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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 June 30, 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

 

13-3974868

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

350 Park Avenue, 20th Floor, New York, New York

 

10022

(Address of principal executive offices)

 

(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

 

356,174,038 shares of the registrant’s common stock, $0.01 par value, were outstanding as of July 29, 2011.

 

 

 



Table of Contents

 

 

TABLE OF CONTENTS

 

 

 

 

 

 

Page

 

 

 

 

PART I

 

 

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Consolidated Balance Sheets as of June 30, 2011
(Unaudited) and December 31, 2010

1

 

 

 

 

Consolidated Statements of Operations (Unaudited) for the
Three and Six Months Ended June 30, 2011 and June 30, 2010

2

 

 

 

 

Consolidated Statements of Comprehensive (Loss)/Income (Unaudited) for the
Three and Six Months Ended June 30, 2011 and June 30, 2010

3

 

 

 

 

Consolidated Statement of Changes in Stockholders’ Equity (Unaudited)
for the Six Months Ended June 30, 2011

4

 

 

 

 

Consolidated Statements of Cash Flows (Unaudited) for the
Six Months Ended June 30, 2011 and June 30, 2010

5

 

 

 

 

Notes to the Unaudited Consolidated Financial Statements

6

 

 

 

Item 2.

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

36

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

54

 

 

 

Item 4.

Controls and Procedures

61

 

 

 

 

PART II

 

 

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

62

 

 

 

Item 1A.

Risk Factors

62

 

 

 

Item 6.

Exhibits

62

 

 

 

Signatures

65

 



Table of Contents

 

MFA FINANCIAL, INC.

CONSOLIDATED BALANCE SHEETS

 

(In Thousands, Except Per Share Amounts)

 

June 30,
2011

 

December 31,
2010

 

 

 

(Unaudited)

 

 

 

Assets:

 

 

 

 

 

Mortgage-backed securities (“MBS”):

 

 

 

 

 

Agency MBS, at fair value ($6,777,305 and $5,519,879 pledged as collateral, respectively)

 

$

7,295,275

 

$

5,980,623

 

Non-Agency MBS, at fair value ($903,119 and $867,655 pledged as collateral, respectively)

 

1,337,967

 

1,372,383

 

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

 

2,626,312

 

705,704

 

Cash and cash equivalents

 

503,228

 

345,243

 

Restricted cash

 

22,993

 

41,927

 

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

 

60,022

 

179,915

 

Interest receivable

 

46,648

 

38,215

 

Derivative hedging instruments, at fair value

 

1,843

 

 

Real estate held-for-sale as of June 30, 2011, net

 

10,642

 

10,732

 

Goodwill

 

7,189

 

7,189

 

Prepaid and other assets

 

14,935

 

5,476

 

Total Assets

 

$

11,927,054

 

$

8,687,407

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

Repurchase agreements

 

$

7,870,251

 

$

5,992,269

 

Securitized debt (2)

 

1,062,040

 

220,933

 

Accrued interest payable

 

7,615

 

8,007

 

Derivative hedging instruments, at fair value

 

125,320

 

139,142

 

Dividends and dividend equivalents rights (“DERs”) payable

 

90,080

 

67,040

 

Accrued expenses and other liabilities

 

15,990

 

9,569

 

Total Liabilities

 

$

9,171,296

 

$

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; 355,459 and 280,481 issued and outstanding, respectively

 

3,554

 

2,805

 

Additional paid-in capital, in excess of par

 

2,791,092

 

2,184,493

 

Accumulated deficit

 

(206,898

)

(191,569

)

Accumulated other comprehensive income

 

167,972

 

254,680

 

Total Stockholders’ Equity

 

$

2,755,758

 

$

2,250,447

 

Total Liabilities and Stockholders’ Equity

 

$

11,927,054

 

$

8,687,407

 

 


(1)  Non-Agency MBS transferred to consolidated VIEs included in the Consolidated Balance Sheet at June 30, 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 June 30, 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

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(In Thousands, Except Per Share Amounts)

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Interest Income:

 

 

 

 

 

 

 

 

 

Agency MBS

 

$

65,982

 

$

54,530

 

$

126,157

 

$

133,209

 

Non-Agency MBS

 

28,825

 

33,985

 

51,719

 

62,950

 

Non-Agency MBS transferred to consolidated VIEs

 

37,275

 

 

64,030

 

