must comply with a number of requirements under federal tax law, including that it must distribute at least 90% of its annual REIT taxable income to its stockholders.  (See Note 10(b))

 

2.                   Summary of Significant Accounting Policies

 

(a)  Basis of Presentation and Consolidation

 

The interim unaudited financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”).  Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted according to these SEC rules and regulations.  Management believes that the disclosures included in these interim financial statements are adequate to make the information presented not misleading.  The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.  In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31, 2011 and results of operations for all periods presented have been made.  The results of operations for the three months ended March 31, 2011 should not be construed as indicative of the results to be expected for the full year.

 

The consolidated financial statements of the Company have been prepared on the accrual basis of accounting in accordance with GAAP.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  The consolidated financial statements of the Company include the accounts of all subsidiaries; significant intercompany accounts and transactions have been eliminated.

 

(b)  Agency MBS and Non-Agency MBS (including Non-Agency MBS transferred to a consolidated VIE)

 

The Company has investments in residential MBS that are issued or guaranteed as to principal and/or interest by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or any agency of the U.S. Government, such as Ginnie Mae (collectively, “Agency MBS”), and residential MBS that are not guaranteed by any U.S. Government agency or any federally chartered corporation (“Non-Agency MBS”), as described in Note 3.

 

Designation

 

The Company generally intends to hold its MBS until maturity; however, from time to time, it may sell any of its securities as part of the overall management of its business.  As a result, all of the Company’s MBS are designated as “available-for-sale” and, accordingly, are carried at their fair value with unrealized gains and losses excluded from earnings (except when an other-than-temporary impairment is recognized, as discussed below) and reported in accumulated other comprehensive income, a component of stockholders’ equity.

 

Upon the sale of an investment security, any unrealized gain or loss is reclassified out of accumulated other comprehensive income to earnings as a realized gain or loss using the specific identification method.

 

Revenue Recognition, Premium Amortization and Discount Accretion

 

Interest income on securities is accrued based on the outstanding principal balance and their contractual terms.  Premiums and discounts associated with Agency MBS and Non-Agency MBS rated AA and higher at the time of purchase are amortized into interest income over the life of such securities using the effective yield method.  Adjustments to premium amortization are made for actual prepayment activity.

 

Interest income on the Non-Agency MBS that were purchased at a discount to par value and/or were rated below AA at the time of purchase is recognized based on the security’s effective interest rate.  The effective interest rate on these securities is based on management’s estimate of the projected cash flows from each security, which are estimated based on the Company’s observation of current information and events and include assumptions related to fluctuations in interest rates, prepayment speeds and the timing and amount of credit losses.  On at least a quarterly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and its judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors.  Changes in cash flows from those originally projected, or

 

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Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

from those estimated at the last evaluation, may result in a prospective change in the yield/interest income recognized on these securities.  (See Note 3)

 

Based on the projected cash flows from the Company’s Non-Agency MBS purchased at a discount to par value, a portion of the purchase discount may be designated as non-accretable purchase discount (“Credit Reserve”), which effectively provides credit protection against future credit losses and is not expected to be accreted into interest income.  The amount designated as Credit Reserve may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors.  If the performance of a security with a Credit Reserve is more favorable than forecasted, a portion of the amount designated as Credit Reserve may be accreted into interest income over time.  Conversely, if the performance of a security with a Credit Reserve is less favorable than forecasted, the amount designated as Credit Reserve may be increased, or impairment charges and write-downs of such securities to a new cost basis could result.

 

Determination of MBS Fair Value

 

The Company determines the fair value of its Agency MBS based upon prices obtained from a third-party pricing service, which are indicative of market activity.  In determining the fair value of its Non-Agency MBS, management considers a number of observable market data points including prices obtained from third-party pricing services and brokers as well as dialogue with market participants.  (See Note 13)

 

Impairments

 

When the fair value of an investment security is less than its amortized cost at the balance sheet date, the security is considered impaired.  The Company assesses its impaired securities on at least a quarterly basis and designates such impairments as either “temporary” or “other-than-temporary.”  If the Company intends to sell an impaired security, or it is more likely than not that it will be required to sell the impaired security before its anticipated recovery, then the Company must recognize an other-than-temporary impairment through charges to earnings equal to the entire difference between the investment’s amortized cost and its fair value at the balance sheet date.  If the Company does not expect to sell an other-than-temporarily impaired security, only the portion of the other-than-temporary impairment related to credit losses is recognized through charges to earnings with the remainder recognized through other accumulated comprehensive income on the consolidated balance sheet.  Impairments recognized through other comprehensive income do not impact earnings.  Following the recognition of an other-than-temporary impairment through earnings, a new cost basis is established for the security and may not be adjusted for subsequent recoveries in fair value through earnings.  However, other-than-temporary impairments recognized through charges to earnings may be accreted back to the amortized cost basis of the security on a prospective basis through interest income.  The determination as to whether an other-than-temporary impairment exists and, if so, the amount considered other-than-temporarily impaired is subjective, as such determinations are based on both factual and subjective information available at the time of assessment.  As a result, the timing and amount of other-than-temporary impairments constitute material estimates that are susceptible to significant change.  (See Note 3)

 

Non-Agency MBS on which impairments are recognized have experienced, or are expected to experience, credit-related adverse cash flow changes.  The Company’s estimate of cash flows for its Non-Agency MBS is based on its review of the underlying mortgage loans securing the MBS.  The Company considers information available about the performance of underlying mortgage loans, including prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, Fair Isaac Corporation (“FICO”) scores at loan origination, year of origination, loan-to-value ratios, geographic concentrations, as well as reports by credit rating agencies, such as Moody’s Investors Services, Inc., Standard & Poor’s Corporation (“S&P”), or Fitch, Inc. (collectively, “Rating Agencies”), general market assessments, and dialogue with market participants.  As a result, significant judgment is used in the Company’s analysis to determine the expected cash flows for its Non-Agency MBS.  In determining the other-than-temporary impairment related to credit losses, the Company compares the present value of the remaining cash flows expected to be collected at the purchase date (or last date previously revised) against the present value of the cash flows expected to be collected at the current financial reporting date.

