10-Q 1 mfa-03312019x10q.htm 10-Q Document

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
_____________________________________________ 
FORM 10-Q
(Mark One) 
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2019
 
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, 20th Floor, New York, New York
(Address of principal executive offices)
 
10022
(Zip Code)
 (212) 207-6400
(Registrant’s telephone number, including area code)
_____________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Not Applicable 
(Former name, former address and former fiscal year, if changed since last period)
_____________________________________________ 
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 website, 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, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company o
 
 
Emerging growth company o
 If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
MFA
New York Stock Exchange
 
 
 
7.50% Series B Cumulative Redeemable
Preferred Stock, par value $0.01 per share
MFA/PB
New York Stock Exchange
 
 
 
8.00% Senior Notes due 2042
MFO
New York Stock Exchange

450,555,570 shares of the registrant’s common stock, $0.01 par value, were outstanding as of May 2, 2019.
 



MFA FINANCIAL, INC.

TABLE OF CONTENTS
 
 
Page
 
 
PART I
FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





MFA FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS




 (In Thousands Except Per Share Amounts)
 
March 31,
2019
 
December 31,
2018
 
 
(Unaudited)
 
 
Assets:
 
 

 
 

Residential mortgage securities:
 
 

 
 

Agency MBS, at fair value ($2,524,612 and $2,575,331 pledged as collateral, respectively)
 
$
2,546,597

 
$
2,698,213

Non-Agency MBS, at fair value ($3,068,294 and $3,248,900 pledged as collateral, respectively)
 
3,099,272

 
3,318,299

Credit Risk Transfer (“CRT”) securities, at fair value ($419,877 and $480,315 pledged as collateral, respectively)
 
423,702

 
492,821

Residential whole loans, at carrying value ($2,441,975 and $1,645,372 pledged as collateral, respectively) (1)
 
3,724,146

 
3,016,715

Residential whole loans, at fair value ($822,235 and $738,638 pledged as collateral, respectively) (1)
 
1,512,337

 
1,665,978

Mortgage servicing rights (“MSR”) related assets ($825,363 and $611,807 pledged as collateral, respectively)
 
825,363

 
611,807

Cash and cash equivalents
 
76,579

 
51,965

Restricted cash
 
41,999

 
36,744

Other assets
 
551,618

 
527,785

Total Assets
 
$
12,801,613

 
$
12,420,327

 
 
 
 
 
Liabilities:
 
 
 
 
Repurchase agreements
 
$
8,509,713

 
$
7,879,087

Other liabilities
 
887,369

 
1,125,139

Total Liabilities
 
$
9,397,082

 
$
9,004,226

 
 
 
 
 
Commitments and contingencies (See Note 10)
 


 


 
 
 
 
 
Stockholders’ Equity:
 
 
 
 
Preferred stock, $.01 par value; 7.50% Series B cumulative redeemable; 8,050 shares authorized;
8,000 shares issued and outstanding ($200,000 aggregate liquidation preference)
 
$
80

 
$
80

Common stock, $.01 par value; 886,950 shares authorized; 450,483 and 449,787 shares issued
and outstanding, respectively
 
4,505

 
4,498

Additional paid-in capital, in excess of par
 
3,622,636

 
3,623,275

Accumulated deficit
 
(637,286
)
 
(632,040
)
Accumulated other comprehensive income
 
414,596

 
420,288

Total Stockholders’ Equity
 
$
3,404,531

 
$
3,416,101

Total Liabilities and Stockholders’ Equity
 
$
12,801,613

 
$
12,420,327

 

(1)
Includes approximately $202.7 million and $209.4 million of Residential whole loans, at carrying value and $647.0 million and $694.7 million of Residential whole loans, at fair value transferred to consolidated variable interest entities (“VIEs”) at March 31, 2019 and December 31, 2018, respectively. Such assets can be used only to settle the obligations of each respective VIE.


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

1


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
 
Three Months Ended
March 31,
(In Thousands, Except Per Share Amounts)
 
2019
 
2018
Interest Income:
 
 
 
 
Agency MBS
 
$
18,441

 
$
15,293

Non-Agency MBS
 
54,001

 
56,102

CRT securities
 
6,200

 
9,496

Residential whole loans held at carrying value
 
49,620

 
14,329

MSR-related assets
 
10,620

 
7,623

Cash and cash equivalent investments
 
764

 
909

Other interest-earning assets
 
1,306

 

Interest Income
 
$
140,952

 
$
103,752

 
 
 
 
 
Interest Expense:
 
 
 
 
Repurchase agreements
 
$
70,809

 
$
45,717

Other interest expense
 
8,217

 
4,837

Interest Expense
 
$
79,026

 
$
50,554

 
 
 
 
 
Net Interest Income
 
$
61,926

 
$
53,198

 
 
 
 
 
Other Income, net:
 
 
 
 
Net gain on residential whole loans measured at fair value through earnings
 
$
25,267

 
$
38,498

Net realized gain on sales of residential mortgage securities
 
24,609

 
8,817

Net unrealized gain/(loss) on residential mortgage securities measured at fair value through earnings
 
8,672

 
(880
)
Net loss on Swaps not designated as hedges for accounting purposes
 
(8,944
)
 

Other, net
 
1,565

 
1,225

Other Income, net
 
$
51,169

 
$
47,660

 
 
 
 
 
Operating and Other Expense:
 
 
 
 
Compensation and benefits
 
$
8,554

 
$
6,748

Other general and administrative expense
 
4,645

 
3,832

Loan servicing and other related operating expenses
 
11,039

 
6,883

Operating and Other Expense
 
$
24,238

 
$
17,463

 
 
 
 
 
Net Income
 
$
88,857

 
$
83,395

Less Preferred Stock Dividends
 
3,750

 
3,750

Net Income Available to Common Stock and Participating Securities
 
$
85,107

 
$
79,645

 
 
 
 
 
Earnings per Common Share - Basic and Diluted
 
$
0.19

 
$
0.20


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

2


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(UNAUDITED)

 
 
Three Months Ended
March 31,
(In Thousands)
 
2019
 
2018
Net income
 
$
88,857

 
$
83,395

Other Comprehensive Income/(Loss):
 
 
 
 
Unrealized gain/(loss) on Agency MBS, net
 
9,315

 
(10,052
)
Unrealized gain/(loss) on Non-Agency MBS, CRT securities and MSR term notes, net
 
12,788

 
(27,488
)
Reclassification adjustment for MBS sales included in net income
 
(17,009
)
 
(8,623
)
Derivative hedging instrument fair value changes, net
 
(10,445
)
 
19,669

Amortization of de-designated hedging instruments, net
 
(341
)
 

Other Comprehensive Income/(Loss)
 
(5,692
)
 
(26,494
)
Comprehensive income before preferred stock dividends
 
$
83,165

 
$
56,901

Dividends declared on preferred stock
 
(3,750
)
 
(3,750
)
Comprehensive Income Available to Common Stock and Participating Securities
 
$
79,415

 
$
53,151

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

3


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(UNAUDITED)

 
 
Three Months Ended March 31, 2019
(In Thousands, 
Except Per Share Amounts)
 
Preferred Stock
7.50% Series B Cumulative Redeemable - Liquidation Preference $25.00 per Share
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated
Deficit
 
Accumulated Other Comprehensive Income
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2018
 
8,000

 
$
80

 
449,787

 
$
4,498

 
$
3,623,275

 
$
(632,040
)
 
$
420,288

 
$
3,416,101

Net income
 

 

 

 

 

 
88,857

 

 
88,857

Issuance of common stock, net of expenses
 

 

 
1,066

 
7

 
544

 

 

 
551

Repurchase of shares of common stock (1)
 

 

 
(370
)
 

 
(2,610
)
 

 

 
(2,610
)
Equity based compensation expense
 

 

 

 

 
992

 

 

 
992

Accrued dividends attributable to stock-based awards
 

 

 

 

 
435

 

 

 
435

Dividends declared on common stock ($0.20 per share)
 

 

 

 

 

 
(90,097
)
 

 
(90,097
)
Dividends declared on preferred stock ($0.46875 per share)
 

 

 

 

 

 
(3,750
)
 

 
(3,750
)
Dividends attributable to dividend equivalents
 

 

 

 

 

 
(256
)
 

 
(256
)
Change in unrealized gains on MBS, net
 

 

 

 

 

 

 
5,094

 
5,094

Derivative hedging instrument fair value changes, net
 

 

 

 

 

 

 
(10,786
)
 
(10,786
)
Balance at March 31, 2019
 
8,000

 
$
80

 
450,483

 
$
4,505

 
$
3,622,636

 
$
(637,286
)
 
$
414,596

 
$
3,404,531


 
 
Three Months Ended March 31, 2018
(In Thousands, 
Except Per Share Amounts)
 