 

Cash and cash equivalent investments

 

27

 

112

 

81

 

165

 

Interest Income

 

132,109

 

88,627

 

241,987

 

196,324

 

 

 

 

 

 

 

 

 

 

 

Interest Expense:

 

 

 

 

 

 

 

 

 

Repurchase agreements

 

34,535

 

35,741

 

67,589

 

74,192

 

Securitized debt

 

2,660

 

 

4,259

 

 

Total Interest Expense

 

37,195

 

35,741

 

71,848

 

74,192

 

 

 

 

 

 

 

 

 

 

 

Net Interest Income

 

94,914

 

52,886

 

170,139

 

122,132

 

 

 

 

 

 

 

 

 

 

 

Other-Than-Temporary Impairments:

 

 

 

 

 

 

 

 

 

Total other-than-temporary impairment losses

 

(637

)

(3,370

)

(637

)

(3,370

)

Portion of loss reclassified from other comprehensive income

 

(1,755

)

(2,042

)

(1,755

)

(2,042

)

Net Impairment Losses Recognized in Earnings

 

(2,392

)

(5,412

)

(2,392

)

(5,412

)

 

 

 

 

 

 

 

 

 

 

Other (Loss)/Income, net:

 

 

 

 

 

 

 

 

 

Unrealized net (losses)/gains and net interest income from Linked Transactions

 

(5,613

)

7,197

 

9,237

 

19,997

 

Gains on sale of MBS

 

 

 

 

33,739

 

Revenue from operations of real estate held-for-sale

 

375

 

357

 

756

 

731

 

Loss on termination of repurchase agreements

 

 

 

 

(26,815

)

Other, net

 

12

 

 

12

 

 

Other (Loss)/Income, net

 

(5,226

)

7,554

 

10,005

 

27,652

 

 

 

 

 

 

 

 

 

 

 

Operating and Other Expense:

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

4,991

 

4,053

 

10,114

 

8,421

 

Other general and administrative expense

 

2,789

 

2,139

 

4,950

 

3,992

 

Real estate held-for-sale operating expense, mortgage interest and prepayment penalty

 

230

 

546

 

537

 

992

 

Operating and Other Expense

 

8,010

 

6,738

 

15,601

 

13,405

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

79,286

 

48,290

 

162,151

 

130,967

 

Less: Preferred Stock Dividends

 

2,040

 

2,040

 

4,080

 

4,080

 

Net Income Available to Common Stock and Participating Securities

 

$

77,246

 

$

46,250

 

$

158,071

 

$

126,887

 

 

 

 

 

 

 

 

 

 

 

Earnings per Common Share - Basic and Diluted

 

$

0.22

 

$

0.16

 

$

0.48

 

$

0.45

 

 

 

 

 

 

 

 

 

 

 

Dividends Declared on Common Stock

 

$

0.25

 

$

0.24

 

$

0.49

 

$

0.24

 (1)

 


(1)  A dividend of $0.19 per share for the quarter ended June 30, 2010 was declared on July 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 (LOSS)/INCOME

(UNAUDITED)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(In Thousands)

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

$

79,286

 

$

48,290

 

$

162,151

 

$

130,967

 

Other Comprehensive Income:

 

 

 

 

 

 

 

 

 

Unrealized gain/(loss) on Agency MBS, net

 

46,456

 

5,463

 

37,713

 

(7,746

)

Unrealized (loss)/gain on Non-Agency MBS, net

 

(159,657

)

6,512

 

(141,551

)

57,780

 

Reclassification adjustment for MBS sales

 

 

 

 

(41,459

)

Reclassification adjustment for net losses included in net income for other-than-temporary impairments

 

2,392

 

5,412

 

2,392

 

5,412

 

Unrealized (loss)/gain on derivative hedging instruments, net

 

(10,933

)

(13,929

)

14,738

 

(15,216

)

Comprehensive (loss)/income before preferred dividends

 

$

(42,456

)

$

51,748

 

$

75,443

 

$

129,738

 

Dividends declared on preferred stock

 

(2,040

)

(2,040

)

(4,080

)

(4,080

)

Comprehensive (Loss)/Income Available to Common Stock and Participating Securities

 

$

(44,496

)

$

49,708

 

$

71,363

 

$

125,658

 

 

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)

 

 

 

Six Months Ended

 

 

 

June 30, 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 June 30, 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