 

Balance Sheet Presentation

 

The Company’s MBS pledged as collateral against repurchase agreements and Swaps are included in MBS on the consolidated balance sheets with the fair value of the MBS pledged disclosed parenthetically.  Purchases and sales of securities are recorded on the trade date or when all significant uncertainties regarding the securities are removed.  However, if a repurchase agreement is determined to be linked to the purchase of an MBS, then the MBS and linked repurchase borrowing will be reported net, as Linked Transactions.  (See Notes 2(m) and 4)

 

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Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

(c)  Cash and Cash Equivalents

 

Cash and cash equivalents include cash on deposit with financial institutions and investments in money market funds, all of which have original maturities of three months or less.  Cash and cash equivalents may also include cash pledged as collateral to the Company by its repurchase agreement and/or Swap counterparties as a result of reverse margin calls (i.e., margin calls made by the Company).  The Company did not hold any cash pledged by its counterparties at March 31, 2011 or December 31, 2010.  At March 31, 2011 and December 31, 2010, all of the Company’s cash investments were comprised of overnight money market funds, which are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.  (See Notes 8 and 13)

 

(d)  Restricted Cash

 

Restricted cash represents the Company’s cash held by its counterparties as collateral against the Company’s Swaps and/or repurchase agreements.  Restricted cash, which earns interest, is not available to the Company for general corporate purposes, but may be applied against amounts due to counterparties to the Company’s repurchase agreements and/or Swaps, or returned to the Company when the collateral requirements are exceeded or at the maturity of the Swap or repurchase agreement.  The Company had aggregate restricted cash held as collateral against its Swaps and repurchase agreements of $34.6 million and $41.9 million at March 31, 2011 and December 31, 2010, respectively.  (See Notes 4, 7, 8 and 13)

 

(e)  Goodwill

 

At March 31, 2011 and December 31, 2010, the Company had goodwill of $7.2 million, which represents the unamortized portion of the excess of the fair value of its common stock issued over the fair value of net assets acquired in connection with its formation in 1998.  Goodwill is tested for impairment at least annually, or more frequently under certain circumstances, at the entity level.  Through March 31, 2011, the Company had not recognized any impairment against its goodwill.

 

(f)  Depreciation

 

Real Estate/Real Estate Held for Sale

 

The Company has 100% of the ownership interest in Lealand Place, a 191-unit apartment property located in Lawrenceville, Georgia, through Lealand Place, LLC (“Lealand”), an indirect, wholly-owned subsidiary.  This property was acquired through a tax-deferred exchange under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Code”).  (See Note 6)

 

The property, capital improvements and other assets held in connection with this investment are carried at cost, net of accumulated depreciation and amortization.  Maintenance, repairs and minor improvements are expensed in the period incurred, while real estate assets, except land, and capital improvements are depreciated over their useful life using the straight-line method.  The estimated life is 27.5 years for buildings and five to seven years for furniture and fixtures.

 

On March 31, 2011, the Company classified its investment in Lealand as held-for-sale and accordingly ceased depreciating assets related to this investment as of such date.  Upon the reclassification, Lealand was reviewed for impairment and it was determined that Lealand’s fair value was in excess of its carrying value less cost to sell.  Lealand’s historical results of operations are not material to the Company.

 

Leasehold Improvements and Other Depreciable Assets

 

Depreciation is computed on the straight-line method over the estimated useful life of the related assets or, in the case of leasehold improvements, over the shorter of the useful life or the lease term.  Furniture, fixtures, computers and related hardware have estimated useful lives ranging from five to eight years at the time of purchase.

 

(g)  Resecuritization Related Costs

 

Resecuritization related costs are costs associated with the issuance of beneficial interests by consolidated VIEs and incurred by the Company in connection with the resecuritization transactions that were completed in October 2010 and February 2011.  These costs include underwriting, rating agency, legal, accounting and other fees.  Such costs, which reflect deferred charges, are included on the Company’s consolidated balance sheet in prepaid and other assets.  These deferred charges are amortized as an adjustment to interest expense using the effective interest method, based upon the actual repayments of the associated beneficial interests.

 

(h)  Repurchase Agreements

 

The Company finances the acquisition of a significant portion of its MBS with repurchase agreements.  Under repurchase agreements, the Company sells securities to a lender and agrees to repurchase the same securities in the future for a price that is higher than the original sale price.  The difference between the sale price that the Company

 

8



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

receives and the repurchase price that the Company pays represents interest paid to the lender.  Although legally structured as a sale and repurchase, the Company accounts for its repurchase agreements as secured borrowings, with the exception of those repurchase agreements accounted for as components of Linked Transactions.  (See Note 2(m) below).  Under its repurchase agreements, the Company pledges its securities as collateral to secure the borrowing, which is equal in value to a specified percentage of the fair value of the pledged collateral, while the Company retains beneficial ownership of the pledged collateral.  At the maturity of a repurchase financing, unless the repurchase financing is renewed with the same counterparty, the Company is required to repay the loan and concurrently receives back its pledged collateral from the lender.  With the consent of the lender, the Company may renew a repurchase financing at the then prevailing financing terms.  Margin calls, whereby a lender requires that the Company pledge additional securities or cash as collateral to secure borrowings under its repurchase financing with such lender, are routinely experienced by the Company when the value of the MBS pledged as collateral declines as a result of principal amortization or due to changes in market interest rates, spreads or other market conditions.  To date, the Company has satisfied all of its margin calls and has never sold assets in response to a margin call.

 

The Company’s repurchase financings typically have terms ranging from one month to six months at inception, with some having longer terms.  Should a counterparty decide not to renew a repurchase financing at maturity, the Company must either refinance elsewhere or be in a position to satisfy the obligation.  If, during the term of a repurchase financing, a lender should file for bankruptcy, the Company might experience difficulty recovering its pledged assets which could result in an unsecured claim against the lender for the difference between the amount loaned to the Company plus interest due to the counterparty and the fair value of the collateral pledged to such lender.  The Company enters into repurchase agreements with multiple counterparties with a maximum loan from any lender of no more than three times the Company’s stockholders’ equity.   (See Notes 2(m), 4, 7, 8 and 13)

 

(i)  Equity-Based Compensation

 

Compensation expense for equity based awards is recognized ratably over the vesting period of such awards, based upon the fair value of such awards at the grant date.  With respect to awards granted in 2009 and prior years, the Company has applied a zero forfeiture rate for these awards, as they were granted to a limited number of employees, and historical forfeitures have been minimal.  Forfeitures, or an indication that forfeitures may occur, would result in a revised forfeiture rate and would be accounted for prospectively as a change in estimate.

