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350 Park Avenue, New York, NY 10022
Telephone: 212.207.6400
Fax: 212.207.6420
www.mfafinancial.com
F I N A N C I A L , I N C.
F I N A N C I A L , I N C.
2 0 1 7 A N N U A L R E P O R T
2017 ANNUAL REPORT CONTENTS: LET TER TO SHAREHOLDERS | FORM 10 -K | STOCK PERFORMANCE GR APH | CORPOR ATE INFORMATION
James Casebere, Landscape with Houses
(Dutchess County, NY) #2, 2010 (detail)
IN MEMORY OF OUR FR IEND AND COLLE AGUE BILL GOR IN
For nearly two decades, Bill’s steady hand guided MFA Financial to outstanding
results for our shareholders and employees. More importantly, Bill was a trusted
friend, mentor, husband and father.
We will miss him greatly.
F I N A N C I A L , I N C.
The Board of Directors and Employees of MFA Financial, Inc.
F I N A N C I A L , I N C.
M FA F I N A NCI A L , I NC . is an internally managed real estate investment trust (REIT)
with the objective of delivering shareholder value through the generation of distributable income
and through asset performance linked to residential mortgage credit fundamentals. We selectively
invest, on a leveraged basis, in residential mortgage assets with a focus on credit analysis, projected
prepayment rates, interest rate sensitivity and expected return.
2017 ANNUAL REPORT
PAGE ONE
DE A R F E L L OW SH A R E HOL DE R S,
DURING 2017, MFA FURTHER EXECUTED ITS STR ATEGY OF SELECTIVE INVESTMENT WITHIN THE RESIDENTIAL
MORTGAGE CREDIT UNIVERSE . OUR MANY YEARS OF EXPERIENCE IN ANALY ZING AND INVESTING IN SUCH
A SSETS COUPLED WITH OUR DILIGENT OVERSIGHT AND PORTFOLIO MANAGEMENT CONTINUE TO PRODUCE
STRONG INVESTMENT RETURNS THAT ARE MORE DEPENDENT ON CREDIT PERFORMANCE THAN ON INTEREST
R ATES. OUR PERMANENT CAPITAL REIT STRUCTURE PROVIDES US WITH THE STAYING POWER TO HOLD THESE
ASSETS THROUGHOUT MARKET CYCLES.
During 2017, the Federal Reserve increased the target Federal Funds
rate three times (compared to only one such increase in each of 2015
and 2016). While higher short-term interest rates increase the cost of
MFA’s borrowing, our strategy of shifting our investment focus from
interest rate sensitive assets to credit sensitive assets has moderated
this effect, as our credit sensitive assets require less leverage to produce
our target returns. As a result, MFA’s net income available to common
shareholders has remained consistent over the last three years despite
five Federal Funds rate increases since December 2015. MFA share-
holders earned a total return (including reinvestment of dividends) of
14.3% for calendar year 2017.
2017 was an eventful year beginning with the U.S. presidential inau-
guration in January. While the political landscape has monopolized
headlines, the financial markets featured strong stock market gains,
generally benign interest rate movements and a continuous grind
tighter on nearly all asset classes. Investment activity was at times
challenging, as higher prices adversely affected risk and return rela-
tionships. Further exacerbating this challenge was the fact that MFA
experienced unprecedented portfolio run-off in 2017 ($4.3 billion vs.
$3.5 billion in 2016), which generated additional pressure to make
new investments. We are extremely proud of our investment team,
which was able to maintain pricing discipline in this environment
and worked tirelessly to source assets both within our existing asset
classes as well as through new opportunities. We believe that we were
able to identify and take advantage of attractive investments that will
provide meaningful returns for our shareholders over time.
Despite this challenging investment environment, we significantly
grew our investments in re-performing and non-performing whole
loans, increasing our holdings of credit sensitive residential whole
loans by approximately $1 billion to approximately $2.4 billion. This
loan portfolio provides exposure to residential mortgage credit, while
offering us the opportunity to improve outcomes through our over-
sight of sensible and effective servicing decisions. In addition, we
added and expanded investments in assets related to mortgage servicing
rights (MSR) to nearly $500 million which provide attractive current
returns on equity. We also grew our portfolio of GSE credit risk
transfer (CRT) securities by over 50% to $664 million at year end.
Both MSR-related assets and CRT securities are structured as floating
rate coupons, so our realized ROE on these investments actually
increases as the Federal Reserve acts to raise interest rates.
Our credit sensitive residential assets benefited from improved housing
fundamentals. Home price appreciation and underlying mortgage
loan amortization have decreased the loan-to-value ratio (“LTV”) of
many of the mortgages underlying MFA’s Non-Agency MBS issued
prior to 2008 (Legacy Non-Agency MBS). In addition, delinquencies
continue to decline. Due to these important credit indicators and
other factors, we again reduced our estimate of future defaults and
losses during the year. This decrease in estimated future losses is
expected to increase the interest income realized over the remaining
life of MFA’s Legacy Non-Agency MBS.
We also took advantage of market opportunities to lock in attractive
financing through two securitizations in 2017. We sponsored a rated
securitization in the second quarter backed by re-performing whole
loans, and we sponsored a non-rated securitization in the fourth
quarter backed by non-performing whole loans. These transactions
provide attractive term financing at a fixed rate that does not increase
as interest rates increase.
2018 AND BEYOND
With significant liquidity, a short duration portfolio and a low level
of leverage, MFA has considerable capacity to take advantage of
market opportunities. Global economic growth appears to be accel-
erating and recent U.S. tax reform seems to be bolstering domestic
growth. These are good omens for MFA’s substantial residential
mortgage credit investments, as are continued robust home sales and
declining housing inventory, which augment home prices. We expect
that economic growth will likely keep the Federal Reserve on its path
of increasing the target Fed Funds rate, and together with the Federal
Reserve’s announced normalization of its balance sheet, there exists a
possibility of some market disruption that could foster attractive
investment prospects. We believe we are well positioned to continue
to take advantage of investment opportunities within the residential
mortgage universe as they arise. On behalf of the Board of Directors
and all of MFA’s dedicated and talented employees, we thank you for
your continued ownership and support.
CRAIG L. KNUTSON
Chief Executive Officer, President and Director
Various forward-looking statements are made in this Annual Report, which generally include the words “ believe,” “expect,” “may,” “will,” “anticipate,”
“estimate” and similar expressions. Certain factors that may affect these forward-looking statements, including MFA’s ability to achieve its goals and
meet its objectives, are discussed on pages 5 to 28 and page 77 of MFA’s Annual Report on Form 10-K, which is a part hereof.