 

749

 

74,978

 

Balance at June 30, 2011

 

3,554

 

355,459

 

 

 

 

 

 

 

Additional Paid-in Capital, in excess of Par:

 

 

 

 

 

Balance at December 31, 2010

 

2,184,493

 

 

 

Issuance of common stock, net of expenses

 

604,643

 

 

 

Equity-based compensation expense

 

1,956

 

 

 

Balance at June 30, 2011

 

2,791,092

 

 

 

 

 

 

 

 

 

Accumulated Deficit:

 

 

 

 

 

Balance at December 31, 2010

 

(191,569

)

 

 

Net income

 

162,151

 

 

 

Dividends declared on common stock

 

(172,699

)

 

 

Dividends declared on preferred stock

 

(4,080

)

 

 

Dividends attributable to DERs

 

(701

)

 

 

Balance at June 30, 2011

 

(206,898

)

 

 

 

 

 

 

 

 

Accumulated Other Comprehensive Income:

 

 

 

 

 

Balance at December 31, 2010

 

254,680

 

 

 

Change in unrealized gains on MBS, net

 

(101,446

)

 

 

Change in unrealized losses on derivative hedging instruments

 

14,738

 

 

 

Balance at June 30, 2011

 

167,972

 

 

 

 

 

 

 

 

 

Total Stockholders’ Equity at June 30, 2011

 

$

2,755,758

 

 

 

 

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)

 

 

 

Six Months Ended

 

 

 

June 30,

 

(In Thousands)

 

2011

 

2010

 

 

 

 

 

 

 

Cash Flows From Operating Activities:

 

 

 

 

 

Net income

 

$

162,151

 

$

130,967

 

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

 

Other-than-temporary impairment charges

 

2,392

 

5,412

 

Net (accretion of purchase discounts)/amortization of purchase premiums

 

(6,331

)

6,208

 

(Increase)/decrease in interest receivable

 

(8,433

)

7,134

 

Depreciation and amortization on real estate and other assets

 

901

 

341

 

Unrealized losses/(gains) and other on Linked Transactions

 

1,840

 

(12,028

)

Increase in prepaid and other assets and other

 

(2,952

)

(780

)

Increase/(decrease) in accrued expenses and other liabilities

 

6,421

 

(5,933

)

Decrease in accrued interest payable

 

(392

)

(5,504

)

Equity-based compensation expense

 

1,956

 

1,568

 

Net cash provided by operating activities

 

$

157,553

 

$

120,461

 

 

 

 

 

 

 

Cash Flows From Investing Activities:

 

 

 

 

 

Principal payments on MBS

 

$

1,061,032

 

$

1,886,404

 

Proceeds from sale of MBS

 

 

939,119

 

Purchases of MBS

 

(3,643,387

)

(1,944,922

)

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

 

(1,027

)

(228

)

Net cash (used in)/provided by investing activities

 

$

(2,583,382

)

$

880,373

 

 

 

 

 

 

 

Cash Flows From Financing Activities:

 

 

 

 

 

Principal payments on repurchase agreements

 

$

(27,834,730

)

$

(27,181,964

)

Proceeds from borrowings under repurchase agreements

 

29,666,014

 

26,260,357

 

Proceeds from issuance of securitized debt

 

963,255

 

 

Principal payments on securitized debt

 

(122,148

)

 

Payments to terminate repurchase agreements

 

 

(26,815

)

Payments made for resecuritization related costs

 

(6,981

)

 

Cash disbursements on financial instruments underlying Linked Transactions

 

(1,595,158

)

(542,358

)

Cash received from financial instruments underlying Linked Transactions

 

1,043,911

 

500,237

 

Payments made for margin calls on repurchase agreements and Swaps

 

(5,800

)

(432,205

)

Proceeds from reverse margin calls on repurchase agreements and Swaps

 

25,414

 

456,350

 

Payments made to purchase Swaptions

 

(915

)

 

Proceeds from issuances of common stock

 

605,392

 

273

 

Dividends paid on preferred stock

 

(4,080

)

(4,080

)

Dividends paid on common stock and DERs

 

(150,360

)

(143,403

)

Principal amortization and prepayment on mortgage loan

 

 

(9,143

)

Net cash provided by/(used in) financing activities

 

$

2,583,814

 

$

(1,122,751

)

Net increase/(decrease) in cash and cash equivalents

 