 

During 2010, the Company granted certain restricted stock units (“RSUs”) that vest after either two or four years of service and provided that certain criteria are met, which are based on a formula that includes changes in the Company’s closing stock price over a two- or four-year period and dividends declared on the Company’s common stock during those periods.  Such criteria constitute a “market condition” which impacts the determination of compensation expense recognized for these awards.  Specifically, the uncertainty regarding whether the market condition will be achieved is reflected in the grant date fair valuation of the RSUs, which in addition to estimates regarding the amount of RSUs expected to be forfeited during the associated service period, determines the amount of compensation expense that is recognized.  Compensation expense is not reversed should the market condition not be achieved, while differences in actual forfeiture experience relative to estimated forfeitures will result in adjustments to the timing and amount of compensation expense recognized.

 

Payments pursuant to DERs, which are attached to certain equity based awards, are charged to stockholders’ equity when declared to the extent the underlying equity award is expected to vest.  Compensation expense is recognized for DERs to the extent that associated equity awards do not or are not expected to vest and grantees are not required to return payments of dividends or DERs to the Company.  (See Notes 2(j) and 12)

 

(j)  Earnings per Common Share (“EPS”)

 

Basic earnings per common share is computed using the two-class method, which includes the weighted-average number of shares of common stock outstanding during the period and other securities that participate in dividends, such as the Company’s unvested restricted stock and RSUs that have non-forfeitable rights to dividends and DERs attached to vested stock options to arrive at total common equivalent shares.  In applying the two-class method, earnings are allocated to both common stock shares and securities that participate in dividends based on their respective weighted-average shares outstanding for the period.  For the diluted EPS calculation, common equivalent shares are further adjusted for the effect of dilutive unexercised stock options and RSUs outstanding that are unvested and have dividends that are subject to forfeiture using the treasury stock method.  Under the treasury stock method, common equivalent shares are calculated assuming that all dilutive common stock equivalents are exercised and the proceeds, along with future compensation expenses associated with such instruments, are used to repurchase shares of the Company’s outstanding common stock at the average market price during the reported period.  (See Note 11)

 

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Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

(k)  Comprehensive Income

 

The Company’s comprehensive income includes net income, the change in net unrealized gains/(losses) on its MBS and hedging instruments, adjusted by realized net gains/(losses) reclassified out of accumulated other comprehensive income for MBS and is reduced by dividends declared on the Company’s preferred stock.

 

(l)  U.S. Federal Income Taxes

 

The Company has elected to be taxed as a REIT under the provisions of the Code and the corresponding provisions of state law.  The Company expects to operate in a manner that will enable it to continue to be taxed as a REIT.  A REIT is not subject to tax on its earnings to the extent that it distributes at least 90% of its annual REIT taxable income to its stockholders.  As such, no provision for current or deferred income taxes has been made in the accompanying consolidated financial statements.  To the extent that the company incurs interest and/or penalties in connection with its tax obligations, such amounts shall be classified as income tax expense on the Company’s consolidated statements of operations.

 

(m) Derivative Financial Instruments

 

Hedging Activity

 

As part of the Company’s interest rate risk management, it periodically hedges a portion of its interest rate risk using derivative financial instruments and does not enter into derivative transactions for speculative or trading purposes and, accordingly, accounts for its Swaps as cash flow hedges.  The Company’s Swaps have the effect of modifying the interest rate repricing characteristics of the Company’s repurchase agreements and cash flows for such liabilities.  No cost is incurred at the inception of a Swap, pursuant to which the Company agrees to pay a fixed rate of interest and receive a variable interest rate, generally based on one-month or three-month London Interbank Offered Rate (“LIBOR”), on the notional amount of the Swap.  The Company documents its risk-management policies, including objectives and strategies, as they relate to its hedging activities and the relationship between the hedging instrument and the hedged liability.  The Company assesses, both at inception of a hedge and on a quarterly basis thereafter, whether or not the hedge is “highly effective.”

 

The Company discontinues hedge accounting on a prospective basis and recognizes changes in the fair value through earnings when:  (i) it is determined that the derivative is no longer effective in offsetting cash flows of a hedged item (including forecasted transactions); (ii) it is no longer probable that the forecasted transaction will occur; or (iii) it is determined that designating the derivative as a hedge is no longer appropriate.

 

Swaps are carried on the Company’s balance sheet at fair value, as assets, if their fair value is positive, or as liabilities, if their fair value is negative.  Changes in the fair value of the Company’s Swaps are recorded in other comprehensive income provided that the hedge remains effective.  A change in fair value for any ineffective amount of a Swap would be recognized in earnings.  The Company has not recognized any change in the value of its existing Swaps through earnings as a result of hedge ineffectiveness, except that all gains and losses realized on Swaps that were terminated early were recognized, as the borrowings that such Swaps hedged were repaid.

 

Although permitted under certain circumstances, the Company does not offset cash collateral receivables or payables against its net derivative positions.  (See Notes 4 and 13)

 

Non-Hedging Activity/Linked Transactions

 

It is presumed that the initial transfer of a financial asset (i.e., the purchase of an MBS by the Company) and contemporaneous repurchase financing of such MBS with the same counterparty are considered part of the same arrangement, or a “linked transaction.”  The two components of a linked transaction (MBS purchase and repurchase financing) are not reported separately but are evaluated on a combined basis and reported as a forward (derivative) contract and are presented as “Linked Transactions” on the Company’s consolidated balance sheet.  Changes in the fair value of the assets and liabilities underlying Linked Transactions and associated interest income and expense are reported as “unrealized net gains and net interest income from Linked Transactions” on the Company’s consolidated statements of operations and are not included in other comprehensive income.  However, if certain criteria are met, the initial transfer (i.e., the purchase of a security by the Company) and repurchase financing will not be treated as a linked transaction and will be evaluated and reported separately, as an MBS purchase and repurchase financing.  When or if a transaction is no longer considered to be linked, the MBS and repurchase financing will be reported on a gross basis.  In this case, the fair value of the MBS at the time the transactions are no longer considered linked will become the cost basis of the MBS, and the income recognition yield for such MBS will be calculated prospectively using this new cost basis.  (See Notes 4 and 13)

 

(n)  Fair Value Measurements and the Fair Value Option for Financial Assets and Financial Liabilities

 

The Company’s presentation of fair value for its financial assets and liabilities is determined within a framework that stipulates that the fair value of a financial asset or liability is an exchange price in an orderly

 

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Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability.  The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability.  This definition of fair value is based on a consistent definition of fair value which focuses on exit price and prioritizes the use of market-based inputs over entity-specific inputs when determining fair value.  In addition, the framework for measuring fair value establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.  (See Note 13)

 

Although permitted under GAAP to measure many financial instruments and certain other items at fair value, the Company has not elected the fair value option for any of its assets or liabilities.  If the fair value option is elected, unrealized gains and losses on such items for which fair value is elected would be recognized in earnings at each subsequent reporting date.  A decision to elect the fair value option for an eligible financial instrument, which may be made on an instrument by instrument basis, is irrevocable.