Preferred Stock
7.50% Series B Cumulative Redeemable - Liquidation Preference $25.00 per Share
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated
Deficit
 
Accumulated Other Comprehensive Income
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2017
 
8,000

 
$
80

 
397,831

 
$
3,978

 
$
3,227,304

 
$
(578,950
)
 
$
609,224

 
$
3,261,636

Cumulative effect adjustment on adoption of new accounting standard for revenue recognition
 

 

 

 

 

 
295

 

 
295

Net income
 

 

 

 

 

 
83,395

 

 
83,395

Issuance of common stock, net of expenses
 

 

 
849

 
6

 
1,224

 

 

 
1,230

Repurchase of shares of common stock (1)
 

 

 
(251
)
 

 
(1,957
)
 

 

 
(1,957
)
Equity based compensation expense
 

 

 

 

 
549

 

 

 
549

Accrued dividends attributable to stock-based awards
 

 

 

 

 
430

 

 

 
430

Dividends declared on common stock ($0.20 per share)
 

 

 

 

 

 
(79,686
)
 

 
(79,686
)
Dividends declared on preferred stock ($0.46875 per share)
 

 

 

 

 

 
(3,750
)
 

 
(3,750
)
Dividends attributable to dividend equivalents
 

 

 

 

 

 
(217
)
 

 
(217
)
Change in unrealized losses on MBS, net
 

 

 

 

 

 

 
(46,163
)
 
(46,163
)
Derivative hedging instruments fair value changes, net
 

 

 

 

 

 

 
19,669

 
19,669

Balance at March 31, 2018
 
8,000

 
$
80

 
398,429

 
$
3,984

 
$
3,227,550

 
$
(578,913
)
 
$
582,730

 
$
3,235,431


(1)  For the three months ended March 31, 2019 and 2018, includes approximately $2.6 million (370,244 shares) and $2.0 million (250,946 shares), respectively surrendered for tax purposes related to equity-based compensation awards.

4


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Three Months Ended
March 31,
(In Thousands)
 
2019
 
2018
Cash Flows From Operating Activities:
 
 

 
 

Net income
 
$
88,857

 
$
83,395

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

 
 
Gain on sales of residential mortgage securities
 
(24,609
)
 
(8,817
)
Gain on sales of real estate owned
 
(1,398
)
 
(1,993
)
Gain on liquidation of residential whole loans
 
(4,684
)
 
(5,279
)
Accretion of purchase discounts on residential mortgage securities, residential whole loans and
MSR-related assets
 
(15,915
)
 
(19,793
)
Amortization of purchase premiums on residential mortgage securities and residential whole loans
 
7,620

 
5,392

Depreciation and amortization on real estate, fixed assets and other assets
 
432

 
423

Equity-based compensation expense
 
998

 
553

Unrealized losses/(gains) on residential whole loans at fair value
 
1,060

 
(13,747
)
Unrealized losses/(gains) on residential mortgage securities and interest rate swap agreements ("Swaps") and other
 
200

 
(2,020
)
Increase in other assets
 
(8,770
)
 
(19,990
)
Decrease in other liabilities
 
(6,709
)
 
(12,228
)
Net cash provided by operating activities
 
$
37,082

 
$
5,896

 
 
 
 
 
Cash Flows From Investing Activities:
 
 

 
 

Principal payments on residential mortgage securities and MSR-related assets
 
$
391,641

 
$
484,334

Proceeds from sales of residential mortgage securities
 
208,306

 
19,362

Purchases of residential mortgage securities and MSR-related assets
 
(327,221
)
 
(194,328
)
Purchases of residential whole loans, loan related investments and capitalized advances
 
(1,021,557
)
 
(513,851
)
Principal payments on residential whole loans
 
233,724

 
71,865

Proceeds from sales of real estate owned
 
23,963

 
19,307

Purchases of real estate owned and capital improvements
 
(5,923
)
 
(2,678
)
Additions to leasehold improvements, furniture and fixtures
 
(391
)
 
(171
)
Net cash used in investing activities
 
$
(497,458
)
 
$
(116,160
)
 
 
 
 
 
Cash Flows From Financing Activities:
 
 

 
 
Principal payments on repurchase agreements
 
$
(18,879,173
)
 
$
(16,609,092
)
Proceeds from borrowings under repurchase agreements
 
19,509,794

 
16,553,139

Principal payments on securitized debt
 
(25,501
)
 
(12,817
)
Payments made for settlements on Swaps
 
(21,478
)
 
(10,666
)
Proceeds from settlements on Swaps
 

 
30,711

Proceeds from issuances of common stock
 
551

 
1,230

Dividends paid on preferred stock
 
(3,750
)
 
(3,750
)
Dividends paid on common stock and dividend equivalents
 
(90,198
)
 
(79,769
)
Net cash provided by/(used in) financing activities
 
$
490,245

 
$
(131,014
)
Net increase/(decrease) in cash, cash equivalents and restricted cash
 
$
29,869

 
$
(241,278
)
Cash, cash equivalents and restricted cash at beginning of period
 
$
88,709

 
$
463,743

Cash, cash equivalents and restricted cash at end of period
 
$
118,578

 
$
222,465

 
 
 
 
 
Supplemental Disclosure of Cash Flow Information
 
 
 
 
Interest Paid
 
$
81,435

 
$
51,334

 
 
 
 
 
Non-cash Investing and Financing Activities:
 
 
 
 
Net decrease in securities obtained as collateral/obligation to return securities obtained as collateral
 
$

 
$
(248,650
)
Transfer from residential whole loans to real estate owned
 
$
65,160

 
$
54,822

Dividends and dividend equivalents declared and unpaid
 
$
90,353

 
$
79,905

Payable for unsettled residential whole loans purchases
 
$

 
$
13,525


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

5

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

 
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 U.S. 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.  The Company has elected to treat certain of its subsidiaries as a taxable REIT subsidiary (“TRS”). In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate related business. (See Note 2(o))
 
2.   Summary of Significant Accounting Policies
 
(aBasis of Presentation and Consolidation
 
The interim unaudited consolidated financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “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 unaudited consolidated financial statements are adequate to make the information presented not misleading.  The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.  In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31, 2019 and results of operations for all periods presented have been made.  The results of operations for the three months ended March 31, 2019 should not be construed as indicative of the results to be expected for the full year.
 
The accompanying 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 differ from 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 mortgage-backed securities (“MBS”) (See Note 3), valuation of MBS, CRT securities and MSR-related assets (See Notes 3 and 14), income recognition and valuation of residential whole loans (See Notes 4 and 14), valuation of derivative instruments (See Notes 5(b) and 14) and income recognition on certain Non-Agency MBS (defined below) purchased at a discount. (See Note 3)  In addition, estimates are used in the determination of taxable income used in the assessment of REIT compliance and contingent liabilities for related taxes, penalties and interest. (See Note 2(o))  Actual results could differ from those estimates.

The Company has one reportable segment as it manages its business and analyzes and reports its results of operations on the basis of one operating segment; investing, on a leveraged basis, in residential mortgage assets.
 
The consolidated financial statements of the Company include the accounts of all subsidiaries; all intercompany accounts and transactions have been eliminated. In addition, the Company consolidates entities established to facilitate transactions related to the acquisition and securitization of residential whole loans completed in prior years. Certain prior period amounts have been reclassified to conform to the current period presentation.
 

6

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

(bResidential Mortgage Securities
 
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 the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), or an agency of the U.S. Government, such as the Government National Mortgage Association (“Ginnie Mae”) (collectively, “Agency MBS”), and residential MBS that are not guaranteed by any agency of the U.S. Government or any federally chartered corporation (“Non-Agency MBS”). In addition, the Company has investments in CRT securities that are issued or sponsored by Fannie Mae and Freddie Mac. The coupon payments on CRT securities are paid by Fannie Mae and Freddie Mac and the principal payments received are dependent on the performance of loans in either a reference pool or an actual pool of loans. As the loans in the underlying pool are paid, the principal balance of the CRT securities is paid. As an investor in a CRT security, the Company may incur a principal loss if the performance of the actual or reference pool loans results in either an actual or calculated loss that exceeds the credit enhancement of the security owned by the Company.
 
Designation
 
MBS that the Company generally intends to hold until maturity, but that it may sell from time to time as part of the overall management of its business, are designated as “available-for-sale” (“AFS”). Such MBS 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/(loss) (“AOCI”), a component of Stockholders’ Equity.
 
Upon the sale of an AFS security, any unrealized gain or loss is reclassified out of AOCI to earnings as a realized gain or loss using the specific identification method.

The Company has elected the fair value option for certain of its Agency MBS that it does not intend to hold to maturity. These securities are carried at their fair value with changes in fair value included in earnings for the period and reported in Other Income, net on the Company’s consolidated statements of operations.