2017 ANNUAL REPORT
PAGE T WO
F O R M 1 0 - K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
OR
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)
350 Park Avenue, 20th Floor, New York, New York
(Address of principal executive offices)
13-3974868
(I.R.S. Employer Identification No.)
10022
(Zip Code)
(212) 207-6400
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock, par value $0.01 per share
7.50% Series B Cumulative Redeemable
Preferred Stock, par value $0.01 per share
8.00% Senior Notes due 2042
Name of Each Exchange on Which Registered
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes
No
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
No
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
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the
definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Non-accelerated filer
Accelerated filer
Smaller reporting company
Emerging growth company
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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes
No
On June 30, 2017, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $3.3 billion based on the closing
sales price of our common stock on such date as reported on the New York Stock Exchange.
On February 8, 2018, the registrant had a total of 398,423,464 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s proxy statement to be filed with the Securities and Exchange Commission in connection with the Annual Meeting of Stockholders
scheduled to be held on or about May 23, 2018, are incorporated by reference into Part III of this Annual Report on Form 10-K.
This page intentionally left blank
TABLE OF CONTENTS
PART I
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
PART II
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Quantitative and Qualitative Disclosures About Market Risk
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
PART III
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions and Director Independence
Principal Accountant Fees and Services
PART IV
Item 15.
Exhibits and Financial Statement Schedules
Signatures
1
5
29
29
29
29
30
34
36
74
82
143
143
146
146
146
146
146
146
147
148
In this Annual Report on Form 10-K, references to “we,” “us,” “our” or “the Company” refer to MFA Financial, Inc. and
its subsidiaries unless specifically stated otherwise or the context otherwise indicates. The following defines certain of the
commonly used terms in this Annual Report on Form 10-K: MBS generally refers to mortgage-backed securities secured by pools
of residential mortgage loans; Agency MBS refers to MBS that are issued or guaranteed 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”); Non-
Agency MBS refers to MBS that are not guaranteed by any agency of the U.S. Government or any federally chartered corporation
and include (i) Legacy Non-Agency MBS, which are Non-Agency MBS issued prior to 2008, and (ii) RPL/NPL MBS, which refers
to MBS backed by securitized re-performing and non-performing loans and are structured with a contractual coupon step-up
feature where the coupon increases up to 300 basis points at 36 months from issuance or sooner. Hybrids refer to hybrid mortgage
loans that 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; ARMs refer to adjustable-rate mortgage loans and to Hybrids that are past their fixed-rate
period, both of which typically have interest rates that adjust annually to an increment over a specified interest rate index; CRT
securities refer to credit risk transfer securities which are debt obligations issued by Fannie Mae and Freddie Mac; and MSRs
refer to mortgage servicing rights with respect to residential loans.
CAUTIONARY NOTE REGARDING FORWARD LOOKING STATEMENTS
This Annual Report on Form 10-K includes forward-looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995, which are subject to risks and uncertainties. The forward-looking statements contain words such as “will,”
“believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “could,” “would,” “may” or similar
expressions.
These forward-looking statements include information about possible or assumed future results with respect to our business,
financial condition, liquidity, results of operations, plans and objectives. Statements regarding the following subjects, among
others, may be forward-looking: changes in interest rates and the market (i.e., fair) value of our MBS, residential whole loans,
CRT securities and other assets; changes in the prepayment rates on the mortgage loans securing our MBS, an increase of which
could result in a reduction of the yield on MBS in our portfolio and an increase of which could require us to reinvest the proceeds
received by us as a result of such prepayments in MBS with lower coupons; credit risks underlying our assets, including changes
in the default rates and management’s assumptions regarding default rates on the mortgage loans securing our Non-Agency MBS
and relating to our residential whole loan portfolio; our ability to borrow to finance our assets and the terms, including the cost,
maturity and other terms, of any such borrowings; implementation of or changes in government regulations or programs affecting
our business; our estimates regarding taxable income the actual amount of which is dependent on a number of factors, including,
but not limited to, changes in the amount of interest income and financing costs, the method elected by us to accrete the market
discount on Non-Agency MBS and residential whole loans and the extent of prepayments, realized losses and changes in the
composition of our Agency MBS, Non-Agency MBS and residential whole loan portfolios that may occur during the applicable
tax period, including gain or loss on any MBS disposals and whole loan modification foreclosure and liquidation; the timing and
amount of distributions to stockholders, which are declared and paid at the discretion of our Board and will depend on, among
other things, our taxable income, our financial results and overall financial condition and liquidity, maintenance of our REIT
qualification and such other factors as the Board deems relevant; our ability to maintain our qualification as a REIT for federal
income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act of 1940, as
amended (or the Investment Company Act), including statements regarding the concept release issued by the SEC relating to
interpretive issues under the Investment Company Act with respect to the status under the Investment Company Act of certain
companies that are engaged in the business of acquiring mortgages and mortgage-related interests; our ability to successfully
implement our strategy to grow our residential whole loan portfolio, which is dependent on, among other things, the supply of
loans offered for sale in the market; expected returns on our investments in nonperforming loans (or NPLs), which are affected
by, among other things, the length of time required to foreclose upon, sell, liquidate or otherwise reach a resolution of the property
underlying the NPL, home price values, amounts advanced to carry the asset (e.g., taxes, insurance, maintenance expenses, etc.
on the underlying property) and the amount ultimately realized upon resolution of the asset; risks associated with our investments
in MSR related assets, including servicing, regulatory and economic risks, and risks associated with investing in real estate assets,
including changes in business conditions and the general economy. These and other risks, uncertainties and factors, including
those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ
materially from those projected in any forward-looking statements we make. All forward-looking statements are based on beliefs,
assumptions and expectations of our future performance, taking into account all information currently available. Readers are
cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are
made. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except
as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a
result of new information, future events or otherwise. (See Part I, Item 1A. “Risk Factors” of this Annual Report on Form 10-K)
Item 1. Business.
PART I
GENERAL
We are primarily engaged in the real estate finance business. We engage in our business through subsidiaries that invest, on
a leveraged basis, in residential mortgage assets, including Non-Agency MBS, Agency MBS, residential whole loans, CRT
securities and MSR related assets. Our principal business objective is to deliver shareholder value through the generation of
distributable income and through asset performance linked to residential mortgage credit fundamentals. We selectively invest in
residential mortgage assets with a focus on credit analysis, projected prepayment rates, interest rate sensitivity and expected return.