 

(o)  Variable Interest Entities

 

An entity is referred to as a VIE if it meets at least one of the following criteria:  (1) the entity has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support of other parties; or (2) as a group, the holders of the equity investment at risk lack (a) the power to direct the activities of a entity that most significantly impact the entity’s economic performance; (b) the obligation to absorb the expected losses; or (c) the right to receive the expected residual returns; or (3) have disproportional voting rights and the entity’s activities are conducted on behalf of the investor that has disproportionally few voting rights.

 

The Company consolidates a VIE when it has both the power to direct the activities that most significantly impact the economic performance of the VIE and a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE.   The Company is required to reconsider its evaluation of whether to consolidate a VIE each reporting period, based upon changes in the facts and circumstances pertaining to the VIE.

 

The Company has entered into resecuritization transactions which result in the Company consolidating the VIEs that were created to facilitate the transactions and to which the underlying assets in connection with the resecuritizations were transferred.  In determining the accounting treatment to be applied to these resecuritization transactions, the Company evaluated whether the entities used to facilitate these transactions were VIEs and, if so, whether they should be consolidated.  Based on its evaluation, the Company concluded that the VIEs should be consolidated.  If the Company had determined that consolidation was not required, it would have then assessed whether the transfer of the underlying assets would qualify as a sale or should be accounted for as secured financings under GAAP.

 

Prior to the completion of its initial resecuritization transaction in October 2010, the Company had not transferred assets to VIEs or Qualifying Special Purpose Entities (“QSPEs”) and other than acquiring MBS issued by such entities, had no other involvement with VIEs or QSPEs.  (See Note 14)

 

(p)  New and Proposed Accounting Standards and Interpretations

 

Fair Value

 

For fiscal years beginning after December 15, 2010 (and for interim periods within those fiscal years), Accounting Standards Update (“ASU”) 2010-06 requires separate disclosure of purchases, sales, issuances, and settlements in the Level 3 roll-forward.  The Company’s adoption of the additional disclosure provisions of ASU 2010-06 beginning on January 1, 2011 did not have an impact on its consolidated financial statements.

 

Proposed Accounting Standards

 

The Financial Accounting Standards Board has recently issued or discussed a number of proposed standards on such topics as consolidation, financial statement presentation, revenue recognition, leases, financial instruments, hedging, contingencies, measurement of credit impairment and fair value measurement.  Some of the proposed changes are potentially significant and could have a material impact on the Company’s reporting.  The Company has not yet fully evaluated the potential impact of these proposals but will make such an evaluation as the standards are finalized.

 

(q)  Reclassifications

 

Certain prior period amounts have been reclassified to conform to the current period presentation.

 

11



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

3.                   MBS

 

The Company’s MBS are comprised of Agency MBS and Non-Agency MBS.  These MBS are secured by:  (i) hybrid mortgages (“Hybrids”), which have interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index; (ii) adjustable-rate mortgages (“ARMs”); (iii) mortgages that have interest rates that reset more frequently (“Floaters”) (collectively, “ARM-MBS”); and (iv) 15-year and longer-term fixed rate mortgages.  MBS do not have a single maturity date, and further, the mortgage loans underlying ARM-MBS do not all reset at the same time.

 

The Company pledges a significant portion of its MBS as collateral against its borrowings under repurchase agreements and Swaps.  Non-Agency MBS that are accounted for as components of Linked Transactions are not reflected in the tables set forth in this note.  (See Notes 4 and 8)

 

Agency MBS:  Agency MBS are guaranteed as to principal and/or interest by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae, and, as such, carry an implied AAA rating.  The payment of principal and/or interest on Ginnie Mae MBS is backed by the full faith and credit of the U.S. Government.  Since the third quarter of 2008, Fannie Mae and Freddie Mac have been under the conservatorship of the Federal Housing Finance Agency, which significantly strengthened the backing for these government-sponsored entities.

 

Non-Agency MBS (including Non-Agency MBS transferred to VIEs):  The Company’s Non-Agency MBS are secured by pools of residential mortgages, which are not guaranteed by an agency of U.S. Government or any federally chartered corporation.  Non-Agency MBS may be rated by one or more Rating Agencies or may be unrated (i.e., not assigned a rating by any Rating Agency).  The rating indicates the opinion of the Rating Agency as to the creditworthiness of the investment, indicating the obligor’s ability to meet its full financial commitment on the obligation.  A rating of “D” is assigned when a security has defaulted on any of its contractual terms.  The Company’s Non-Agency MBS are primarily comprised of the senior-most tranches from the MBS structure.  Within the Company’s Non-Agency MBS portfolio are securities that were purchased beginning in late 2008 at discounts to par and, to a lesser extent, Non-Agency MBS that were purchased at or near par by the Company prior to July 2007.

 

The following tables present certain information about the Company’s MBS at March 31, 2011 and December 31, 2010:

 

March 31, 2011

 

 

 

 

 

 

 

 

 

Discount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Designated

 

 

 

 

 

 

 

 

 

 

 

 

 

Principal/

 

 

 

Accretable

 

as Credit

 

 

 

Carrying

 

Gross

 

Gross

 

Net

 

 

 

Current

 

Purchase

 

Purchase

 

Reserve

 

Amortized

 

Value/

 

Unrealized

 

Unrealized

 

Unrealized

 

(In Thousands)

 

Face

 

Premiums

 

Discounts

 

and OTTI (1)

 

Cost (2)

 

Fair Value

 

Gains

 

Losses

 

Gain/(Loss)

 

Agency MBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fannie Mae

 

$

6,162,458

 

$

136,133

 

$

(182

)

$

 

$

6,298,409

 

$

6,442,019

 

$

150,327

 

$

(6,717

)

$

143,610

 

Freddie Mac

 

870,924

 

25,013

 

 

 

904,670

 

914,554

 

12,996

 

(3,112

)

9,884

 

Ginnie Mae

 

17,267

 

300

 

 

 

17,567

 

17,937

 

370

 

 

370

 

Total Agency MBS

 

7,050,649

 

161,446

 