The Company has elected the fair value option for certain of its CRT securities as it considers this method of accounting to more appropriately reflect the risk sharing structure of these securities. Such securities are carried at their fair value with changes in fair value included in earnings for the period and reported in Other Income, net on the Company’s consolidated statements of operations.
 
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 assessed as high credit quality 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 are considered to be of less than high credit quality is recognized based on the security’s effective interest rate which is the security’s internal rate of return (“IRR”). The IRR is determined using management’s estimate of the projected cash flows for each security, which are 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 from those estimated at the last evaluation, may result in a prospective change in the IRR/ interest income recognized on these securities or in the recognition of OTTIs.  (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 mitigates the Company’s risk of loss on the mortgages collateralizing such MBS 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 reallocated to accretable discount and recognized into interest income over time.  Conversely, if the performance of a security with

7

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

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 Fair Value for Residential Mortgage Securities
 
In determining the fair value of the Company’s residential mortgage securities, management considers a number of observable market data points, including prices obtained from pricing services, brokers and repurchase agreement counterparties, dialogue with market participants, as well as management’s observations of market activity.  (See Note 14)
 
Impairments/OTTI

When the fair value of an AFS 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 impairment related to credit losses is recognized through charges to earnings with the remainder recognized through AOCI on the consolidated balance sheets.  Impairments recognized through other comprehensive income/(loss) (“OCI”) do not impact earnings.  Following the recognition of an OTTI through earnings, a new cost basis is established for the security, which may not be adjusted for subsequent recoveries in fair value through earnings.  However, OTTIs recognized through charges to earnings may, upon recovery, 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 of credit impairment recognized in earnings is subjective, as such determinations are based on factual information available at the time of assessment as well as the Company’s estimates of future performance and cash flow projections.  As a result, the timing and amount of OTTIs constitute material estimates that are susceptible to significant change.  (See Note 3)

Non-Agency MBS that are assessed to be of less than high credit quality and 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 past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, year of origination, loan-to-value ratios (“LTVs”), geographic concentrations 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 OTTI related to credit losses for securities that were purchased at significant discounts to par and/or are considered to be of less than high credit quality, 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.  The discount rate used to calculate the present value of expected future cash flows is the current yield used for income recognition purposes.  Impairment assessment for Non-Agency MBS that were purchased at prices close to par and/or are otherwise considered to be of high credit quality involves comparing the present value of the remaining cash flows expected to be collected against the amortized cost of the security at the assessment date.  The discount rate used to calculate the present value of the expected future cash flows is based on the instrument’s IRR.
 
Balance Sheet Presentation
 
The Company’s residential mortgage securities pledged as collateral against repurchase agreements and Swaps are included on the consolidated balance sheets with the fair value of the securities pledged disclosed parenthetically.  Purchases and sales of securities are recorded on the trade date. 

8

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019


(cResidential Whole Loans (including Residential Whole Loans transferred to consolidated VIEs)

Residential whole loans included in the Company’s consolidated balance sheets are primarily comprised of pools of fixed and adjustable rate residential mortgage loans acquired through consolidated trusts in secondary market transactions. The accounting model utilized by the Company is determined at the time each loan package is initially acquired and is generally based on the delinquency status of the majority of the underlying borrowers in the package at acquisition. The accounting model described below for Purchased Credit Impaired Loans that are held at carrying value is typically utilized by the Company for Purchased Credit Impaired Loans where the underlying borrower has a delinquency status of less than 60 days at the acquisition date. The Company also acquires Purchased Performing Loans that are typically held at carrying value, but the accounting methods for income recognition and determination and measurement of any required loan loss reserves (as discussed below) differ from those used for Purchased Credit Impaired Loans held at carrying value. The accounting model described below for residential whole loans held at fair value is typically utilized by the Company for loans where the underlying borrower has a delinquency status of 60 days or more at the acquisition date. The accounting model initially applied is not subsequently changed.

The Company’s residential whole loans pledged as collateral against repurchase agreements are included in the consolidated balance sheets with amounts pledged disclosed parenthetically.  Purchases and sales of residential whole loans are recorded on the trade date, with amounts recorded reflecting management’s current estimate of assets that will be acquired or disposed at the closing of the transaction. This estimate is subject to revision at the closing of the transaction, pending the outcome of due diligence performed prior to closing. Recorded amounts of residential whole loans for which the closing of the purchase transaction is yet to occur are not eligible to be pledged as collateral against any repurchase agreement financing until the closing of the purchase transaction. (See Notes 4, 6, 7, 14 and 15)

Residential Whole Loans at Carrying Value

Purchased Performing Loans

Acquisitions of Purchased Performing Loans to date have been primarily comprised of: (i) loans to finance (or refinance) one-to-four family residential properties that are not considered to meet the definition of a “Qualified Mortgage” in accordance with guidelines adopted by the Consumer Financial Protection Bureau (“Non-QM loans”), (ii) short-term business purpose loans collateralized by residential properties made to non-occupant borrowers who intend to rehabilitate and sell the property for a profit (“Rehabilitation loans” or “Fix and Flip loans”), (iii) loans to finance (or refinance) non-owner occupied one-to four-family residential properties that are rented to one or more tenants (“Single-family rental loans”), and (iv) previously originated loans secured by residential real estate that is generally owner occupied (“Seasoned performing loans”). Purchased Performing Loans are initially recorded at their purchase price. Interest income on Purchased Performing Loans acquired at par is accrued based on each loan’s current interest bearing balance and current interest rate, net of related servicing costs. Interest income on such loans purchased at a premium/discount to par is recorded each period based on the contractual coupon net of any amortization of premium or accretion of discount, adjusted for actual prepayment activity. For loans acquired with related servicing rights retained by the seller, interest income is reported net of related serving costs.

An allowance for loan losses is recorded when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the existing contractual terms of the loan agreement. Any required loan loss allowance would typically be measured based on the fair value of the collateral securing the loan and would reduce the carrying value of the loan with a corresponding charge to earnings. Significant judgments are required in determining any allowance for loan loss, including assumptions regarding the loan cash flows expected to be collected, the value of the underlying collateral and the ability of the Company to collect on any other forms of security, such as a personal guaranty provided either by the borrower or an affiliate of the borrower. Income recognition is suspended for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. When the ultimate collectability of the principal of an impaired loan is in doubt, all payments are applied to principal under the cost recovery method. When the ultimate collectability of the principal of an impaired loan is not in doubt, interest income is recorded under the cash basis method as interest payments are received. Interest accruals are resumed when the loan becomes contractually current and performance is demonstrated to be resumed. A loan is written off when it is no longer realizable and/or it is legally discharged.


9

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

Purchased Credit Impaired Loans

The Company has elected to account for these loans as credit impaired as they were acquired at discounted prices that reflect, in part, the impaired credit history of the borrower. Substantially all of these loans have previously experienced payment delinquencies and the amount owed may exceed the value of the property pledged as collateral. Consequently, these loans generally have a higher likelihood of default than newly originated mortgage loans with LTVs of 80% or less to creditworthy borrowers. The Company believes that amounts paid to acquire these loans represent fair market value at the date of acquisition. Loans considered credit impaired are initially recorded at the purchase price with no allowance for loan losses. Subsequent to acquisition, the recorded amount for these loans reflects the original investment amount, plus accretion of interest income, less principal and interest cash flows received. These loans are presented on the Company’s consolidated balance sheets at carrying value, which reflects the recorded amount reduced by any allowance for loan losses established subsequent to acquisition.

Under the application of the accounting model for Purchased Credit Impaired Loans, the Company may aggregate into pools loans acquired in the same fiscal quarter that are assessed as having similar risk characteristics. For each pool established, or on an individual loan basis for loans not aggregated into pools, the Company estimates at acquisition and periodically on at least a quarterly basis, the principal and interest cash flows expected to be collected. The difference between the cash flows expected to be collected and the carrying amount of the loans is referred to as the “accretable yield.” This amount is accreted as interest income over the life of the loans using an effective interest rate (level yield) methodology. Interest income recorded each period reflects the amount of accretable yield recognized and not the coupon interest payments received on the underlying loans. The difference between contractually required principal and interest payments and the cash flows expected to be collected is referred to as the “non-accretable difference,” and includes estimates of both the effect of prepayments and expected credit losses over the life of the underlying loans.

A decrease in expected cash flows in subsequent periods may indicate impairment at the pool and/or individual loan level, thus requiring the establishment of an allowance for loan losses by a charge to the provision for loan losses. The allowance for loan losses generally represents the present value of cash flows expected at acquisition, adjusted for any increases due to changes in estimated cash flows, that are subsequently no longer expected to be received at the relevant measurement date. Under the accounting model applied to Purchased Credit Impaired Loans, a significant increase in expected cash flows in subsequent periods first reduces any previously recognized allowance for loan losses and then will result in a recalculation in the amount of accretable yield. The adjustment of accretable yield due to a significant increase in expected cash flows is accounted for prospectively as a change in estimate and results in reclassification from nonaccretable difference to accretable yield.