We were incorporated in Maryland on July 24, 1997, and began operations on April 10, 1998. We have elected to be treated
as a real estate investment trust (or REIT) for U.S. federal income tax purposes. In order to maintain our qualification as a REIT,
we must comply with a number of requirements under federal tax law, including that we must distribute at least 90% of our annual
REIT taxable income to our stockholders. We have elected to treat certain of our subsidiaries as a taxable REIT subsidiary (or
TRS). In general, a TRS may hold assets and engage in activities that a REIT or qualified REIT subsidiary (or QRS) may not
hold or engage in directly and generally may engage in any real estate or non-real estate related business.
We are a holding company and conduct our real estate finance businesses primarily through wholly-owned subsidiaries, so
as to maintain an exemption from registration under the Investment Company Act of 1940, as amended (or the Investment Company
Act) by ensuring that less than 40% of the value of our total assets, exclusive of U.S. Government securities and cash items (which
we refer to as our adjusted total assets for Investment Company Act purposes), on an unconsolidated basis consist of “investment
securities” as defined by the Investment Company Act. We refer to this test as the “40% Test.”
INVESTMENT STRATEGY
As stated above, we primarily invest through subsidiaries in Non-Agency MBS, Agency MBS, residential whole loans, CRT
securities and MSR related assets.
Our Non-Agency MBS portfolio primarily consists of (i) Legacy Non-Agency MBS and (ii) RPL/NPL MBS. In addition
to Non-Agency MBS investments, we invest in re-performing and non-performing residential whole loans through our consolidated
trusts. Our strategy of combining investments in Agency MBS, Non-Agency MBS and residential whole loans is designed to
generate attractive returns with less overall sensitivity to changes in the yield curve, the general level of interest rates and
prepayments. The investment landscape is challenging, as market pricing for all asset classes remains high, thereby making it
difficult to purchase assets at attractive risk/reward levels. In addition, unlike Agency MBS, certain of our other asset classes are
not always available for purchase, as sellers offer these investments from time to time as opposed to more liquid markets which
feature active buyers and sellers at nearly all times. We expect that our purchase focus will be primarily on additional residential
mortgage assets, including residential whole loans.
1
Our Legacy Non-Agency MBS have been acquired primarily at discounts to face/par value, which we believe serves to
mitigate our exposure to credit risk. A portion of the purchase discount on substantially all of our Legacy Non-Agency MBS is
designated as a non-accretable discount (also referred to hereafter as Credit Reserve), which effectively mitigates our risk of loss
on the mortgages collateralizing such MBS and is not expected to be accreted into interest income. The portion of the purchase
discount that is designated as accretable discount is accreted into interest income over the life of the security. The mortgages
collateralizing our Legacy Non-Agency MBS consist primarily of ARMs, 30-year fixed-rate mortgages and Hybrids. Legacy
Non-Agency ARMs and Hybrids typically exhibit reduced interest rate sensitivity (as compared to fixed-rate Legacy Non-Agency
MBS) due to their interest rate adjustments (similar to Agency ARMs and Hybrids). However, yields on Legacy Non-Agency
MBS, unlike Agency MBS, also exhibit sensitivity to changes in credit performance. If credit performance improves, the Credit
Reserve may be decreased (and accretable discount increased), resulting in a higher yield over the remaining life of the security.
Similarly, deteriorating credit performance could increase the Credit Reserve and decrease the yield over the remaining life of the
security or other-than-temporary impairment could result. To the extent that higher interest rates in the future are indicative of an
improving economy, better employment data and/or higher home prices, it is possible that these factors will improve the credit
performance of Legacy Non-Agency MBS and therefore mitigate the interest rate sensitivity of these securities.
Our RPL/NPL MBS were purchased primarily at prices around par and represent the senior and mezzanine tranches of the
related securitizations. The majority of these securities are structured with significant credit enhancement (typically approximately
50%) and the subordinate tranches absorb all credit losses (until those tranches are extinguished) and typically receive no cash
flow (interest or principal) until the senior tranche is paid off. Prior to purchase, we analyze the deal structure in order to assess
the associated credit risk. Subsequent to purchase, the ongoing credit risk associated with the deal is evaluated by analyzing the
extent to which actual credit losses occur that result in a reduction in the amount of subordination enjoyed by our bond. Based
on the recent performance of the collateral underlying our RPL/NPL MBS and current subordination levels, we do not believe
that we are currently exposed to significant risk of credit loss on these investments. In addition, the structures of these investments
contain a contractual coupon step-up feature, where the coupon increases up to 300 basis points at 36 months or sooner. We expect
that the combination of the priority cash flow of the senior tranche and the 36-month step-up will result in these securities’ exhibiting
short average lives and, accordingly, reduced interest rate sensitivity. Consequently, we believe that RPL/NPL MBS provide
attractive returns given our assessment of the interest rate and credit risks associated with these securities.
The mortgages collateralizing our Agency MBS portfolio are predominantly Hybrids, 15-year fixed-rate mortgages and
ARMs. Our Agency MBS were selected to generate attractive returns relative to interest rate and prepayment risks. The Hybrid
loans collateralizing our MBS typically have initial fixed-rate periods at origination of three, five, seven or ten years. At the end
of this fixed-rate period, these mortgages become adjustable and their interest rates adjust based on the London Interbank Offered
Rate (or LIBOR) or in some cases the one-year constant maturity treasury rate (or CMT). These interest rate adjustments are
typically limited by periodic caps (which limit the amount of the interest rate change from the prior rate) and lifetime caps (which
are maximum interest rates permitted for the life of the mortgage). As coupons earned on Agency Hybrids and ARMs adjust over
time as interest rates change, these assets are generally less sensitive to changes in interest rates than are fixed-rate MBS. In
general, Hybrid loans and ARMs have 30-year final maturities and they amortize over this 30-year period. While the coupons on
15-year fixed-rate mortgages do not adjust, they amortize according to a 15-year amortization schedule and have a 15-year final
maturity. Due to their accelerated amortization and shorter final maturity, these assets are generally less sensitive to changes in
long-term interest rates as compared to fixed-rate mortgages with a longer final maturity, such as 30-year mortgages.