(182

)

 

7,220,646

 

7,374,510

 

163,693

 

(9,829

)

153,864

 

Non-Agency MBS (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rated AAA

 

13,500

 

270

 

 

 

13,770

 

13,770

 

 

 

 

Rated AA

 

30,018

 

860

 

 

 

30,878

 

27,870

 

 

(3,008

)

(3,008

)

Rated A

 

25,320

 

61

 

(5,828

)

(1,422

)

18,131

 

22,229

 

4,667

 

(569

)

4,098

 

Rated BBB

 

99,077

 

7

 

(6,447

)

(3,423

)

89,214

 

89,083

 

703

 

(834

)

(131

)

Rated BB

 

66,936

 

29

 

(5,981

)

(2,629

)

58,355

 

59,386

 

1,287

 

(256

)

1,031

 

Rated B

 

268,425

 

19

 

(18,672

)

(15,079

)

234,693

 

246,780

 

13,851

 

(1,764

)

12,087

 

Rated CCC

 

1,131,790

 

 

(69,132

)

(242,125

)

820,533

 

887,929

 

73,936

 

(6,540

)

67,396

 

Rated CC

 

873,896

 

 

(42,530

)

(212,151

)

619,215

 

679,950

 

63,492

 

(2,757

)

60,735

 

Rated C

 

1,241,170

 

 

(52,931

)

(325,022

)

863,217

 

947,496

 

91,593

 

(7,314

)

84,279

 

Unrated and D-rated (4)

 

360,919

 

 

(12,404

)

(144,002

)

204,513

 

227,347

 

25,621

 

(2,787

)

22,834

 

Total Non-Agency MBS

 

4,111,051

 

1,246

 

(213,925

)

(945,853

)

2,952,519

 

3,201,840

 

275,150

 

(25,829

)

249,321

 

Total MBS

 

$

11,161,700

 

$

162,692

 

$

(214,107

)

$

(945,853

)

$

10,173,165

 

$

10,576,350

 

$

438,843

 

$

(35,658

)

$

403,185

 

 

(footnotes follow next table)

 

12



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

December 31, 2010

 

 

 

 

 

 

 

 

 

Discount

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Designated

 

 

 

 

 

 

 

 

 

 

 

 

 

Principal/

 

 

 

Accretable

 

as Credit

 

 

 

Carrying

 

Gross

 

Gross

 

Net

 

 

 

Current

 

Purchase

 

Purchase

 

Reserve

 

Amortized

 

Value/

 

Unrealized

 

Unrealized

 

Unrealized

 

(In Thousands)

 

Face

 

Premiums

 

Discounts

 

and OTTI (1)

 

Cost (2)

 

Fair Value

 

Gains

 

Losses

 

Gain/(Loss)

 

Agency MBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fannie Mae

 

$

5,083,076

 

$

88,654

 

$

(210

)

$

 

$

5,171,520

 

$

5,323,475

 

$

157,365

 

$

(5,410

)

$

151,955

 

Freddie Mac

 

602,921

 

16,171

 

 

 

628,355

 

638,582

 

12,744

 

(2,517

)

10,227

 

Ginnie Mae

 

17,830

 

311

 

 

 

18,141

 

18,566

 

425

 

 

425

 

Total Agency MBS

 

5,703,827

 

105,136

 

(210

)

 

5,818,016

 

5,980,623

 

170,534

 

(7,927

)

162,607

 

Non-Agency MBS (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rated AAA

 

2,157

 

52

 

 

 

2,209

 

1,994

 

 

(215

)

(215

)

Rated AA

 

33,257

 

905

 

(446

)

 

33,716

 

30,805

 

334

 

(3,245

)

(2,911

)

Rated A

 

26,761

 

43

 

(6,441

)

(1,632

)

18,731

 

22,968

 

4,773

 

(536

)

4,237

 

Rated BBB

 

44,313

 

27

 

(2,329

)

(840

)

41,171

 

39,468

 

438

 

(2,141

)

(1,703

)

Rated BB

 

44,305

 

 

(3,671

)

(2,250

)

38,384

 

42,441

 

4,057

 

 

4,057

 

Rated B

 

93,552

 

 

(15,108

)

(7,173

)

71,271

 

80,976

 

9,753

 

(48

)

9,705

 

Rated CCC

 

764,579

 

 

(69,899

)

(192,503

)

502,177

 

565,043

 

67,382

 

(4,516

)

62,866

 

Rated CC

 

620,114

 

 

(54,361

)

(196,106

)

369,647

 

432,542

 

63,179

 

(284

)

62,895

 

Rated C

 

1,004,627

 

 

(60,308

)

(281,070

)

663,249

 

745,292

 

88,388

 

(6,345

)

82,043

 

Unrated and D-rated (4)

 

187,824

 

 

(16,403

)

(65,104

)

106,317

 

116,558

 

13,131

 

(2,890

)

10,241

 

Total Non-Agency MBS

 

2,821,489

 

1,027

 

(228,966

)

(746,678

)

1,846,872

 

2,078,087

 

251,435

 

(20,220

)

231,215

 

Total MBS

 

$

8,525,316

 

$

106,163

 

$

(229,176

)

$

(746,678

)

$

7,664,888

 

$

8,058,710

 

$

421,969

 

$

(28,147

)

$

393,822

 

 


(1)  Discount designated as Credit Reserve and amounts related to other-than-temporary impairments (“OTTI”) are generally not expected to be accreted into interest income.  Amounts disclosed at March  31, 2011 reflect Credit Reserve of $899.9 million and OTTI of $46.0 million.  Amounts disclosed at December 31, 2010 reflect Credit Reserve of $700.3 million and OTTI of $46.4 million.

(2)  Includes principal payments receivable of $8.7 million and $9.3 million at March 31, 2011 and December 31, 2010, respectively, which are not included in the Principal/Current Face.

(3)  Non-Agency MBS, including Non-Agency MBS transferred to consolidated VIEs, are reported based on the lowest rating issued by a Rating Agency, if more than one rating is issued on the security, at the date presented.

(4)  Includes 22 Non-Agency MBS that were D-rated and had an aggregate amortized cost and fair value of $190.8 million and $210.1 million, respectively, at March 31, 2011 and 13 Non-Agency MBS that were D-rated and had an aggregate amortized cost and fair value of $98.6 million and $105.9 million, respectively, at December 31, 2010.