Residential Whole Loans at Fair Value

Certain of the Company’s residential whole loans are presented at fair value on its consolidated balance sheets as a result of a fair value election made at the time of acquisition. For the majority of these loans, there is significant uncertainty associated with estimating the timing of and amount of cash flows that will be collected. Further, the cash flows ultimately collected may be dependent on the value of the property securing the loan. Consequently, the Company considers that accounting for these loans at fair value should result in a better reflection over time of the economic returns for the majority of these loans. The Company determines the fair value of its residential whole loans held at fair value after considering portfolio valuations obtained from a third-party who specializes in providing valuations of residential mortgage loans and trading activity observed in the market place. Subsequent changes in fair value are reported in current period earnings and presented in Net gain on residential whole loans measured at fair value through earnings on the Company’s consolidated statements of operations.

Cash received representing coupon payments on residential whole loans held at fair value is not included in Interest Income, but rather is included in Net gain on residential whole loans measured at fair value through earnings on the Company’s consolidated statements of operations. Cash outflows associated with loan-related advances made by the Company on behalf of the borrower are included in the basis of the loan and are reflected in unrealized gains or losses reported each period.

(d) MSR-Related Assets

The Company has investments in financial instruments whose cash flows are considered to be largely dependent on underlying MSRs that either directly or indirectly act as collateral for the investment. These financial instruments, which are referred to as MSR-related assets are discussed in more detail below. The Company’s MSR-related assets pledged as collateral against repurchase agreements are included in the consolidated balance sheets with the amounts pledged disclosed parenthetically. Purchases and sales of MSR-related assets are recorded on the trade date. (See Notes 3, 6, 7 and 14)

10

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019


Term Notes Backed by MSR-Related Collateral
 
The Company has invested in term notes that are issued by special purpose vehicles (“SPV”) that have acquired rights to receive cash flows representing the servicing fees and/or excess servicing spread associated with certain MSRs. The Company considers payment of principal and interest on these term notes to be largely dependent on the cash flows generated by the underlying MSRs as this impacts the cash flows available to the SPV that issued the term notes. Credit risk borne by the holders of the term notes is also mitigated by structural credit support in the form of over-collateralization. Credit support is also provided by a corporate guarantee from the ultimate parent or sponsor of the SPV that is intended to provide for payment of interest and principal to the holders of the term notes should cash flows generated by the underlying MSRs be insufficient.

The Company’s term notes backed by MSR-related collateral are treated as AFS securities and reported at fair value on the Company’s consolidated balance sheets with unrealized gains and losses excluded from earnings and reported in AOCI. Interest income is recognized on an accrual basis on the Company’s consolidated statements of operations. The Company’s valuation process for such notes considers a number of factors, including a comparable bond analysis performed by a third-party pricing service which involves determining a pricing spread at issuance of the term note. The pricing spread is used at each subsequent valuation date to determine an implied yield to maturity of the term note, which is then used to derive an indicative market value for the security. This indicative market value is further reviewed by the Company and may be adjusted to ensure it reflects a realistic exit price at the valuation date given the structural features of these securities. Other factors taken into consideration include indicative values provided by repurchase agreement counterparties, estimated changes in fair value of the related underlying MSR collateral and the financial performance of the ultimate parent or sponsoring entity of the issuer, which has provided a guarantee that is intended to provide for payment of interest and principal to the holders of the term notes should cash flows generated by the related underlying MSR collateral be insufficient.

Corporate Loans
 
The Company has made or participated in loans to provide financing to entities that originate residential mortgage loans and own the related MSRs. These corporate loans are generally secured by certain MSRs, as well as certain other unencumbered assets owned by the borrower.

Corporate loans are recorded on the Company’s consolidated balance sheets at the drawn amount, on which interest income is recognized on an accrual basis on the Company’s consolidated statements of operations. Commitment fees received on the undrawn amount are deferred and recognized as interest income over the remaining loan term at the time of draw. At the end of the commitment period, any remaining deferred commitment fees are recorded as Other Income on the Company’s consolidated statements of operations. The Company evaluates the recoverability of its corporate loans on a quarterly basis considering various factors, including the current status of the loan, changes in the fair value of the MSRs that secure the loan and the recent financial performance of the borrower.

(eCash 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 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, 2019 and December 31, 2018. At March 31, 2019 and December 31, 2018, the Company had cash and cash equivalents of $76.6 million and $52.0 million, respectively. The Company’s investments in overnight money market funds, which are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) or any other government agency, were $57.0 million and $30.0 million at March 31, 2019 and December 31, 2018, respectively.  In addition, deposits in FDIC insured accounts generally exceed insured limits. (See Notes 7 and 14)
 
(f Restricted Cash
 
Restricted cash represents the Company’s cash held by its counterparties in connection with certain of the Company’s Swaps and/or repurchase agreements that is not available to the Company for general corporate purposes. Restricted cash may be applied against amounts due to repurchase agreement and/or Swap counterparties, or may be returned to the Company when the related collateral requirements are exceeded or at the maturity of the Swaps and/or repurchase agreement.  The Company had aggregate

11

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

restricted cash held as collateral or otherwise in connection with its repurchase agreements and/or Swaps of $42.0 million and $36.7 million at March 31, 2019 and December 31, 2018, respectively.  (See Notes 5(b), 6, 7 and 14)
 
(gGoodwill
 
At March 31, 2019 and December 31, 2018, 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, which is no longer subject to amortization, is tested for impairment at least annually, or more frequently under certain circumstances, at the entity level.  Through March 31, 2019, the Company had not recognized any impairment against its goodwill. Goodwill is included in Other assets on the Company’s consolidated balance sheets.

(h) Real Estate Owned (“REO”)
 
REO represents real estate acquired by the Company, including through foreclosure, deed in lieu of foreclosure, or purchased in connection with the acquisition of residential whole loans. REO acquired through foreclosure or deed in lieu of foreclosure is initially recorded at fair value less estimated selling costs. REO acquired in connection with the acquisition of residential whole loans is initially recorded at its purchase price. Subsequent to acquisition, REO is reported, at each reporting date, at the lower of the current carrying amount or fair value less estimated selling costs and for presentation purposes is included in Other assets on the Company’s consolidated balance sheets. Changes in fair value that result in an adjustment to the reported amount of an REO property that has a fair value at or below its carrying amount are reported in Other Income, net on the Company’s consolidated statements of operations. (See Note 5(a))

(iDepreciation
 
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.
 
(jLoan Securitization and Other Debt Issuance Costs
 
Loan securitization related costs are costs associated with the issuance of beneficial interests by consolidated VIEs and incurred by the Company in connection with various financing transactions completed by the Company.  Other debt issuance and related costs include costs incurred by the Company in connection with issuing 8% Senior Notes due 2042 (“Senior Notes”) and certain other repurchase agreement financings. These costs may include underwriting, rating agency, legal, accounting and other fees.  Such costs, which reflect deferred charges, are included on the Company’s consolidated balance sheets as a direct deduction from the corresponding debt liability. These deferred charges are amortized as an adjustment to interest expense using the effective interest method. For Senior Notes and other repurchase agreement financings, such costs are amortized over the shorter of the period to the expected or stated legal maturity of the debt instruments. The Company periodically reviews the recoverability of these deferred costs and in the event an impairment charge is required, such amount will be included in Operating and Other Expense on the Company’s consolidated statements of operations.

(kRepurchase Agreements

The Company finances the holdings of a significant portion of its residential mortgage assets 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 receives and the repurchase price that the Company pays represents interest paid to the lender.  Although legally structured as sale and repurchase transactions, the Company accounts for repurchase agreements as secured borrowings. Under its repurchase agreements, the Company pledges its securities as collateral to secure the borrowing, in an amount which is equal 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 including any accrued interest 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 assets or cash as collateral to secure borrowings under its repurchase financing with

12

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

such lender, are routinely experienced by the Company when the value of the assets pledged as collateral declines as a result of principal amortization and prepayments or due to changes in market interest rates, spreads or other market conditions.  The Company also may make margin calls on counterparties when collateral values increase.
 
