Mortgage REITs’ investors have witnessed a bloodbath since Ben Bernanke sent confusing signals of a possible Fed tapering before the end of this year. While the entire sector is down since the start of the second quarter, I have reasons to believe MFA Financial, Inc. (NYSE:MFA) has a better shot than its peers. Let’s see why?
The edge
MFA Financial operates as a hybrid mortgage REIT with investments in both Agency and non-Agency backed mortgage backed securities. While the company is structured like its peers Invesco Mortgage Capital Inc (NYSE:IVR) and Javelin Mortgage Investment Corp (NYSE:JMI), MFA Financial has a competitive edge.
The competitive edge is the company’s non-Agency MBS strategy. The company has allocated a larger chunk to the non-Agency paper. Around 67% of its equity is allotted to to high yielding non-Agency MBS, while the remainder is Agency paper and cash. This large concentration in the non-Agency paper brings a competitive edge to the company as they are high-yielding assets usually bought on a discount to their par values.
Non-Agency MBS are not backed by the government, which is why they are not part of the Fed’s bond buying program. If the Fed decides to cool down its Agency MBS purchases, MFA Financial’s non-Agency could provide support to its book value.
The California effect
The housing fundamental trends have given mixed signals over the past few months. However, the situation in California is better. A combination of low mortgage rates, rising multifamily rents, limited housing supply, and capital flows into the own-to-rent purchases have led to price appreciation in the California region.
MFA Financial, Inc. (NYSE:MFA)’s largest chunk of residential MBS lies in this region. Around 46% of the company’s non-Agency holdings are from this region, followed by 8% in Florida. Home prices have appreciated as much as 17% over the past few months in Alameda, within the California region. Stabilized or increased home prices provide higher MBS yields. Therefore, you can expect the company’s non-Agency MBS to provide major support to the second quarter’s bottom line.
Fewer losses
During the first quarter, the company’s non-Agency MBS produced an unlevered loss adjusted yield of 6.8%. Going forward, you can expect this loss adjusted unlevered yield to go up as the company expects fewer losses due to home price appreciation coupled with mortgage amortization.
Competition
Let’s look at a couple of MFA Financial, Inc. (NYSE:MFA)’s peers to explore their potential.
Invesco Mortgage Capital is another hybrid mortgage REIT that has structured its portfolio to benefit from increasing mortgage rates. However, if the Fed prolongs or accelerates its bond buying program, you can expect the company to report lower income and a possible dividend cut.
If the Fed halts its bond buying program and the mortgage rates climb 50 bps, you can expect Invesco Mortgage to report over 19% increase in its net interest income. However, a decline in the rates, coupled with higher cost of funds due to a funding base diversification, can lead to compression in its spread. While the shift to term financing decreases exposure to repos, it will also increase the cost of funds for Invesco Mortgage.
Javelin Mortgage Investment is another hybrid mortgage REIT and a sister concern of ARMOUR Residential REIT, Inc. (NYSE:ARR), a major pure-play mortgage REIT. ARMOUR and Javelin have been the worst and second-worst performers amid speculations about the Fed’s exit. Javelin has structured its portfolio in such a way that it will clearly not benefit in an increasing interest rate environment.
During an increasing interest rate environment, which is highly likely, Javelin would probably report a decline in its next quarter’s interest income. Besides, Javelin is highly leveraged (at 7.9 times), which can magnify the negative impact of adverse changes in interest rates or any disruptions in its sole funding source (the repos).
Therefore, MFA Financial, Inc. (NYSE:MFA) has a better shot than both Invesco Mortgage and Javelin Mortgage during times of rising interest rates.
Foolish takeaway
Fewer anticipated losses, the company’s non-Agency MBS’ concentration within the California region, and a relatively higher proportion of non-Agency MBS in the entire investment portfolio lead me to think that MFA Financial will report a strong second quarter.
Adnan Khan has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned
The article A Few Reasons to Buy This 10% Yielder originally appeared on Fool.com.
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