 

The table below presents the repricing characteristics of mortgages underlying the Company’s MBS portfolio as of March 31, 2011:

 

 

 

March 31, 2011

 

Underlying Mortgages

 

Agency MBS

 

Non-Agency MBS

 

Total

 

Percent

 

(In Thousands)

 

Fair Value (1)

 

Fair Value (2)

 

MBS (1)

 

of Total

 

Hybrids in contractual fixed-rate period

 

$

4,841,004

 

$

1,577,664

 

$

6,418,668

 

60.75

%

Hybrids in adjustable period

 

645,267

 

728,914

 

1,374,181

 

13.00

 

15-year fixed rate

 

1,709,780

 

43

 

1,709,823

 

16.18

 

Greater than 15-year to 25-year fixed rate

 

 

2,413

 

2,413

 

0.02

 

30-year to 40-year fixed rate

 

 

791,669

 

791,669

 

7.49

 

Floaters

 

169,727

 

101,137

 

270,864

 

2.56

 

Total

 

$

7,365,778

 

$

3,201,840

 

$

10,567,618

 

100.00

%

 


(1)  Does not include principal receivable of $8.7 million.

(2)  Does not reflect $406.4 million of Non-Agency MBS underlying the Company’s Linked Transactions.

 

13



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

Unrealized Losses on MBS and Impairments

 

The following table presents information about the Company’s MBS that were in an unrealized loss position at March 31, 2011:

 

Unrealized Loss Position For:

 

 

 

Less than 12 Months

 

12 Months or more

 

Total

 

 

 

Fair

 

Unrealized

 

Number of

 

Fair

 

Unrealized

 

Number of

 

Fair

 

Unrealized

 

(In Thousands)

 

Value

 

Losses

 

Securities

 

Value

 

Losses

 

Securities

 

Value

 

Losses

 

Agency MBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fannie Mae

 

$

1,088,520

 

$

4,954

 

54

 

$

173,365

 

$

1,763

 

17

 

$

1,261,885

 

$

6,717

 

Freddie Mac

 

376,932

 

2,971

 

29

 

3,056

 

141

 

1

 

379,988

 

3,112

 

Total Agency MBS

 

1,465,452

 

7,925

 

83

 

176,421

 

1,904

 

18

 

1,641,873

 

9,829

 

Non-Agency MBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rated AA

 

 

 

 

27,870

 

3,008

 

3

 

27,870

 

3,008

 

Rated A

 

5,019

 

18

 

1

 

2,513

 

551

 

3

 

7,532

 

569

 

Rated BBB

 

37,142

 

494

 

4

 

10,761

 

340

 

1

 

47,903

 

834

 

Rated BB

 

10,485

 

117

 

2

 

1,260

 

139

 

1

 

11,745

 

256

 

Rated B

 

85,972

 

215

 

6

 

9,195

 

1,549

 

2

 

95,167

 

1,764

 

Rated CCC

 

295,891

 

2,656

 

13

 

24,050

 

3,884

 

4

 

319,941

 

6,540

 

Rated CC

 

283,470

 

2,757

 

14

 

 

 

 

283,470

 

2,757

 

Rated C

 

254,260

 

3,762

 

11

 

95,049

 

3,552

 

2

 

349,309

 

7,314

 

Unrated and other

 

49,991

 

509

 

2

 

21,458

 

2,278

 

2

 

71,449

 

2,787

 

Total Non-Agency MBS

 

1,022,230

 

10,528

 

53

 

192,156

 

15,301

 

18

 

1,214,386

 

25,829

 

Total MBS

 

$

2,487,682

 

$

18,453

 

136

 

$

368,577

 

$

17,205

 

36

 

$

2,856,259

 

$

35,658

 

 

At March 31, 2011, the Company did not intend to sell any of its MBS that were in an unrealized loss position, and it is “more likely than not” that the Company will not be required to sell these MBS before recovery of their amortized cost basis, which may be at their maturity.  With respect to Non-Agency MBS held by consolidated VIEs, the ability of any entity to cause the sale of such assets by the VIE prior to the maturity of these Non-Agency MBS is either specifically precluded, or is limited to specified events of default, none of which have occurred to date.

 

Gross unrealized losses on the Company’s Agency MBS were $9.8 million at March 31, 2011.  Given the credit quality inherent in Agency MBS, the Company does not consider any of the current impairments on its Agency MBS to be credit related.  In assessing whether it is “more likely than not” that it will be required to sell any impaired security before its anticipated recovery, which may be at their maturity, the Company considers the significance of each investment, the amount of impairment, the projected future performance of such impaired securities, as well as the Company’s current and anticipated leverage capacity and liquidity position.  Based on these analyses, the Company determined that at March 31, 2011 any unrealized losses on its Agency MBS were temporary.

 

Unrealized losses on the Company’s Non-Agency MBS (including Non-Agency MBS transferred to consolidated VIEs) were $25.8 million at March 31, 2011.  The Company does not consider these unrealized losses to be credit related, but are rather due to non-credit related factors, including a widening of interest rate spreads relative to the spreads that existed when such assets were acquired and market fluctuations.

 

The Company did not recognize any OTTI losses in earnings during the three month periods ended March 31, 2011 or 2010.

 

MBS on which OTTI is recognized have experienced, or are expected to experience, adverse cash flow changes.  The Company’s estimation of cash flows for its Non-Agency MBS is based on its review of the underlying mortgage loans securing these MBS.  The Company considers information available about the structure of the securitization, including structural credit enhancement, if any, and the performance of underlying mortgage loans, including prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing, FICO scores at loan origination, year of origination, loan-to-value ratios, geographic concentrations, as well as Rating Agency reports, general market assessments, and dialogue with market participants.  Significant judgment is used in both the Company’s analysis of the expected cash flows for its MBS and any determination of the credit component of OTTI.