The Company’s repurchase financings typically have terms ranging from one month to six months at inception, but may also have longer or shorter 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 default on its obligation, 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 by the Company to such lender, including accrued interest receivable on such collateral.  (See Notes 6, 7 and 14)
 
In addition to the repurchase agreement financing arrangements discussed above, as part of its financing strategy for Non-Agency MBS, the Company in prior periods entered into contemporaneous repurchase and reverse repurchase agreements with a single counterparty.  Under a typical reverse repurchase agreement, the Company buys securities from a borrower for cash and agrees to sell the same securities in the future for a price that is higher than the original purchase price.  The difference between the purchase price the Company originally paid and the sale price represents interest received from the borrower.  In contrast, the contemporaneous repurchase and reverse repurchase transactions effectively resulted in the Company pledging Non-Agency MBS as collateral to the counterparty in connection with the repurchase agreement financing and obtaining U.S. Treasury securities as collateral from the same counterparty in connection with the reverse repurchase agreement.  No net cash was exchanged between the Company and counterparty at the inception of the transactions. 
 
(lEquity-Based Compensation
 
Compensation expense for equity-based awards that are subject to vesting conditions, is recognized ratably over the vesting period of such awards, based upon the fair value of such awards at the grant date.  For certain awards granted prior to January 1, 2017, compensation expense recognized included the impact of estimated forfeitures, with any changes in estimated forfeiture rates accounted for as a change in estimate. Upon adoption of new accounting guidance that was effective for the Company on January 1, 2017, the Company made a policy election to account for forfeitures as they occur.
 
Beginning in 2014, the Company has made annual grants of restricted stock units (“RSUs”) certain of which cliff vest after a three-year period, subject only to continued employment, and others of which cliff vest after a three-year period, subject to both continued employment and the achievement of certain performance criteria based on a formula tied to the Company’s achievement of average total shareholder return during that three-year period, as well as the total shareholder return (“TSR”) of the Company relative to the TSR of a group of peer companies (over the three-year period) selected by the Compensation Committee of the Company’s Board of Directors (the “Compensation Committee”) at the date of grant. The features in these awards related to the attainment of total shareholder return over a specified period constitute a “market condition” which impacts the amount of compensation expense recognized for these awards.  Specifically, the uncertainty regarding the achievement of the market condition was reflected in the grant date fair valuation of the RSUs, which is recognized as compensation expense over the relevant vesting period.  The amount of compensation expense recognized is not dependent on whether the market condition was or will be achieved.
 
The Company makes dividend equivalent payments in connection with certain of its equity-based awards.   A dividend equivalent is a right to receive a distribution equal to the dividend distributions that would be paid on a share of the Company’s common stock.  Dividend equivalents may be granted as a separate instrument or may be a right associated with the grant of another award (e.g., an RSU) under the Company’s Equity Compensation Plan (the “Equity Plan”), and they are paid in cash or other consideration at such times and in accordance with such rules, terms and conditions, as the Compensation Committee may determine in its discretion.  Payments pursuant to dividend equivalents are generally charged to Stockholders’ Equity to the extent that the attached equity awards are expected to vest.  Compensation expense is recognized for payments made for dividend equivalents to the extent that the attached equity awards (i) do not or are not expected to vest and (ii) grantees are not required to return payments of dividends or dividend equivalents to the Company.  (See Notes 2(m) and 13)
 
(mEarnings 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 an estimate of other securities that participate in dividends, such as the Company’s unvested restricted stock and RSUs that have non-forfeitable rights to dividends and dividend equivalents attached to/associated with RSUs

13

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

and vested stock options to arrive at total common equivalent shares.  In applying the two-class method, earnings are allocated to both shares of common stock and estimated 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 12)
 
(nComprehensive Income/(Loss)
 
The Company’s comprehensive income/(loss) available to common stock and participating securities includes net income, the change in net unrealized gains/(losses) on its AFS securities and derivative hedging instruments, (to the extent that such changes are not recorded in earnings), adjusted by realized net gains/(losses) reclassified out of AOCI for sold AFS securities and is reduced by dividends declared on the Company’s preferred stock and issuance costs of redeemed preferred stock.
 
(oU.S. Federal Income Taxes

The Company has elected to be taxed as a REIT under the provisions of the Internal Revenue Code of 1986, as amended, (the “Code”) and the corresponding provisions of state law.  The Company expects to operate in a manner that will enable it to satisfy the various requirements to maintain its status as a REIT for federal income tax purposes. In order to maintain its status as a REIT, the Company must, among other things, distribute at least 90% of its REIT taxable income (excluding net long-term capital gains) to stockholders in the timeframe permitted by the Code.  As long as the Company maintains its status as a REIT, the Company will not be subject to regular federal income tax to the extent that it distributes 100% of its REIT taxable income (including net long-term capital gains) to its stockholders within the permitted timeframe.  Should this not occur, the Company would be subject to federal taxes at prevailing corporate tax rates on the difference between its REIT taxable income and the amounts deemed to be distributed for that tax year.  As the Company’s objective is to distribute 100% of its REIT taxable income to its stockholders within the permitted timeframe, no provision for current or deferred income taxes has been made in the accompanying consolidated financial statements.  Should the Company incur a liability for corporate income tax, such amounts would be recorded as REIT income tax expense on the Company’s consolidated statements of operations. Furthermore, if the Company fails to distribute during each calendar year, or by the end of January following the calendar year in the case of distributions with declaration and record dates falling in the last three months of the calendar year, at least the sum of (i) 85% of its REIT ordinary income for such year, (ii) 95% of its REIT capital gain income for such year, and (iii) any undistributed taxable income from prior periods, the Company would be subject to a 4% nondeductible excise tax on the excess of the required distribution over the amounts actually distributed. To the extent that the Company incurs interest, penalties or related excise taxes in connection with its tax obligations, including as a result of its assessment of uncertain tax positions, such amounts will be included in Operating and Other Expense on the Company’s consolidated statements of operations.

In addition, the Company has elected to treat certain of its subsidiaries as a TRS. In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. Generally, a domestic TRS is subject to U.S. federal, state and local corporate income taxes. Since a portion of the Company’s business is conducted through one or more TRS, its net taxable income earned by its domestic TRS, if any, is subject to corporate income taxation. To maintain the Company’s REIT election, no more than 20% of the value of a REIT’s assets at the end of each calendar quarter may consist of stock or securities in TRS. For purposes of the determination of U.S. federal and state income taxes, the Company’s subsidiaries that elected to be treated as a TRS record current or deferred income taxes based on differences (both permanent and timing) between the determination of their taxable income and net income under GAAP. No net deferred tax benefit was recorded by the Company for the three months ended March 31, 2019 and 2018, related to the net taxable losses in the TRS, since a valuation allowance for the full amount of the associated deferred tax asset of approximately $22.9 million was recognized as its recovery is not considered more likely than not. The related net operating loss carryforwards generated prior to 2018 will begin to expire in 2034; those generated in 2019 do not expire.

 Based on its analysis of any potential uncertain tax positions, the Company concluded that it does not have any material uncertain tax positions that meet the relevant recognition or measurement criteria as of March 31, 2019, December 31, 2018, or March 31, 2018. The Company’s tax returns for tax years 2015 through 2017 are open to examination.


14

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

(pDerivative Financial Instruments
 
The Company may use a variety of derivative instruments to economically hedge a portion of its exposure to market risks, including interest rate risk and prepayment risk. The objective of the Company’s risk management strategy is to reduce fluctuations in net book value over a range of interest rate scenarios. In particular, the Company attempts to mitigate the risk of the cost of its variable rate liabilities increasing during a period of rising interest rates. The Company’s derivative instruments are currently comprised of Swaps, the majority which are designated as cash flow hedges against the interest rate risk associated with its borrowings.

Swaps
 
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 for all Swaps designated as hedging transactions.  The Company assesses, both at the inception of a hedge and on a quarterly basis thereafter, whether or not the hedge is “highly effective.”
 
Swaps are carried on the Company’s consolidated balance sheets at fair value, in Other assets, if their fair value is positive, or in Other liabilities, if their fair value is negative.  Beginning in January 2017, variation margin payments on the Company’s Swaps that have been novated to a clearing house are treated as a legal settlement of the exposure under the Swap contract. Previously such payments were treated as collateral pledged against the exposure under the Swap contract. The effect of this change is to reduce what would have otherwise been reported as the fair value of the Swap. All of the Company’s Swaps have been novated to a central clearing house. Changes in the fair value of the Company’s Swaps designated in hedging transactions are recorded in OCI provided that the hedge remains effective.  Periodic payments accrued in connection with Swaps designated as hedges are included in interest expense, and are treated as an operating cash flow.

The Company discontinues hedge accounting on a prospective basis and recognizes changes in 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. (See Notes 5(b), 7 and 14)

Changes in the fair value of the Company’s Swaps not designated in hedging transactions are recorded in Other income, net on the Company’s consolidated statement of operations.

(qFair 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 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 observability of inputs to the valuation of an asset or liability as of the measurement date. 