$

157,985

 

$

(121,917

)

Cash and cash equivalents at beginning of period

 

$

345,243

 

$

653,460

 

Cash and cash equivalents at end of period

 

$

503,228

 

$

531,543

 

 

 

 

 

 

 

Non-cash Investing and Financing Activities:

 

 

 

 

 

MBS recorded upon de-linking of Linked Transactions

 

$

715,998

 

$

36,132

 

Repurchase agreements recorded upon de-linking of Linked Transactions

 

$

46,698

 

$

 

Dividends and DERs declared and unpaid

 

$

90,080

 

$

487

 

 

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

 

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Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 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 June 30, 2011 and results of operations for all periods presented have been made.  The results of operations for the six months ended June 30, 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. Although the Company’s estimates contemplate current conditions and how it expects them to change in the future, it is reasonably possible that actual conditions could be worse than anticipated in those estimates, which could materially impact the Company’s results of operations and its financial condition.  Management has made significant estimates in several areas, including other-than-temporary impairment (“OTTI”) on Agency and Non-Agency MBS (Note 3), valuation of Agency and Non-Agency MBS (Notes 3 and 13) and derivative hedging instruments (Notes 4 and 13) and income recognition on certain Non-Agency MBS purchased at a discount (Note 3). 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.  Certain prior period amounts have been reclassified to conform to the current period presentation.

 

(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 OTTI 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

 

6



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 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 OTTI 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 OTTI 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 OTTI 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 OTTI 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. (“Moody’s”), 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 interest rate swaps (“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

JUNE 30, 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 June 30, 2011 or December 31, 2010.  At June 30, 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 $23.0 million and $41.9 million at June 30, 2011 and December 31, 2010, respectively.  (See Notes 4, 7, 8 and 13)

 

(e)  Goodwill

 

At June 30, 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 June 30, 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, February 2011 and June 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

 

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Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 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 EPS 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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MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

 

(k)  Comprehensive Income

 

The Company’s comprehensive income includes net income, the change in net unrealized gains/(losses) on its MBS and its derivative hedging instruments, which are comprised of Swaps and interest rate swaptions (“Swaptions”), (to the extent that such changes are not recorded in earnings), 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, currently comprised of Swaps and Swaptions, and does not enter into derivative transactions for speculative or trading purposes and, accordingly, accounts for its Swaps and Swaptions as hedging instruments.

 

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.

 

Although permitted under certain circumstances, the Company does not offset cash collateral receivables or payables against its net derivative positions.  (See Notes 4, 8 and 13)

 

Swaps

 

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.  Changes in fair value for any ineffective amount of a Swap are 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.

 

Swaptions

 

As part of its strategy to hedge its exposure to increases in interest rates, the Company has purchased Swaptions, which give it the right, but not the obligation, to enter into a Swap at a future date.  Swaptions are carried as assets on the Company’s balance sheet at fair value.  Changes in the intrinsic value of the Swap underlying the Swaption are recorded in other comprehensive income, a component of stockholders’ equity, provided that the hedge remains effective, while changes in the time value of the Swaption are recorded as gains/losses through earnings as a component of other income/loss during the option period.  The Company uses the cumulative dollar-offset ratio to assess the hedge effectiveness of its Swaptions.

 

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,” unless certain criteria are met.  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

 

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MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

 

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 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 an 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.

 

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MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

 

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.

 

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, as they are accounted for as derivatives.  (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.

 

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MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

 

The following tables present certain information about the Company’s MBS at June 30, 2011 and December 31, 2010:

 

June 30, 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

 

$6,070,322

 

$139,199

 

$(164

)

$—

 

$6,209,357

 

$6,391,550

 

$185,436

 

$(3,243

)

$182,193

 

Freddie Mac

 

836,913

 

24,214

 

 

 

868,345

 

886,088

 

17,937

 

(194

)

17,743

 

Ginnie Mae

 

16,958

 

295

 

 

 

17,253

 

17,637

 

384

 

 

384

 

Total Agency MBS

 

6,924,193

 

163,708

 

(164

)

 

7,094,955

 

7,295,275

 

203,757

 

(3,437

)

200,320

 

Non-Agency MBS (3)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rated AAA

 

13,500

 

270

 

 

 

13,770

 

13,635

 

 

(135

)

(135

)

Rated AA

 

27,665

 

792

 