 

14



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

The following table presents the impact on accumulated other comprehensive income of the Company’s MBS for the quarters ended March 31, 2011 and 2010:

 

 

 

Three Months Ended

 

 

 

March 31,

 

(In Thousands)

 

2011

 

2010

 

Accumulated other comprehensive income from MBS:

 

 

 

 

 

Unrealized gain on MBS at beginning of period

 

$

393,822

 

$

339,470

 

Unrealized gain on MBS, net

 

9,363

 

38,059

 

Reclassification adjustment for MBS sales included in net income

 

 

(41,459

)

Balance at end of period

 

$

403,185

 

$

336,070

 

 

Purchase Discounts on Non-Agency MBS

 

The following table presents the changes in the components of the Company’s purchase discount on its Non-Agency MBS between purchase discount designated as Credit Reserve and accretable purchase discount for the three months ended March 31, 2011 and March 31, 2010:

 

 

 

Three Months Ended

 

Three Months Ended

 

 

 

March 31, 2011

 

March 31, 2010

 

 

 

Discount

 

 

 

Discount

 

 

 

 

 

Designated as

 

Accretable

 

Designated as

 

Accretable

 

(In Thousands)

 

Credit Reserve (1)

 

Discount (1)

 

Credit Reserve (2)

 

Discount (2)

 

Balance at beginning of period

 

$

(700,328

)

$

(228,966

)

$

(455,004

)

$

(149,319

)

Accretion of discount, net

 

 

10,161

 

 

8,659

 

Realized credit losses

 

2,976

 

 

48

 

 

Purchases

 

(154,943

)

11,726

 

(91,330

)

(1,661

)

Sales

 

 

 

7,856

 

683

 

Unlinking of Linked Transactions

 

(51,423

)

(3,030

)

(1,272

)

(2,039

)

Transfers from/(to) (3)

 

3,816

 

(3,816

)

1,943

 

(1,943

)

Balance at end of period

 

$

(899,902

)

$

(213,925

)

$

(537,759

)

$

(145,620

)

 


(1)  In addition, the Company reallocated $1.2 million of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the three months ended March 31, 2011.

(2)  The Company did not reallocate purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the three months ended March 31, 2010.

(3)  Together with coupon interest, accretable purchase discount is recognized as interest income over the life of the security.  Therefore, the Company expects that the amounts transferred to accretable purchase discount will be reflected in interest income over the life of the Non-Agency MBS.

 

Sales of MBS

 

The Company did not sell any MBS during the three months ended March 31, 2011.  During the three months ended March 31, 2010, the Company sold $931.9 million of Agency MBS, realizing gross gains of $33.1 million, and sold one Non-Agency MBS for $7.2 million, realizing a gain of $654,000.  The Company has no continuing involvement with the MBS sold.

 

MBS Interest Income

 

The following table presents components of interest income on the Company’s Agency MBS for the three months ended March 31, 2011 and 2010:

 

 

 

Three Months Ended March 31,

 

(In Thousands)

 

2011

 

2010

 

Coupon interest

 

$

67,707

 

$

86,829

 

Effective yield adjustment (1)

 

(7,532

)

(8,150

)

Agency MBS interest income

 

$

60,175

 

$

78,679

 

 


(1)  Includes amortization of premium paid net of accretion of purchase discount.  For Agency MBS, interest income is recorded at an effective yield, which reflects net premium amortization and discount accretion based on actual prepayment activity.

 

15



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

The following table presents components of interest income for the Company’s Non-Agency MBS (including MBS transferred to consolidated VIEs) for the three months ended March 31, 2011 and 2010:

 

 

 

Three Months Ended March 31,

 

(In Thousands)

 

2011

 

2010

 

Coupon interest

 

$

39,537

 

$

20,330

 

Effective yield adjustment (1)

 

10,112

 

8,635

 

Non-Agency MBS interest income

 

$

49,649

 

$

28,965

 

 


(1)  The effective yield adjustment is the difference between the net income calculated using the net yield, which is based on management’s estimates of future cash flows for Non-Agency MBS, less the current coupon yield.

 

4.      Derivatives

 

The Company’s derivatives are comprised of Swaps, which are designated as cash flow hedges against the interest rate risk associated with its borrowings, and Linked Transactions, which are not designated as hedging instruments.  The following table presents the fair value of the Company’s derivative instruments and their balance sheet location at March 31, 2011 and December 31, 2010:

 

Derivative Instrument

 

 

 

Balance Sheet

 

March 31,

 

December 31,

 

(In Thousands)

 

Designation

 

Location

 

2011

 

2010

 

Swaps, at fair value

 

Hedging

 

Assets

 

$

2,862

 

$

 

Linked Transactions, at fair value

 

Non-Hedging

 

Assets

 

$

103,855

 

$

179,915

 

Swaps, at fair value

 

Hedging

 

Liabilities

 

$

(116,333

)

$

(139,142

)

 

The Company’s Linked Transactions are evaluated on a combined basis, reported as a forward (derivative) instrument and are reported as assets on the Company’s consolidated balance sheets at fair value.  The fair value of Linked Transactions reflect the value of the underlying Non-Agency MBS, linked repurchase agreement borrowings and accrued interest receivable/payable on such instruments.  The Company’s Linked Transactions are not designated as hedging instruments and, as a result, the change in the fair value of Linked Transactions is reported as a net gain or loss in Other Income in the Company’s consolidated statements of operations.

 

The following tables present certain information about the Non-Agency MBS and repurchase agreements underlying the Company’s Linked Transactions at March 31, 2011 and December 31, 2010:

 

Linked Transactions at March 31, 2011

 

Linked Repurchase Agreements

 

 

 

 

 

Weighted

 

Maturity or Repricing

 

 

 

Average

 

(Dollars in Thousands)

 

Balance

 

Interest Rate

 

Within 30 days

 

$

252,959

 

1.62

%

>30 days to 90 days

 

51,169

 

1.62

 

Total

 

$

304,128

 

1.62

%

 

Linked MBS

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

Average

 

Non-Agency MBS

 

 

 

Amortized

 

Par/Current

 

Coupon

 

(Dollars in Thousands)

 

Fair Value

 

Cost

 

Face

 

 Rate

 

Rated AAA

 

$

32,242

 

$

31,933

 

$

32,935

 

3.36

%

Rated AA

 

21,179

 

20,276

 

20,764

 

5.00

 

Rated A

 

3,135

 

2,916

 

4,019

 

2.15

 

Rated BBB

 

33,469

 

31,195

 

36,504

 

3.11

 

Rated B

 

22,420

 

21,931

 

26,282

 

2.76

 

Rated CCC

 

117,671

 

114,801

 

141,897

 

4.54

 

Rated CC

 

63,489

 

63,238

 

81,102

 

5.14

 

Rated C

 

112,788

 

111,941

 

138,983

 

5.80

 

Total

 

$

406,393

 

$

398,231

 

$

482,486

 

4.72

%

 

16



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

Linked Transactions at December 31, 2010

 

Linked Repurchase Agreements

 

Maturity or Repricing
(Dollars in Thousands)

 

Balance

 

Weighted
Average
Interest Rate

 

Within 30 days

 

$

289,522

 

1.62

%

>30 days to 90 days

 