In addition to the financial instruments that it is required to report at fair value, the Company has elected the fair value option for certain of its residential whole loans, Agency MBS and CRT securities at the time of acquisition. Subsequent changes in the fair value of these financial instruments are reported in Other income, net, in the Company’s consolidated statements of operations. 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. (See Notes 2(b), 2(c), 3, 4 and 14)


15

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

 (rVariable Interest Entities
 
An entity is referred to as a VIE if it meets at least one of the following criteria:  (i) the entity has equity that is insufficient to permit the entity to finance its activities without the additional subordinated financial support of other parties; or (ii) 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 (iii) the holders of the equity investment at risk have disproportional voting rights and the entity’s activities are conducted on behalf of the investor that has disproportionately 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 several financing transactions which resulted in the Company forming entities to facilitate these transactions.  In determining the accounting treatment to be applied to these transactions, the Company concluded that the entities used to facilitate these transactions are VIEs and that they should be consolidated.  If the Company had determined that consolidation was not required, it would have then assessed whether the transfers of the underlying assets would qualify as sale or should be accounted for as secured financings under GAAP. (See Note 15)

The Company also includes on its consolidated balance sheets certain financial assets and liabilities that are acquired/issued by trusts and/or other special purpose entities that have been evaluated as being required to be consolidated by the Company under the applicable accounting guidance.

(sOffering Costs Related to Issuance and Redemption of Preferred Stock

Offering costs related to the issuance of preferred stock are recorded as a reduction in Additional paid-in capital, a component of Stockholders’ Equity, at the time such preferred stock is issued. On redemption of preferred stock, any excess of the fair value of the consideration transferred to the holders of the preferred stock over the carrying amount of the preferred stock in the Company’s consolidated balance sheets is included in the determination of Net Income Available to Common Stock and Participating Securities in the calculation of EPS.

(tNew Accounting Standards and Interpretations

Accounting Standards Adopted in 2019

Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement

In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurements (“ASU 2018-13”). The amendments in ASU 2018-13 eliminate, add and modify certain disclosure requirements for fair value measurements as part of the FASB’s disclosure framework project, which aims to improve the effectiveness of disclosures in the notes to financial statements by focusing on requirements that are the most important to the users. The Company early adopted ASU 2018-13 effective on January 1, 2019 and its adoption did not have a significant impact on its financial position or financial statement disclosures.

Compensation - Stock Compensation - Improvements to Nonemployee Share-Based Payment Accounting

In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”). The amendments in this ASU simplify the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. The amendments in ASU 2018-07 do not change existing guidance on accounting for share-based payment transactions for employees. The Company adopted ASU 2018-07 on January 1, 2019 and its adoption did not have a significant impact on its financial position or financial statement disclosures.


16

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

Derivatives and Hedging - Targeted Improvements to Accounting for Hedging Activities

In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities (“ASU 2017-12”). The amendments in this ASU expand an entity’s ability to hedge non-financial and financial risk components and reduce complexity in fair value hedges of interest rate risk. The new guidance eliminates the requirement to separately measure and report hedge ineffectiveness and requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. ASU 2017-12 also simplifies certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. The Company adopted ASU 2017-12 on January 1, 2019 and its adoption did not have a significant impact on its financial statements or financial statement disclosures.

Receivables - Nonrefundable Fees and Other Costs

In March 2017, the FASB issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities (“ASU 2017-08”). The amendments in this ASU shorten the amortization period for certain purchased callable debt securities held at a premium to the earliest call date. The Company adopted ASU 2017-08 on January 1, 2019 and its adoption did not have a significant impact on its financial statements or financial statement disclosures.

Leases

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”). The amendments in this ASU establish a right-of-use model that requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The Company’s significant lease contracts are discussed in Note 10(a) of the consolidated financial statements. The Company adopted ASU 2016-02 on January 1, 2019 and, given the relatively limited nature and extent of lease financing transactions that the Company has entered into, its adoption did not have a material impact on its financial position or financial statement disclosures.
 


17

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

3.                   Residential Mortgage Securities and MSR-Related Assets
 
Agency and Non-Agency MBS

The Company’s MBS are comprised of Agency MBS and Non-Agency MBS which include MBS issued prior to 2008 (“Legacy 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”), which have interest rates that reset annually or more frequently (collectively, “ARM-MBS”); and (iii) 15 and 30 year fixed-rate mortgages for Agency MBS and, for Non-Agency MBS, 30-year and longer-term fixed rate mortgages. In addition, the Company’s MBS are also comprised of MBS backed by securitized re-performing/non-performing loans (“RPL/NPL MBS”), where the cash flows of the bond may not reflect the contractual cash flows of the underlying collateral. The Company’s RPL/NPL MBS are generally structured with a contractual coupon step-up feature where the coupon increases from 300 - 400 basis points at 36 - 48 months from issuance or sooner. The Company pledges a significant portion of its MBS as collateral against its borrowings under repurchase agreements and Swaps.  (See Note 7)
 
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.  The payment of principal and/or interest on Ginnie Mae MBS is explicitly 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:  The Company’s Non-Agency MBS are primarily secured by pools of residential mortgages, which are not guaranteed by an agency of the U.S. Government or any federally chartered corporation.  Credit risk associated with Non-Agency MBS is regularly assessed as new information regarding the underlying collateral becomes available and based on updated estimates of cash flows generated by the underlying collateral.
 
CRT Securities

CRT securities are debt obligations issued or sponsored by Fannie Mae and Freddie Mac. The payments of principal and interest on the CRT securities are paid by Fannie Mae or Freddie Mac, as the case may be, on a monthly basis, and are dependent on the performance of loans in either a reference pool or an actual pool of loans. As the loans in the underlying pool are paid, the principal balance of the CRT securities is paid. As an investor in a CRT security, the Company may incur a principal loss if the performance of the actual or reference pool loans results in either an actual or calculated loss that exceeds the credit enhancement of the security owned by the Company. The Company assesses the credit risk associated with CRT securities by assessing the current and expected future performance of the associated loan pool. The Company pledges a portion of its CRT securities as collateral against its borrowings under repurchase agreements.  (See Note 7)



18

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

The following tables present certain information about the Company’s residential mortgage securities at March 31, 2019 and December 31, 2018:
 
March 31, 2019
(In Thousands)
 
Principal/ Current
Face
 
Purchase
Premiums
 
Accretable
Purchase
Discounts
 
Discount
Designated
as Credit Reserve and 
OTTI (1)
 
Amortized
Cost (2)
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Net
Unrealized
Gain/(Loss)
 
Fair Value
Agency MBS: (3)
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
1,594,136

 
$
61,287

 
$
(24
)
 
$

 
$
1,655,399

 
$
11,697

 
$
(25,881
)
 
$
(14,184
)
 
$
1,641,215

Freddie Mac
 
871,714

 
35,450

 

 

 
907,687

 
2,635

 
(9,631
)
 
(6,996
)
 
900,691

Ginnie Mae
 
4,566

 
84

 

 

 
4,650

 
41

 

 
41

 
4,691

Total Agency MBS
 
2,470,416

 
96,821

 
(24
)
 

 
2,567,736

 
14,373

 
(35,512
)
 
(21,139
)
 
2,546,597

Non-Agency MBS:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

 
 

Expected to Recover Par (4)(5)
 
1,424,461

 
9

 
(20,410
)
 

 
1,404,060

 
21,802

 
(1,602
)
 
20,200

 
1,424,260

Expected to Recover Less than Par (4)
 
1,861,227

 

 
(109,737
)
 
(501,619
)
 
1,249,871

 
425,519

 
(378
)
 
425,141

 
1,675,012

Total Non-Agency MBS (6)
 
3,285,688

 
9

 
(130,147
)
 
(501,619
)
 
2,653,931

 
447,321

 
(1,980
)
 
445,341

 
3,099,272

Total MBS
 
5,756,104

 
96,830

 
(130,171
)
 
(501,619
)
 
5,221,667

 
461,694

 
(37,492
)
 
424,202

 
5,645,869

CRT securities (7)
 
406,338

 
7,519

 
(15
)
 

 
413,842

 
11,646

 
(1,786
)
 
9,860

 
423,702

Total MBS and CRT securities
 
$
6,162,442

 
$
104,349

 
$
(130,186
)
 
$
(501,619
)
 
$
5,635,509

 
$
473,340

 
$
(39,278
)
 
$
434,062

 
$
6,069,571


December 31, 2018
(In Thousands)
 
Principal/ Current
Face
 
Purchase
Premiums
 
Accretable
Purchase
Discounts
 
Discount
Designated
as Credit Reserve and 
OTTI (1)
 
Amortized
Cost (2)
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Net
Unrealized
Gain/(Loss)
 
Fair Value
Agency MBS: (3)
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
1,716,340

 
$
65,930

 
$
(24
)
 
$

 
$
1,782,246

 
$
12,107

 
$
(32,321
)
 
$
(20,214
)
 