During 2017, we continued to invest in more credit sensitive, less interest rate sensitive residential whole loans, which we
acquired through interests in certain trusts established to acquire the loans, that are consolidated on our balance sheet for financial
reporting purposes. We expect this trend to continue during 2018. To date, we have focused primarily on purchasing packages
of both re-performing and non-performing whole loans. Re-performing loans are typically characterized by borrowers who have
experienced payment delinquencies in the past and the amount owed on the mortgage loan may exceed the value of the property
pledged as collateral. The majority of these loans are purchased at purchase prices that are discounted (often substantially so) to
the contractual loan balance to reflect the impaired credit history of the borrower, the loan-to-value (or LTV) of the loan and the
coupon. Non-performing loans are typically characterized by borrowers who have defaulted on their obligations and/or have
payment delinquencies of 60 days or more at the time we acquire the loan. The majority of these loans are also purchased at
purchase prices that are discounted (often substantially so) to the contractual loan balance that reflects primarily the non-performing
nature of the loan. Typically, this purchase price is a discount to the expected value of the collateral securing the loan, such value
to be realized after foreclosure and liquidation of the property. The majority of the residential whole loans were purchased on a
servicing-released basis (i.e., the sellers of such loans transferred the right to service the loans as part of the sale). Because we
do not directly service any loans, we have contracted with loan servicing companies with specific expertise in working with
delinquent borrowers in an effort to cure delinquencies through, among other things, loan modification and third-party refinancing.
To the extent these efforts are successful, we believe our investments in residential whole loans will yield attractive returns. In
addition, to the extent that it is not possible to achieve a successful outcome for a particular borrower and the real property collateral
must be foreclosed on and liquidated, we believe that the discounted purchase price at which the asset was acquired provides us
2
with a level of protection against financial loss. Given the increase in the size of our residential whole loan investments and our
ongoing focus on this asset class, we expect that balances of real estate owned (or REO) property to increase in the short- to
medium-term.
During the past several years, we have also invested in CRT securities. CRT securities are debt obligations issued 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 a reference pool of Agency MBS securitized
by the issuing entity. As an investor in a CRT security, we may incur a loss if losses on the mortgage loans in the reference pool
exceed the credit enhancement on the underlying CRT security owned by us. We assess the credit risk associated with CRT
securities by assessing the current and expected future performance of the associated reference pool. We pledge a portion of our
CRT securities as collateral against our borrowings under repurchase agreements.
Although we do not own or otherwise invest directly in MSRs, we have made investments in MSR related assets, which are
financial instruments whose cash flows are considered to be largely dependent on cash flows generated by underlying MSRs that
either directly or indirectly act as collateral for the investment. Credit risk on these investments is mitigated by structural credit
support in the form of over-collateralization as well as a corporate guarantee from the ultimate parent or sponsor of the MSR
related asset that is intended to provide for payment of interest and principal to the holders of the investments should cash flows
generated by the underlying MSRs be insufficient.
FINANCING STRATEGY
Our financing strategy is designed to increase the size of our investment portfolio by borrowing against a substantial portion
of the market value of the assets in our portfolio. We primarily use repurchase agreements to finance our holdings of residential
mortgage assets. We enter into interest rate derivatives to hedge the interest rate risk associated with a portion of our repurchase
agreement borrowings. Going forward, in connection with our current and any future investment in residential whole loans, our
financing strategy may include the use of additional loan securitization transactions or the use of other forms of structured financing.
Repurchase agreements, although legally structured as sale and repurchase transactions, are financing contracts (i.e.,
borrowings) under which we pledge our residential mortgage assets as collateral to secure loans with repurchase agreement
counterparties (i.e., lenders). Repurchase agreements involve the transfer of the pledged collateral to a lender at an agreed upon
price in exchange for such lender’s simultaneous agreement to return the same security back to the borrower at a future date (i.e.,
the maturity of the borrowing) at a higher price. The difference between the sale price that we receive and the repurchase price
that we pay represents interest paid to the lender. Our cost of borrowings under repurchase agreements is generally LIBOR based.
Under our repurchase agreements, we pledge our securities as collateral to secure the borrowing, which is equal in value to a
specified percentage of the fair value of the pledged collateral, while we retain beneficial ownership of the pledged collateral. At
the maturity of a repurchase financing, unless the repurchase financing is renewed with the same counterparty, we are required to
repay the loan including any accrued interest and concurrently receive back our pledged collateral from the lender. With the
consent of the lender, we may renew a repurchase financing at the then prevailing financing terms. Margin calls, whereby a lender
requires that we pledge additional securities or cash as collateral to secure borrowings under our repurchase financing with such
lender, are routinely experienced by us when the value of the MBS 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. We also may make margin calls
on counterparties when collateral values increase.
In order to reduce our exposure to counterparty-related risk, we generally seek to enter into repurchase agreements and other
financing arrangements, and derivatives, with a diversified group of financial institutions. At December 31, 2017, we had
outstanding balances under repurchase agreements with 31 separate lenders.
In addition to repurchase agreements and 8% Senior Notes due 2042 (or Senior Notes), we may also use other sources of
funding in the future to finance our residential mortgage assets, including, but not limited to, other types of collateralized borrowings,
loan agreements, lines of credit or the issuance of debt and/or equity securities.
3
COMPETITION
We operate in the mortgage REIT industry. We believe that our principal competitors in the business of acquiring and holding
residential mortgage assets of the types in which we invest are financial institutions, such as banks, savings and loan institutions,
specialty finance companies, insurance companies, institutional investors, including mutual funds and pension funds, hedge funds
and other mortgage REITs, as well as the U.S. Federal Reserve as part of its monetary policy activities. Some of these entities
may not be subject to the same regulatory constraints (i.e., REIT compliance or maintaining an exemption under the Investment
Company Act) as we are. In addition, many of these entities have greater financial resources and access to capital than we have.
The existence of these entities, as well as the possibility of additional entities forming in the future, may increase the competition
for the acquisition of residential mortgage assets, resulting in higher prices and lower yields on such assets.
EMPLOYEES
At December 31, 2017, we had 54 full-time and one part-time employee. We believe that our relationship with our employees
is good. None of our employees is unionized or represented under a collective bargaining agreement.
AVAILABLE INFORMATION
We maintain a website at www.mfafinancial.com. We make available, free of charge, on our website our (a) Annual Report
on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K (including any amendments thereto), proxy
statements and other information (or, collectively, the Company Documents) filed with, or furnished to, the Securities and Exchange
Commission (or SEC), as soon as reasonably practicable after such documents are so filed or furnished, (b) Corporate Governance
Guidelines, (c) Code of Business Conduct and Ethics and (d) written charters of the Audit Committee, Compensation Committee
and Nominating and Corporate Governance Committee of our Board of Directors (or our Board). Our Company Documents filed
with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov. We also provide copies of the foregoing
materials, free of charge, to stockholders who request them. Requests should be directed to the attention of our General Counsel
at MFA Financial, Inc., 350 Park Avenue, 20th Floor, New York, New York 10022.
4
Item 1A. Risk Factors.