277,765

 

1.62

 

Total

 

$

567,287

 

1.62

%

 

Linked MBS

 

Non-Agency MBS
(Dollars in Thousands)

 

Fair Value

 

Amortized
Cost

 

Par/Current
Face

 

Weighted
Average
Coupon
Rate

 

Rated AAA

 

$

46,710

 

$

46,367

 

$

47,151

 

4.13

%

Rated AA

 

57,634

 

54,176

 

61,389

 

3.51

 

Rated A

 

36,440

 

34,620

 

41,984

 

2.53

 

Rated BBB

 

69,397

 

66,848

 

78,741

 

3.38

 

Rated BB

 

14,536

 

14,456

 

17,513

 

2.51

 

Rated B

 

129,962

 

121,198

 

139,763

 

4.28

 

Rated CCC

 

216,398

 

211,302

 

255,667

 

4.98

 

Rated CC

 

89,833

 

86,509

 

110,518

 

5.45

 

Rated C

 

78,181

 

78,038

 

100,204

 

5.77

 

Unrated

 

5,278

 

5,220

 

10,350

 

6.00

 

Total

 

$

744,369

 

$

718,734

 

$

863,280

 

4.56

%

 

The following table presents certain information about the components of the unrealized net gains and net

interest income from Linked Transactions included in the Company’s consolidated statements of operations for the quarterly periods ended March 31, 2011 and 2010:

 

Components of Unrealized Net Gains and Net Interest Income
from Linked Transactions

 

Three Months Ended March 31,

 

(In Thousands)

 

2011

 

2010

 

Interest income attributable to MBS underlying Linked Transactions

 

$

9,437

 

$

7,003

 

Interest expense attributable to repurchase agreement borrowings underlying Linked Transactions

 

(1,766

)

(1,268

)

Change in fair value of Linked Transactions included in earnings

 

7,179

 

7,065

 

Unrealized net gains and net interest income from Linked Transactions

 

$

14,850

 

$

12,800

 

 

Swaps

 

Consistent with market practice, the Company has agreements with its Swap counterparties that provide for the posting of collateral based on the fair values of its derivative contracts.  Through this margining process, either the Company or its Swap counterparty may be required to pledge cash or securities as collateral.  Collateral requirements vary by counterparty and change over time based on the market value, notional amount and remaining term of the Swap.  Certain Swaps provide for cross collateralization with repurchase agreements with the same counterparty.

 

A number of the Company’s Swaps include financial covenants, which, if breached, could cause an event of default or early termination event to occur under such agreements.  If the Company were to cause an event of default or trigger an early termination event pursuant to one of its Swaps, the counterparty to such agreement may have the option to terminate all of its outstanding Swaps with the Company and, if applicable, any close-out amount due to the counterparty upon termination of the Swaps would be immediately payable by the Company.  The Company was in compliance with all of its financial covenants through March 31, 2011.  At March 31, 2011, the aggregate fair value of assets needed to immediately settle Swaps that were in a liability position to the Company, if so required, was approximately $116.3 million.

 

17



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

The following table presents the assets pledged as collateral against the Company’s Swaps at March 31, 2011 and December 31, 2010:

 

(In Thousands)

 

March 31, 2011

 

December 31, 2010

 

Agency MBS, at fair value

 

$

144,306

 

$

153,534

 

Restricted cash

 

33,898

 

35,083

 

Total assets pledged against Swaps

 

$

178,204

 

$

188,617

 

 

The use of hedging instruments exposes the Company to counterparty credit risk.  In the event of a default by a Swap counterparty, the Company may not receive payments to which it is entitled under its Swap agreements, and may have difficulty recovering its assets pledged as collateral against such Swaps.  If, during the term of the Swap, a counterparty should file for bankruptcy, the Company may experience difficulty recovering its assets pledged as collateral which could result in the Company having an unsecured claim against such counterparty’s assets for the difference between the fair value of the Swap and the fair value of the collateral pledged to such counterparty.  At March 31, 2011, all of the Company’s Swap counterparties were rated A or better by a Rating Agency.  At March 31, 2011, the Company had Swaps with an aggregate notional balance of $2.645 billion that were in a liability position and $375.0 million that were in an asset position.

 

The Company’s Swaps, or a portion thereof, could become ineffective in the future if the associated repurchase agreements that such Swaps hedge fail to exist or fail to have terms that match those of the Swaps that hedge such borrowings.  At March 31, 2011, all of the Company’s Swaps were deemed effective for hedging purposes and no Swaps were terminated during the three months ended March 31, 2011 and March 31, 2010.  The Company has not recognized any change in the value of its Swaps in earnings as a result of the hedge or a portion thereof being ineffective during the three months ended March 31, 2011 and March 31, 2010.

 

The following table presents the net impact of the Company’s Swaps on its interest expense and the weighted average interest rate paid and received for such Swaps for the three months ended March 31, 2011 and 2010:

 

 

 

Three Months Ended

 

 

 

March 31,

 

(Dollars in Thousands)

 

2011

 

2010

 

Interest expense attributable to Swaps

 

$

24,034

 

$

29,134

 

Weighted average Swap rate paid

 

3.67

%

4.24

%

Weighted average Swap rate received

 

0.27

%

0.24

%

 

18



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2011

 

At March 31, 2011, the Company had Swaps with an aggregate notional amount of $3.020 billion, which had gross unrealized losses of $116.3 million, gross unrealized gains of $2.9 million and extended 26 months on average with a maximum term of approximately 59 months.  During the three months ended March 31, 2011, the Company entered into Swaps with an aggregate notional amount of $430.0 million and had Swaps with an aggregate notional amount of $215.9 million expire.  The following table presents information about the Company’s Swaps at March 31, 2011 and December 31, 2010:

 

 

 

March 31, 2011

 

December 31, 2010

 

Maturity (1)
(Dollars in Thousands)

 

Notional
Amount

 

Weighted
Average
Fixed-Pay
Interest Rate

 

Weighted
Average Variable
Interest Rate (2)

 

Notional
Amount

 

Weighted
Average
Fixed-Pay
Interest Rate

 

Weighted
Average Variable
Interest Rate (2)

 

Within 30 days

 

$

40,767

 

3.98

%

0.28

%

$

55,267

 

3.90

%

0.28

%

Over 30 days to 3 months

 

128,491

 

4.03

 

0.28

 

160,589

 

4.35

 

0.27

 

Over 3 months to 6 months

 

131,383

 

4.05