$
1,762,032

Freddie Mac
 
909,561

 
36,991

 

 

 
947,588

 
907

 
(17,177
)
 
(16,270
)
 
931,318

Ginnie Mae
 
4,729

 
87

 

 

 
4,816

 
47

 

 
47

 
4,863

Total Agency MBS
 
2,630,630

 
103,008

 
(24
)
 

 
2,734,650

 
13,061

 
(49,498
)
 
(36,437
)
 
2,698,213

Non-Agency MBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Expected to Recover Par (4)(5)
 
1,536,485

 
40

 
(21,725
)
 

 
1,514,800

 
20,520

 
(7,620
)
 
12,900

 
1,527,700

Expected to Recover Less than Par (4)
 
2,002,319

 

 
(133,300
)
 
(516,116
)
 
1,352,903

 
438,465

 
(769
)
 
437,696

 
1,790,599

Total Non-Agency MBS (6)
 
3,538,804

 
40

 
(155,025
)
 
(516,116
)
 
2,867,703

 
458,985

 
(8,389
)
 
450,596

 
3,318,299

Total MBS
 
6,169,434

 
103,048

 
(155,049
)
 
(516,116
)
 
5,602,353

 
472,046

 
(57,887
)
 
414,159

 
6,016,512

CRT securities (7)
 
476,744

 
9,321

 
107

 

 
486,172

 
12,545

 
(5,896
)
 
6,649

 
492,821

Total MBS and CRT securities
 
$
6,646,178

 
$
112,369

 
$
(154,942
)
 
$
(516,116
)
 
$
6,088,525

 
$
484,591

 
$
(63,783
)
 
$
420,808

 
$
6,509,333

 
(1)
Discount designated as Credit Reserve and amounts related to OTTI are generally not expected to be accreted into interest income.  Amounts disclosed at March 31, 2019 reflect Credit Reserve of $489.1 million and OTTI of $12.5 million.  Amounts disclosed at December 31, 2018 reflect Credit Reserve of $503.3 million and OTTI of $12.8 million.
(2)
Includes principal payments receivable of $524,000 and $1.0 million at March 31, 2019 and December 31, 2018, respectively, which are not included in the Principal/Current Face.
(3)
Amounts disclosed at March 31, 2019 and December 31, 2018 include Agency MBS with a fair value of $714.7 million and $736.5 million, respectively, for which the fair value option has been elected. Such securities had gross unrealized gains of $2.7 million and no unrealized losses at March 31, 2019, and no unrealized gains and gross unrealized losses of approximately $3.3 million at December 31, 2018, respectively.
(4)
Based on managements current estimates of future principal cash flows expected to be received.
(5)
Includes RPL/NPL MBS, which at March 31, 2019 had a $1.3 billion Principal/Current face, $1.3 billion amortized cost and $1.3 billion fair value. At December 31, 2018, RPL/NPL MBS had a $1.4 billion Principal/Current face, $1.4 billion amortized cost and $1.4 billion fair value.
(6)
At March 31, 2019 and December 31, 2018, the Company expected to recover approximately 85% and 85% of the then-current face amount of Non-Agency MBS, respectively.
(7)
Amounts disclosed at March 31, 2019 includes CRT securities with a fair value of $403.3 million for which the fair value option has been elected. Such securities had gross unrealized gains of approximately $11.4 million and gross unrealized losses of approximately $1.8 million at March 31, 2019. Amounts disclosed at December 31, 2018 includes CRT securities with a fair value of $477.4 million for which the fair value option has been elected. Such securities had gross unrealized gains of approximately $12.5 million and gross unrealized losses of approximately $5.6 million at December 31, 2018.
 


19

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019


Sales of Residential Mortgage Securities
 
During the three months ended March 31, 2019, the Company sold certain CRT securities for $83.4 million, realizing gains of $6.5 million. In addition, during the three months ended March 31, 2019, the Company sold certain Non-Agency MBS for $126.1 million, realizing gains of $18.2 million. During the three months ended March 31, 2018, the Company sold certain Non-Agency MBS for $19.4 million, realizing gains of $8.8 million. The Company has no continuing involvement with any of the sold MBS.

Unrealized Losses on Residential Mortgage Securities

The following table presents information about the Company’s residential mortgage securities that were in an unrealized loss position at March 31, 2019:
 
Unrealized Loss Position For:
 
 
Less than 12 Months
 
12 Months or more
 
Total
 
Fair Value
 
Unrealized Losses
 
Number of Securities
Fair Value
 
Unrealized Losses
 
Number of Securities
Fair Value
 
Unrealized Losses
(Dollars in Thousands)
Agency MBS: 
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
99,955

 
$
858

 
52

 
$
860,036

 
$
25,023

 
303

 
$
959,991

 
$
25,881

Freddie Mac
 
242

 
1

 
1

 
277,334

 
9,630

 
126

 
277,576

 
9,631

Total Agency MBS
 
100,197

 
859

 
53

 
1,137,370

 
34,653

 
429

 
1,237,567

 
35,512

Non-Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Expected to Recover Par (1)
 
290,671

 
636

 
5

 
91,257

 
966

 
4

 
381,928

 
1,602

Expected to Recover Less than Par (1)
 
13,382

 
316

 
8

 
2,009

 
62

 
1

 
15,391

 
378

Total Non-Agency MBS
 
304,053

 
952

 
13

 
93,266

 
1,028

 
5

 
397,319

 
1,980

Total MBS
 
404,250

 
1,811

 
66

 
1,230,636

 
35,681

 
434

 
1,634,886

 
37,492

CRT securities (2)
 
136,760

 
1,786

 
33

 

 

 

 
136,760

 
1,786

Total MBS and CRT securities
 
$
541,010

 
$
3,597

 
99

 
$
1,230,636

 
$
35,681

 
434

 
$
1,771,646

 
$
39,278


(1)
Based on management’s current estimates of future principal cash flows expected to be received.
(2)
Amounts disclosed at March 31, 2019 include CRT securities with a fair value of $136.8 million for which the fair value option has been elected. Such securities had unrealized losses of $1.8 million at March 31, 2019.

At March 31, 2019, the Company did not intend to sell any of its investments that were in an unrealized loss position, and it is “more likely than not” that the Company will not be required to sell these securities before recovery of their amortized cost basis, which may be at their maturity. 
 
Gross unrealized losses on the Company’s Agency MBS were $35.5 million at March 31, 2019.  Agency MBS are issued by Government Sponsored Entities (“GSEs”) and enjoy either the implicit or explicit backing of the full faith and credit of the U.S. Government. While the Company’s Agency MBS are not rated by any rating agency, they are currently perceived by market participants to be of high credit quality, with risk of default limited to the unlikely event that the U.S. Government would not continue to support the GSEs. 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 its maturity, the Company considers for each impaired security, 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, 2019 any unrealized losses on its Agency MBS were temporary.

Gross unrealized losses on the Company’s Non-Agency MBS were $2.0 million at March 31, 2019. Based upon the most recent evaluation, the Company does not consider these unrealized losses to be indicative of OTTI and does not believe that these unrealized losses are credit related, but are rather a reflection of current market yields and/or marketplace bid-ask spreads.  The Company has reviewed its Non-Agency MBS that are in an unrealized loss position to identify those securities with losses that

20

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

are other-than-temporary based on an assessment of changes in expected cash flows for such securities, which considers recent bond performance and, where possible, expected future performance of the underlying collateral.
  
The Company did not recognize any credit-related OTTI losses through earnings related to its Non-Agency MBS during the three months ended March 31, 2019 and 2018. Non-Agency 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 these 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 past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, year of origination, LTVs, geographic concentrations, and dialogue with market participants.  Changes in the Company’s evaluation of each of these factors impacts the cash flows expected to be collected at the OTTI assessment date. For Non-Agency MBS purchased at a discount to par that were assessed for and had no OTTI recorded this period, such cash flow estimates indicated that the amount of expected losses decreased compared to the previous OTTI assessment date. These positive cash flow changes are primarily driven by recent improvements in LTVs due to loan amortization and home price appreciation, which, in turn, positively impacts the Company’s estimates of default rates and loss severities for the underlying collateral. In addition, voluntary prepayments (i.e., loans that prepay in full with no loss) have generally trended higher relative to the Company’s assumptions for these MBS which also positively impacts the Company’s estimate of expected loss. Overall, the combination of higher voluntary prepayments and lower LTVs supports the Company’s assessment that such MBS are not other-than-temporarily impaired.