This section highlights specific risks that could affect our Company and its business. Readers should carefully consider each
of the following risks and all of the other information set forth in this Annual Report on Form 10-K. Based on the information
currently known to us, we believe the following information identifies the most significant risk factors affecting our Company.
However, the risks and uncertainties we face are not limited to those described below. Additional risks and uncertainties not
presently known to us or that we currently believe to be immaterial may also adversely affect our business.
If any of the following risks and uncertainties develops into actual events or if the circumstances described in the risks and
uncertainties occur or continue to occur, these events or circumstances could have a material adverse effect on our business,
prospects, financial condition, results of operations, cash flows or liquidity. These events could also have a negative effect on the
trading price of our securities.
General
The results of our business operations are affected by a number of factors, many of which are beyond our control, and
primarily depend on, among other things, the level of our net interest income, the market value of our assets, which is driven by
numerous factors, including the supply and demand for residential mortgage assets in the marketplace, the terms and availability
of adequate financing, general economic and real estate conditions (both on a national and local level), the impact of government
actions in the real estate and mortgage sector, and the credit performance of our credit sensitive residential mortgage assets. Our
net interest income varies primarily as a result of changes in interest rates, the slope of the yield curve (i.e., the differential between
long-term and short-term interest rates), borrowing costs (i.e., our interest expense) and prepayment speeds on our MBS, the
behavior of which involves various risks and uncertainties. Interest rates and conditional prepayment rates (or CPRs) (which
measure the amount of unscheduled principal prepayment on a bond as a percentage of the bond balance) vary according to the
type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any
certainty. Our operating results also depend upon our ability to effectively manage the risks associated with our business operations,
including interest rate, prepayment, financing and credit risks, while maintaining our qualification as a REIT.
We may change our investment strategy, operating policies and/or asset allocations without stockholder consent, which
could materially adversely affect our results of operations.
We may change our investment strategy, operating policies and/or asset allocation with respect to investments, acquisitions,
leverage, growth, operations, indebtedness, capitalization and distributions at any time without the consent of our stockholders.
A change in our investment strategy may increase our exposure to interest rate risk, credit risk, default risk and/or real estate market
fluctuations. Furthermore, a change in our asset allocation could result in our making investments in asset categories different
from our historical investments. For example, in recent years, we have made new investments principally in credit sensitive assets
such as residential whole loans, RPL/NPL MBS, CRT securities and MSR related assets, while we have let our investments in
more interest-rate sensitive assets, such as Agency MBS, run-off. We expect this trend to continue in the near, and possibly the
long, term. These changes could materially adversely affect our financial condition, results of operations, the market price of our
common stock or our ability to pay dividends or make distributions.
Credit and Other Risks Related to Our Investments
Our investments in Non-Agency MBS (including RPL/NPL MBS) involve credit risk, which could materially adversely
affect our results of operations.
The holder of a mortgage or MBS assumes the risk that the related borrowers may default on their obligations to make full
and timely payments of principal and interest. Under our investment policy, we have the ability to acquire Non-Agency MBS,
residential whole loans and other investment assets of lower credit quality. In general, our portfolios of Legacy Non-Agency MBS
and RPL/NPL MBS (which, as of December 31, 2017 represented 32.3% of our total assets) carry greater investment risk than
Agency MBS because the former are not guaranteed as to principal or interest by the U.S. Government, any federal agency or any
federally chartered corporation. Higher-than-expected rates of default and/or higher-than-expected loss severities on the mortgages
underlying these investments could adversely affect the value of these assets. Accordingly, defaults in the payment of principal
and/or interest on our Legacy Non-Agency MBS, RPL/NPL MBS and other investment assets of less-than-high credit quality
would likely result in our incurring losses of income from, and/or losses in market value relating to, these assets, which could
materially adversely affect our results of operations.
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Our investments in re-performing and non-performing residential whole loans involve credit risks, some of which are
different from our Non-Agency MBS, which could materially adversely affect our results of operations.
Our portfolio of residential whole loans continued to be our fastest growing asset class during 2017, and represented
approximately 20.4% of our total assets as of December 31, 2017. We expect that our investment portfolio in residential whole
loans will continue to increase during 2018, as we seek opportunities in these credit sensitive assets. As a holder of residential
whole loans, we are subject to the risk that the related borrowers may default or have defaulted on their obligations to make full
and timely payments of principal and interest. (In addition to the credit risk associated with these assets, residential whole loans
are less liquid than certain of our other credit sensitive assets, such as Non-Agency MBS, which may make them more difficult
to dispose of if the need or desire arises.) If actual results are different from our assumptions in determining the prices paid to
acquire such loans, particularly if the market value of the underlying properties decreases significantly subsequent to purchase,
we may incur significant losses, which could materially adversely affect our results of operations.
A significant portion of our Non-Agency MBS and residential whole loans are secured by properties in a small number of
geographic areas and may be disproportionately affected by economic or housing downturns, natural disasters, terrorist
events, regulatory changes, adverse climate changes or other adverse events specific to those markets.
A significant number of the mortgages underlying our Non-Agency MBS and residential whole loan investments are
concentrated in certain geographic areas. For example, we have significant exposure in California, New York, Florida, New Jersey
and Maryland. (For a discussion of the percentage of these assets in these states, see “Credit Risk” included under Part II, Item
7A “Quantitative and Qualitative Disclosures About Market Risk” in this Annual Report on Form 10-K.) Certain markets within
these states (particularly in California and Florida) have experienced significant decreases in residential home values from time
to time. Any event that adversely affects the economy or real estate market in any of these states could have a disproportionately
adverse effect on our Non-Agency MBS and residential whole loan investments. In general, any material decline in the economy
or significant problems in a particular real estate market would likely cause a decline in the value of residential properties securing
the mortgages in that market, thereby increasing the risk of delinquency, default and foreclosure of re-performing loans and the
loans underlying our Non-Agency MBS and the risk of loss upon liquidation of these assets. This could, in turn, have a material
adverse effect on our credit loss experience on our Non-Agency MBS and residential whole loan investments in the affected market
if higher-than-expected rates of default and/or higher-than-expected loss severities on our re-performing loan investments or the
mortgages underlying our Non-Agency MBS were to occur.
In addition, the occurrence of a natural disaster (such as an earthquake, tornado, hurricane, flood or wildfires), terrorist attack
or a significant adverse climate change may cause a sudden decrease in the value of real estate in the area or areas affected and
would likely reduce the value of the properties securing the mortgages collateralizing our Non-Agency MBS or residential whole
loans. Because certain natural disasters are not typically covered by the standard hazard insurance policies maintained by borrowers
(such as hurricanes or certain flooding), or the proceeds payable under any such policy are not sufficient to cover the related
repairs, the affected borrowers may have to pay for any repairs themselves. Under these circumstances, borrowers may decide
not to repair their property or may stop paying their mortgages under those circumstances. This would cause defaults and credit
loss severities to increase.