 

 

28,457

 

25,121

 

 

(3,336

)

(3,336

)

Rated A

 

22,374

 

31

 

(6,047

)

(1,490

)

14,868

 

18,353

 

3,775

 

(290

)

3,485

 

Rated BBB

 

61,063

 

56

 

(3,690

)

(442

)

56,987

 

54,926

 

291

 

(2,352

)

(2,061

)

Rated BB

 

103,391

 

29

 

(7,764

)

(5,373

)

90,283

 

88,338

 

810

 

(2,755

)

(1,945

)

Rated B

 

406,374

 

18

 

(28,801

)

(28,655

)

348,936

 

346,777

 

9,746

 

(11,905

)

(2,159

)

Rated CCC

 

1,370,656

 

 

(80,808

)

(279,717

)

1,010,131

 

1,039,100

 

57,040

 

(28,071

)

28,969

 

Rated CC

 

1,162,091

 

 

(38,205

)

(252,580

)

871,306

 

887,926

 

39,327

 

(22,707

)

16,620

 

Rated C

 

1,577,213

 

 

(38,494

)

(408,521

)

1,130,198

 

1,160,772

 

60,871

 

(30,297

)

30,574

 

Unrated and D-rated (4)

 

524,520

 

 

(19,121

)

(198,112

)

307,287

 

329,331

 

31,005

 

(8,961

)

22,044

 

Total Non-Agency MBS

 

5,268,847

 

1,196

 

(222,930

)

(1,174,890

)

3,872,223

 

3,964,279

 

202,865

 

(110,809

)

92,056

 

Total MBS

 

$12,193,040

 

$164,904

 

$(223,094

)

$(1,174,890

)

$10,967,178

 

$11,259,554

 

$406,622

 

$(114,246

)

$292,376

 

 

(footnotes follow next table)

 

13



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 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 OTTI are generally not expected to be accreted into interest income.  Amounts disclosed at June 30, 2011 reflect Credit Reserve of $1.127 billion and OTTI of $47.5 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 $7.2 million and $9.3 million at June 30, 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 36 Non-Agency MBS that were D-rated and had an aggregate amortized cost and fair value of $293.1 million and $313.8 million, respectively, at June 30, 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.

 

14



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 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 June 30, 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

 

$

194,061

 

$

1,038

 

16

 

$

161,026

 

$

2,205

 

18

 

$

355,087

 

$

3,243

 

Freddie Mac

 

36,196

 

93

 

2

 

3,010

 

101

 

1

 

39,206

 

194

 

Total Agency MBS

 

230,257

 

1,131

 

18

 

164,036

 

2,306

 

19

 

394,293

 

3,437

 

Non-Agency MBS:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Rated AAA

 

13,635

 

135

 

1

 

 

 

 

13,635

 

135

 

Rated AA

 

 

 

 

25,121

 

3,336

 

2

 

25,121

 

3,336

 

Rated A

 

3,067

 

53

 

1

 

1,283

 

237

 

2

 

4,350

 

290

 

Rated BBB

 

38,074

 

1,235

 

5

 

11,693

 

1,117

 

3

 

49,767

 

2,352

 

Rated BB

 

80,978

 

2,578

 

8

 

1,202

 

177

 

1

 

82,180

 

2,755

 

Rated B

 

251,358

 

9,721

 

18

 

14,745

 

2,184

 

3

 

266,103

 

11,905

 

Rated CCC

 

658,923

 

24,103

 

45

 

18,596

 

3,968

 

3

 

677,519

 

28,071

 

Rated CC

 

622,919

 

22,387

 

37

 

3,683

 

320

 

1

 

626,602

 

22,707

 

Rated C

 

701,403

 

25,872

 

41

 

88,737

 

4,425

 

2

 

790,140

 

30,297

 

Unrated and other

 

133,114

 

5,226

 

12

 

19,603

 

3,735

 

2

 

152,717

 

8,961

 

Total Non-Agency MBS

 

2,503,471

 

91,310

 

168

 

184,663

 

19,499

 

19

 

2,688,134

 

110,809

 

Total MBS

 

$

2,733,728

 

$

92,441

 

186

 

$

348,699

 

$

21,805

 

38

 

$

3,082,427

 

$

114,246

 

 

At June 30, 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 $3.4 million at June 30, 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 June 30, 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 $110.8 million at June 30, 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 recognized credit-related OTTI losses of $2.4 million in earnings during the three and six months ended June 30, 2011, all of which were recognized in connection with six Non-Agency MBS during the second quarter of 2011.  The Company recognized credit-related OTTI losses of $5.4 million through earnings during the three and six months ended June 30, 2010, all of which were recognized in connection with six Non-Agency MBS during the second quarter of 2010.  The impairments recognized during the six months ended June 30, 2011 and June 30, 2010 were recognized on Non-Agency MBS that were purchased at or near par value prior to July 2007 (“Legacy Non-Agency MBS”).