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 OCI.  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 Months Ended
March 31,
(In Thousands)
 
2019
 
2018
Credit loss component of OTTI at beginning of period
 
$
39,596

 
$
38,337

Additions for credit related OTTI not previously recognized
 

 

Subsequent additional credit related OTTI recorded
 

 

Credit loss component of OTTI at end of period
 
$
39,596

 
$
38,337



21

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

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 OTTI and accretable purchase discount for the three months ended March 31, 2019 and 2018:

 
 
Three Months Ended
March 31, 2019
 
Three Months Ended
March 31, 2018
(In Thousands)
 
Discount
Designated as
Credit Reserve and OTTI
 
Accretable
Discount
(1) 
Discount
Designated as
Credit Reserve and OTTI
 
 Accretable Discount (1)
Balance at beginning of period
 
$
(516,116
)
 
$
(155,025
)
 
$
(593,227
)
 
$
(215,325
)
Impact of RMBS Issuer Settlement (2)
 

 
(855
)
 

 

Accretion of discount
 

 
13,307

 

 
17,216

Realized credit losses
 
7,504

 

 
8,447

 

Purchases
 

 
(118
)
 
(535
)
 
488

Sales
 
3,191

 
16,346

 
5,592

 
5,105

Transfers/release of credit reserve
 
3,802

 
(3,802
)
 
7,143

 
(7,143
)
Balance at end of period
 
$
(501,619
)
 
$
(130,147
)
 
$
(572,580
)
 
$
(199,659
)

(1)
Together with coupon interest, accretable purchase discount is recognized as interest income over the life of the security.
(2)
Includes the impact of approximately $855,000 of cash proceeds (a one-time payment) received by the Company during the three months ended March 31, 2019 in connection with the settlement of litigation related to certain residential mortgage backed securitization trusts that were sponsored by JP Morgan Chase & Co. and affiliated entities.

MSR-Related Assets

(a) Term Notes Backed by MSR-Related Collateral

At March 31, 2019 and December 31, 2018, the Company had $753.6 million and $538.5 million, respectively, of term notes issued by SPVs that have acquired rights to receive cash flows representing the servicing fees and/or excess servicing spread associated with certain MSRs. Payment of principal and interest on these term notes is considered to be largely dependent on cash flows generated by the underlying MSRs, as this impacts the cash flows available to the SPV that issued the term notes.

At March 31, 2019, these term notes had an amortized cost of $753.1 million, gross unrealized gains of approximately $505,230, a weighted average yield of 5.44% and a weighted average term to maturity of 4.4 years. At December 31, 2018, the term notes had an amortized cost of $538.5 million, gross unrealized losses of $7,000, a weighted average yield of 5.32% and a weighted average term to maturity of 4.7 years.

(b) Corporate Loans

The Company has made or participated in loans to provide financing to entities that originate residential mortgage loans and own the related MSRs. These corporate loans are secured by MSRs, as well as certain other unencumbered assets owned by the borrower.

During the year ended December 31, 2018, the Company participated in a loan where the Company committed to lend $100.0 million of which approximately $71.8 million was drawn at March 31, 2019. At March 31, 2019, the coupon paid by the borrower on the drawn amount is 5.87%, the remaining term associated with the loan is 1.4 years and the remaining commitment period on any undrawn amount is 1.4 years. During the remaining commitment period, the Company receives a commitment fee between 0.25% and 1.0% based on the undrawn amount of the loan.

In December 2016, the Company entered into a loan agreement under the terms of which it had committed to lend $130.0 million, of which approximately $124.2 million was drawn at March 31, 2018. This loan was paid in full during the three months ended June 30, 2018, at which time any remaining commitment was extinguished.

22

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019


Impact of AFS Securities on AOCI
 
The following table presents the impact of the Company’s AFS securities on its AOCI for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended March 31,
(In Thousands)
2019
 
2018
AOCI from AFS securities:
 
 

 
 

Unrealized gain on AFS securities at beginning of period
 
$
417,167

 
$
620,648

Unrealized gain/(loss) on Agency MBS, net
 
9,315

 
(10,052
)
Unrealized gain/(loss) on Non-Agency MBS, net
 
12,276

 
(27,724
)
Unrealized gain on MSR term notes, net
 
512

 
236

Reclassification adjustment for MBS sales included in net income
 
(17,009
)
 
(8,623
)
Change in AOCI from AFS securities
 
5,094

 
(46,163
)
Balance at end of period
 
$
422,261

 
$
574,485

 

23

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

Interest Income on Residential Mortgage Securities and MSR-Related Assets
 
The following table presents the components of interest income on the Company’s residential mortgage securities and MSR- related assets for the three months ended March 31, 2019 and 2018
 
 
Three Months Ended March 31,
(In Thousands)
 
2019
 
2018
Agency MBS
 
 
 
 
Coupon interest
 
$
24,628

 
$
20,958

Effective yield adjustment (1)
 
(6,187
)
 
(5,665
)
Interest income
 
$
18,441

 
$
15,293

 
 
 
 
 
Legacy Non-Agency MBS
 
 
 
 
Coupon interest
 
$
24,272

 
$
28,835

Effective yield adjustment (2)
 
13,144

 
17,201

Interest income
 
$
37,416

 
$
46,036

 
 
 
 
 
RPL/NPL MBS
 
 
 
 
Coupon interest
 
$
16,443

 
$
10,053

Effective yield adjustment (1)(3)
 
142

 
13

Interest income
 
$
16,585

 
$
10,066

 
 
 
 
 
CRT securities
 
 
 
 
Coupon interest
 
$
6,118

 
$
8,374

Effective yield adjustment (2)
 
82

 
1,122

Interest income
 
$
6,200

 
$
9,496

 
 
 
 
 
MSR-related assets
 
 
 
 
Coupon interest
 
$
10,587

 
$
7,517

Effective yield adjustment (1)
 
33

 
106

Interest income
 
$
10,620

 
$
7,623

 
(1)  Includes amortization of premium paid net of accretion of purchase discount.  For Agency MBS, RPL/NPL MBS and the corporate loan secured by MSRs, interest income is recorded at an effective yield, which reflects net premium amortization/accretion based on actual prepayment activity.
(2) The effective yield adjustment is the difference between the net income calculated using the net yield, which is based on management’s estimates of the amount and timing of future cash flows, less the current coupon yield.
(3) Includes accretion income recognized due to the impact of redemptions of certain securities that had been previously been purchased at a discount of approximately $148,000 during the three months ended March 31, 2019.


24

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

4.    Residential Whole Loans

Included on the Company’s consolidated balance sheets at March 31, 2019 and December 31, 2018 are approximately $5.2 billion and $4.7 billion, respectively, of residential whole loans arising from the Company’s interests in certain trusts established to acquire the loans and certain entities established in connection with its loan securitization transactions. The Company has assessed that these entities are required to be consolidated for financial reporting purposes.

Residential Whole Loans, at Carrying Value

The following table presents the components of the Company’s Residential whole loans, at carrying value at March 31, 2019 and December 31, 2018:
(Dollars In Thousands)
 
March 31, 2019
 
December 31, 2018
Purchased Performing Loans:
 
 
 
 
Non-QM loans
 
$
1,886,024

 
$
1,354,774

Rehabilitation loans
 
621,292

 
494,576

Single-family rental loans
 
227,537

 
145,327

Seasoned performing loans
 
215,352

 
224,051

Total Purchased Performing Loans
 
2,950,205

 
2,218,728

Purchased Credit Impaired Loans
 
773,941

 
797,987

Total Residential whole loans, at carrying value
 
$
3,724,146

 
$
3,016,715

 
 
 
 
 
Number of loans
 
12,643

 
11,149


The following table presents components of interest income on the Company’s Residential whole loans, at carrying value for the three months ended March 31, 2019 and 2018:
 
 
Three Months Ended
March 31,
 (In Thousands)
 
2019
 
2018
Purchased Performing Loans:
 
 
 
 
Non-QM loans
 
$
22,414

 
$
1,708

Rehabilitation loans
 
9,933

 
1,345

Single-family rental loans
 
2,701

 
245

Seasoned performing loans
 
3,173

 

Total Purchased Performing Loans
 
38,221

 
3,298

Purchased Credit Impaired Loans
 
11,399

 
11,031

Total Residential whole loans, at carrying value
 
$
49,620

 
$
14,329




25

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2019

The following table presents additional information regarding the Company’s Residential whole loans, at carrying value at March 31, 2019:

March 31, 2019
 
 
Carrying Value
 
Unpaid Principal Balance (“UPB”)
 
Weighted Average Coupon (1)
 
Weighted Average Term to Maturity (Months)
 
Weighted Average LTV Ratio (2)
 
Aging by UPB
 
 
 
 
 
 
 
 
 
Past Due Days
(Dollars In Thousands)
 
 
 
 
 
 
Current
 
30-59
 
60-89
 
90+
Purchased Performing Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-QM loans
 
$
1,886,024

 
$
1,826,161

 
6.20
%
 
363
 
66
%
 
$
1,782,675

 
$
29,474

 
$
5,745