Changes in governmental laws and regulations, fiscal policies, property taxes and zoning ordinances can also have a negative
impact on property values, which could result in borrowers’ deciding to stop paying their mortgages. This circumstance could
cause defaults and loss severities to increase, thereby adversely impacting our results of operations.
We have investments in Non-Agency MBS collateralized by Alt A loans and may also have investments collateralized by
subprime mortgage loans, which, due to lower underwriting standards, are subject to increased risk of losses.
We have certain investments in Non-Agency MBS backed by collateral pools containing mortgage loans that were originated
under underwriting standards that were less strict than those used in underwriting “prime mortgage loans.” These lower standards
permitted mortgage loans, often with LTV ratios in excess of 80%, to be made to borrowers having impaired credit histories, lower
credit scores, higher debt-to-income ratios and/or unverified income. Difficult economic conditions, including increased interest
rates and lower home prices, can result in Alt A and subprime mortgage loans having increased rates of delinquency, foreclosure,
bankruptcy and loss, and are likely to otherwise experience delinquency, foreclosure, bankruptcy and loss rates that are higher,
and that may be substantially higher, than those experienced by mortgage loans underwritten in a more traditional manner. Thus,
because of higher delinquency rates and losses associated with Alt A and subprime mortgage loans, the performance of our Non-
Agency MBS that are backed by these types of loans could be correspondingly adversely affected, which could materially adversely
impact our results of operations, financial condition and business.
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We are subject to counterparty risk and may be unable to seek indemnity or require counterparties to repurchase residential
whole loans if they breach representations and warranties, which could cause us to suffer losses.
In connection with our residential whole loan investments, we typically enter into a loan purchase agreement, as buyer, of
the loans from a seller. When we invest in mortgage loans, sellers typically make very limited representations and warranties
about such loans that are very limited both in scope and duration. Residential mortgage loan purchase agreements may entitle the
purchaser of the loans to seek indemnity or demand repurchase or substitution of the loans in the event the seller of the loans
breaches a representation or warranty given to the purchaser. However, there can be no assurance that a mortgage loan purchase
agreement will contain appropriate representations and warranties, that we or the trust that purchases the mortgage loans would
be able to enforce a contractual right to repurchase or substitution, or that the seller of the loans will remain solvent or otherwise
be able to honor its obligations under its mortgage loan purchase agreements. The inability to obtain or enforce an indemnity or
require repurchase of a significant number of loans could require us to absorb the associated losses, and adversely affect our results
of operations, financial condition and business.
The due diligence we undertake on potential investments may be limited and/or not reveal all of the risks associated with
such investments and may not reveal other weaknesses in such assets, which could lead to losses.
Before making an investment, we typically conduct (either directly or using third parties) certain due diligence. There can
be no assurance that we will conduct any specific level of due diligence, or that, among other things, our due diligence processes
will uncover all relevant facts, which could result in losses on these assets to the extent we ultimately acquire them, which, in turn,
could adversely affect our results of operations, financial condition and business.
We have experienced and may experience in the future increased volatility in our GAAP results of operations due in part
to the increasing contribution to financial results of assets accounted for under the fair value option.
Over the past several years the proportion of our overall investment portfolio that is accounted for under GAAP using the
fair value option has grown. Changes in the fair value of assets accounted for using the fair value option are recorded in our
consolidated statements of operations each period. The increased contribution of these assets to net income resulted in volatility
in our reported quarterly financial results during 2017. There can be no assurance that such volatility in periodic financial results
will not continue during 2018 or in future periods.
We have experienced, and may in the future experience, declines in the market value of certain of our investment securities
resulting in our recording impairments, which have had, and may in the future have, an adverse effect on our results of
operations and financial condition.
A decline in the market value of our MBS or other investment securities may require us to recognize an “other-than-temporary
impairment” (or OTTI) against such assets under U.S. generally accepted accounting principles (or GAAP). When the fair value
of an available-for-sale (or AFS) security is less than its amortized cost at the balance sheet date, the security is considered impaired.
We assess our impaired securities on at least a quarterly basis and designate such impairments as either “temporary” or “other-
than-temporary.” If we intend to sell an impaired security, or it is more likely than not that we will be required to sell the impaired
security before any anticipated recovery, then we 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 we do not expect to sell an other-than-
temporarily impaired security, only the portion of the OTTI related to credit losses is recognized through charges to earnings with
the remainder recognized through accumulated other comprehensive income/(loss) (or AOCI) on our consolidated balance sheets.
Impairments recognized through other comprehensive income/(loss) (or OCI) do not impact earnings. Following the recognition
of an OTTI through earnings, a new cost basis is established for the security and may not be adjusted for subsequent recoveries
in fair value through earnings. However, OTTIs recognized through charges to earnings may be accreted back to the amortized
cost basis of the security on a prospective basis through interest income. The determination as to whether an OTTI exists and, if
so, the amount 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 on our estimates of the future performance and cash flow projections. As a result,
the timing and amount of OTTIs constitute material estimates that are susceptible to significant change.
Our use of models in connection with the valuation of our assets subjects us to potential risks in the event that such models
are incorrect, misleading or based on incomplete information.
As part of our risk management process, we may use models to evaluate, depending on the asset class, house price appreciation
and depreciation by county, region, prepayment speeds and foreclosure frequency, cost and timing. Certain assumptions used as
inputs to the models may be based on historical trends. These trends may not be indicative of future results. Furthermore, the
assumptions underlying the models may prove to be inaccurate, causing the model output also to be incorrect. In the event models
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and data prove to be incorrect, misleading or incomplete, any decisions made in reliance thereon expose us to potential risks. For
example, by relying on incorrect models and data, we may be induced to buy certain assets at prices that are too high, to sell certain
other assets at prices that are too low or to miss favorable opportunities altogether, which could have a material adverse impact
on our business and growth prospects.
Valuations of some of our assets are subject to inherent uncertainty, may be based on estimates, may fluctuate over short
periods of time and may differ from the values that would have been used if a ready market for these assets existed.
While the determination of the fair value of our investment assets takes into consideration valuations provided by third-party
dealers and pricing services, the final determination of exit price fair values for our investment assets is based on our judgment,
and such valuations may differ from those provided by third-party dealers and pricing services. Valuations of certain assets may
be difficult to obtain or may not be reliable (particularly as related to residential whole loans, as discussed below). In general,
dealers and pricing services heavily disclaim their valuations as such valuations are not intended to be binding bid prices.