 

MBS on which OTTI is 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 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

 

15



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

 

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 Non-Agency MBS and any determination of the credit component of OTTI.

 

The following table presents the composition of OTTI charges recorded by the Company for the three and six months ended June 30, 2011 and 2010:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(In Thousands)

 

2011

 

2010

 

2011

 

2010

 

OTTI included in earnings

 

$

2,392

 

$

5,412

 

$

2,392

 

$

5,412

 

OTTI reclassified from other comprehensive income

 

(1,755

)

(2,042

)

(1,755

)

(2,042

)

Total OTTI losses

 

$

637

 

$

3,370

 

$

637

 

$

3,370

 

 

The following table presents a roll-forward of the credit loss component of OTTI on the Company’s Non-Agency MBS for which a non-credit component of OTTI was previously recognized in other comprehensive income.  Changes in the credit loss component of OTTI are presented based upon whether the current period is the first time OTTI was recorded on a security or a subsequent OTTI charge was recorded.

 

 

 

Three

 

Six

 

 

 

Months Ended

 

Months Ended

 

(In Thousands)

 

June 30, 2011

 

June 30, 2011

 

Credit loss component of OTTI at beginning of period

 

$

24,347

 

$

24,347

 

Additions for credit related OTTI not previously recognized

 

 

 

Subsequent additional credit related OTTI recorded

 

2,392

 

2,392

 

Credit loss component of OTTI at end of period

 

$

26,739

 

$

26,739

 

 

The significant inputs considered and assumptions made in determining the measurement of  the component of OTTI recorded in earnings with respect to the Company’s Non-Agency MBS at June 30, 2011 are summarized as follows:

 

 

 

At Time of
Impairment

 

Credit enhancement (1) (2)

 

 

 

Weighted average (3)

 

3.80%

 

Range (4)

 

0.00-13.30%

 

 

 

 

 

Projected CPR (2) (5)

 

 

 

Weighted average (3)

 

10.80%

 

Range (4)

 

1.90-12.00%

 

 

 

 

 

Projected Loss Severity (2) (6)

 

 

 

Weighted average (3)

 

48.40%

 

Range (4)

 

41.90-60.00%

 

 

 

 

 

60+ days delinquent (2) (7)

 

 

 

Weighted average (3)

 

20.90%

 

Range (4)

 

7.30-32.40%

 

 


(1) Represents a level of protection for these securities, expressed as a percentage of total current underlying loan balance.

 

(2)  Information provided is based on loans for all groups that provide credit enhancement for MBS with credit enhancement.  If an MBS no longer has credit enhancement, information provided is based on loans for the individual group owned by the Company.

 

(3) Calculated by weighting the relevant input/assumptions for each individual security by current outstanding face of the security.

 

(4) Represents the range of inputs/assumptions based on individual securities.

 

(5) CPR - conditional prepayment rate.

 

(6)  Projected loss severity represents the projected amount of loss realized on liquidated properties as a percentage of the principal balance.

 

(7) Includes, for each security, underlying loans 60 or more days delinquent, foreclosed loans and other real estate owned.

 

16



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

 

 

The following table presents the impact on accumulated other comprehensive income of the Company’s MBS for the three and six months ended June 30, 2011 and June 30, 2010:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

(In Thousands)

 

2011

 

2010

 

2011

 

2010

 

Accumulated other comprehensive income on MBS:

 

 

 

 

 

 

 

 

 

Unrealized gain on MBS at beginning of period

 

$

403,185

 

$

336,070

 

$

393,822

 

$

339,470

 

Unrealized gain/(loss) on Agency MBS, net

 

46,456

 

5,463

 

37,713

 

(7,746

)

Unrealized (loss)/gain on Non-Agency MBS, net

 

(159,657

)

6,512

 

(141,551

)