Additionally, dealers may claim to furnish valuations only as an accommodation and without special compensation, and so they
may disclaim any and all liability arising out of any inaccuracy or incompleteness in valuations. Depending on the complexity
and illiquidity of an asset, valuations of the same asset can vary substantially from one dealer or pricing service to another.
Our investments in residential whole loans are difficult to value and are dependent upon the ability to finance and refinance
such investments. The inability to do so could materially and adversely affect our liquidity and results of operations.
The difficulty in valuation is particularly significant with respect to our less liquid investments such as our re-performing
loans (or RPLs) and non-performing loans (or NPLs). RPLs are loans on which a borrower was previously delinquent but has
resumed repaying. Our ability to sell RPLs for a profit depends on the borrower continuing to make payments. An RPL could
become a NPL, which could reduce our earnings. Our investments in residential whole loans may require us to engage in workout
negotiations, restructuring and/or the possibility of foreclosure. These processes may be lengthy and expensive. If loans become
REO, we, through a designated servicer that we retain, will have to manage these properties and may not be able to sell them. See
“Our Ability to Sell REO on Terms Acceptable to Us or at All May Be Limited.”
We may work with our third-party servicers and seek to refinance an NPL or RPL to realize greater value from such loan.
However, there may be impediments to executing a refinancing strategy for NPLs and RPLs. For example, many mortgage lenders
have adjusted their loan programs and underwriting standards, which has reduced the availability of mortgage credit to prospective
borrowers. This has resulted in reduced availability of financing alternatives for borrowers seeking to refinance their mortgage
loans. In addition, the value of some borrowers’ homes may have declined below the amount of the mortgage loans on such homes
resulting in higher loan-to-value ratios, which has left the borrowers with insufficient equity in their homes to permit them to
refinance. To the extent prevailing mortgage interest rates rise from their current low levels, these risks would be exacerbated.
The effect of the above would likely serve to make refinancing of NPLs and RPLs potentially more difficult and less profitable
for us.
Our results of operations, financial condition and business could be materially adversely affected if our fair value
determinations of these assets is materially higher than the values that would exist if a ready market existed for these assets.
Mortgage loan modification and refinancing programs and future legislative action may materially adversely affect the
value of, and the returns on, our MBS and residential whole loan investments.
The U.S. Government, through the U.S. Federal Reserve, the U.S. Treasury Department, the Federal Housing Administration
(or the FHA) and other agencies implemented a number of federal programs designed to assist homeowners, including the Home
Affordable Modification Program (or HAMP), which provided homeowners with assistance in avoiding residential mortgage loan
foreclosures, the Hope for Homeowners Program (or H4H Program), which allowed certain distressed borrowers to refinance their
mortgages into FHA-insured loans in order to avoid foreclosure, and the Home Affordable Refinance Program (or HARP), which
allows borrowers who are current on their mortgage payments to refinance and reduce their monthly mortgage payments without
new mortgage insurance, up to an unlimited loan-to-value ratio for fixed-rate mortgages. While some of these programs (such as
HAMP and the H4H Program) have expired, the U.S. Treasury Department, Federal Housing Finance Agency (or FHFA), FHA,
and Consumer Financial Protection Bureau (CFPB) have issued guiding principles for future loss mitigation programs. In addition,
Fannie Mae and Freddie Mac implemented their Flex Modification foreclosure prevention program, developed at the direction of
FHFA. Federal loss mitigation programs, as well as proprietary loss mitigation programs offered by investors and servicers, may
involve, among other things, the modification of mortgage loans to reduce the principal amount of the loans (through forbearance
and/or forgiveness) and/or the rate of interest payable on the loans, or to extend the payment terms of the loans. Especially with
our Non-Agency MBS and residential whole loan investments, a continuing number of loan modifications with respect to a given
underlying loan, including, but not limited to, those related to principal forgiveness and coupon reduction, could negatively impact
8
the realized yields and cash flows on such investments. These loan modification programs, future legislative or regulatory actions,
including possible amendments to the bankruptcy laws, that result in the modification of outstanding residential mortgage loans,
as well as changes in the requirements necessary to qualify for refinancing mortgage loans with Fannie Mae, Freddie Mac or
Ginnie Mae, may materially adversely affect the value of, and the returns on, these assets.
We may be adversely affected by risks affecting borrowers or the asset or property types in which certain of our investments
may be concentrated at any given time, as well as from unfavorable changes in the related geographic regions.
We are not required to limit our assets in terms of geographic location, diversification or concentration, except that we
concentrate in residential mortgage-related investments. Accordingly, our investment portfolio may be concentrated by geography,
asset type, property type and/or borrower, increasing the risk of loss to us if the particular concentration in our portfolio is subject
to greater risks or is undergoing adverse developments. In addition, adverse conditions in the areas where the properties securing
or otherwise underlying our investments are located (including business layoffs or downsizing, industry slowdowns, changing
demographics and other factors) and local real estate conditions (such as oversupply or reduced demand) may have an adverse
effect on the value of our investments. A material decline in the demand for real estate in these areas may materially and adversely
affect us. Lack of diversification can increase the correlation of non-performance and foreclosure risks to these investments.
The Recent Passage of H.R. 1, the Tax Cuts and Jobs Act May Adversely Affect our Business.
H.R. 1, informally known as the Tax Cuts and Jobs Act (or TCJA), includes changes that could have an adverse impact on
the U.S. residential housing market and potentially impact the market value of our investments. The TCJA includes, among other
items, the reduction of the deduction of interest on mortgage debt, the elimination of the deduction for state and local taxes and a
limitation on property tax deductions, which may reduce home affordability and adversely affect home prices nationally or in local
markets. In addition, such changes may increase taxes payable by certain borrowers, thereby reducing their available cash and
adversely impacting their ability to make payments, which in turn, could cause losses on our investments.
Our investments in residential whole loans subject us to servicing-related risks, including those associated with foreclosure
and liquidation.
The majority of the residential whole loans that have been acquired to date were purchased together with the related mortgage
servicing rights. We rely on third-party servicers to service and manage the mortgages underlying our residential whole loans.