57,780

 

Reclassification adjustment for MBS sales included in net income

 

 

 

 

(41,459

)

Reclassification adjustment for OTTI included in net income

 

2,392

 

5,412

 

2,392

 

5,412

 

Balance at end of period

 

$

292,376

 

$

353,457

 

$

292,376

 

$

353,457

 

 

Purchase Discounts on Non-Agency MBS

 

The following tables present 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 and six months ended June 30, 2011 and June 30, 2010:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2011

 

June 30, 2011

 

 

 

Discount

 

 

 

Discount

 

 

 

 

 

Designated as

 

Accretable

 

Designated as

 

Accretable

 

(In Thousands)

 

Credit Reserve (1)

 

Discount (1) (2)

 

Credit Reserve (1)

 

Discount (1)

 

Balance at beginning of period

 

$

(899,902

)

$

(213,925

)

$

(700,328

)

$

(228,966

)

Accretion of discount, net

 

 

12,161

 

 

22,322

 

Realized credit losses

 

5,786

 

 

8,762

 

 

Purchases

 

(176,571

)

(14,563

)

(331,514

)

(2,837

)

Reclassification adjustment for OTTI

 

 

(101

)

 

(101

)

Unlinking of Linked Transactions

 

(54,647

)

(8,532

)

(106,070

)

(11,562

)

Transfers (to)/from

 

(2,030

)

2,030

 

1,786

 

(1,786

)

Balance at end of period

 

$

(1,127,364

)

$

(222,930

)

$

(1,127,364

)

$

(222,930

)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2010

 

June 30, 2010

 

 

 

Discount

 

 

 

Discount

 

 

 

 

 

Designated as

 

Accretable

 

Designated as

 

Accretable

 

(In Thousands)

 

Credit Reserve (3)

 

Discount (2) (3)

 

Credit Reserve (3)

 

Discount (3)

 

Balance at beginning of period

 

$

(537,759

)

$

(145,969

)

$

(455,004

)

$

(149,319

)

Accretion of discount, net

 

 

8,832

 

 

17,199

 

Realized credit losses

 

364

 

 

412

 

 

Purchases

 

(107,716

)

(7,125

)

(199,046

)

(8,843

)

Sales

 

 

 

7,856

 

683

 

Unlinking of Linked Transactions

 

(1,468

)

(1,124

)

(2,740

)

(3,163

)

Transfers from/(to) (2)

 

63,670

 

(63,670

)

65,613

 

(65,613

)

Balance at end of period

 

$

(582,909

)

$

(209,056

)

$

(582,909

)

$

(209,056

)

 


(1)  In addition, the Company reallocated $366,000 of purchase discount designated as accretable purchase discount to Credit Reserve on Non-Agency MBS underlying Linked Transactions during the three months ended June 30, 2011.  For the six months ended June 30, 2011, the Company reallocated $799,000 of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions.

 

(2)  Together with coupon interest, accretable purchase discount is recognized as interest income over the life of the security.

 

(3)  In addition, the Company reallocated $17.3 million of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the three and six months ended June 30, 2010.

 

17



Table of Contents

 

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2011

 

Sales of MBS

 

The Company did not sell any MBS during the three and six months ended June 30, 2011.  During the six months ended June 30, 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; all of these sales occurred during the first quarter of 2010.  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 and six months ended June 30, 2011 and 2010:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

(In Thousands)

 

2011

 

2010

 

2011

 

2010

 

Coupon interest

 

$

74,343

 

$

70,295

 

$

142,049

 

$

157,124

 

Effective yield adjustment (1)

 

(8,361

)

(15,765

)

(15,892

)

(23,915

)

Agency MBS interest income

 

$

65,982

 

$

54,530

 

$

126,157

 

$

133,209

 

 


(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.

 

The following table presents components of interest income for the Company’s Non-Agency MBS (including MBS transferred to consolidated VIEs) for the three and six months ended June 30, 2011 and 2010:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

(In Thousands)

 

2011

 

2010

 

2011

 

2010

 

Coupon interest

 

$

53,988

 

$

24,913

 

$

93,525

 

$

45,243

 

Effective yield adjustment (1)

 

12,112

 

9,072

 

22,224

 

17,707

 

Non-Agency MBS interest income

 

$

66,100

 

$

33,985

 

$

115,749

 

$

62,950

 

 


(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.