The ultimate returns generated by these investments may depend on the quality of the servicer. If a servicer is not vigilant in seeing
that borrowers make their required monthly payments, borrowers may be less likely to make these payments, resulting in a higher
frequency of default. If a servicer takes longer to liquidate non-performing mortgages, our losses related to those loans may be
higher than originally anticipated. Any failure by servicers to service these mortgages and/or to competently manage and dispose
of REO properties could negatively impact the value of these investments and our financial performance. In addition, while we
have contracted with third-party servicers to carry out the actual servicing of the loans (including all direct interface with the
borrowers), we are nevertheless ultimately responsible, vis-à-vis the borrowers and state and federal regulators, for ensuring that
the loans are serviced in accordance with the terms of the related notes and mortgages and applicable law and regulation. (See
“Regulatory Risk and Risks Related to the Investment Company Act of 1940 -- Our business is subject to extensive regulation”)
In light of the current regulatory environment, such exposure could be significant even though we might have contractual claims
against our servicers for any failure to service the loans to the required standard.
When one of our residential whole loans is foreclosed upon, title to the underlying property is taken by a Company subsidiary.
The foreclosure process, especially in judicial foreclosure states such as New York, Florida and New Jersey, can be lengthy and
expensive, and the delays and costs involved in completing a foreclosure, and then subsequently liquidating the REO property
through sale, may materially increase any related loss. In addition, at such time as title is taken to a foreclosed property, it may
require more extensive rehabilitation than we estimated at acquisition. Thus, a material amount of foreclosed residential mortgage
loans, particularly in the states mentioned above, could result in significant losses in our residential whole loan portfolio and could
materially adversely affect our results of operations.
The expanding body of federal, state and local regulations and the investigations of servicers may increase their cost of
compliance and the risks of noncompliance, and may adversely affect their ability to perform their servicing obligations.
We work with and rely on third-party servicers to service the residential mortgage loans that we acquire through consolidated
trusts. The mortgages underlying the MBS that we acquire are also serviced by third-party servicers that have been hired by the
bond issuers. The mortgage servicing business is subject to extensive regulation by federal, state and local governmental authorities
and is subject to various laws and judicial and administrative decisions imposing requirements and restrictions and increased
compliance costs on a substantial portion of their operations. The volume of new or modified laws and regulations has increased
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in recent years. Some jurisdictions and municipalities have enacted laws that restrict loan servicing activities, including delaying
or preventing foreclosures or forcing the modification of certain mortgages.
Federal laws and regulations have also been proposed or adopted which, among other things, could hinder the ability of a
servicer to foreclose promptly on defaulted residential loans, and which could result in assignees being held responsible for
violations in the residential loan origination process. Certain mortgage lenders and third-party servicers have voluntarily, or as
part of settlements with law enforcement authorities, established loan modification programs relating to loans they hold or service.
These federal, state and local legislative or regulatory actions that result in modifications of our outstanding mortgages, or interests
in mortgages acquired by us either directly through consolidated trusts or through our investments in residential MBS, may
adversely affect the value of, and returns on, such investments. Mortgage servicers may be incented by the federal government to
pursue such loan modifications, as well as forbearance plans and other actions intended to prevent foreclosure, even if such loan
modifications and other actions are not in the best interests of the beneficial owners of the mortgages. As a consequence of the
foregoing matters, our business, financial condition, results of operations and ability to pay dividends, if any, to our stockholders
may be adversely affected.
The federal conservatorship of Fannie Mae and Freddie Mac and related efforts, along with any changes in laws and
regulations affecting the relationship between Fannie Mae and Freddie Mac and the U.S. Government, may materially
adversely affect our business.
The payments of principal and interest we receive on our Agency MBS, which depend directly upon payments on the
mortgages underlying such securities, are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. Fannie Mae and Freddie Mac
are U.S. Government-sponsored entities (or GSEs), but their guarantees are not backed by the full faith and credit of the United
States (although the FHFA largely controls their actions through its conservatorship of the two GSEs, which occurred in the wake
of the 2007-2008 financial crisis). Ginnie Mae is part of a U.S. Government agency and its guarantees are backed by the full faith
and credit of the United States.
Although the U.S. Government has undertaken several measures to support the positive net worth of Fannie Mae and Freddie
Mac since the financial crisis of 2007-2008, there is no guarantee of continuing capital support if such support were to become
necessary. These uncertainties lead to questions about the availability of, and trading market for, Agency MBS. Despite the steps
taken by the U.S. Government, Fannie Mae and Freddie Mac could default on their guarantee obligations which would materially
and adversely affect the value of our Agency MBS. Accordingly, if these government actions are inadequate in the future and the
GSEs were to suffer losses, be significantly reformed, or cease to exist (as discussed below), our business, operations and financial
condition could be materially and adversely affected.
In addition, the problems faced by Fannie Mae and Freddie Mac resulting in their being placed into federal conservatorship
and receiving significant U.S. Government support have sparked serious debate among federal policy makers regarding the
continued role of the U.S. Government in providing liquidity for mortgage loans. In 2011, the Obama administration proposed a
plan to wind down the GSEs, and both houses of Congress have considered legislation to reform the GSEs, their functions and
their missions. President Trump’s Secretary of the Treasury has made comments indicating that housing finance reform may be
on the agenda for the Trump administration, but no detailed proposals have yet been put forth. However, in December 2017, FHFA
and the U.S. Treasury Department announced that Fannie Mae and Freddie Mac will each be allowed to retain $3 billion in capital
reserve in order to cover ordinary income fluctuations. The future roles of Fannie Mae and Freddie Mac may be reduced (perhaps
significantly) and the nature of their guarantee obligations could be limited relative to historical measurements. Alternatively, it
is still possible that Fannie Mae and Freddie Mac could be dissolved entirely or privatized, and, as mentioned above, the U.S.
Government could determine to stop providing liquidity support of any kind to the mortgage market. Any changes to the nature
of the GSEs or their guarantee obligations could redefine what constitutes an Agency MBS and could have broad adverse
implications for the market and our business, operations and financial condition. If Fannie Mae or Freddie Mac were to be
eliminated, or their structures were to change radically (in particular a limitation or removal of the guarantee obligation), we could
be unable to acquire additional Agency MBS and our existing Agency MBS could be materially and adversely impacted.
We could be negatively affected in a number of ways depending on the manner in which events unfold for Fannie Mae and
Freddie Mac. We rely on our Agency MBS as collateral for a significant portion of our financings under our repurchase agreements.
Any decline in their value, or perceived market uncertainty about their value, would make it more difficult for us to obtain financing
on our Agency MBS on acceptable terms or at all, or to maintain our compliance with the terms of any financing transactions.
As indicated above, future legislation could, among other things, reform the GSEs and their functions, or nationalize, privatize,
or eliminate them entirely. Any law affecting the GSEs may create market uncertainty and have the effect of reducing the actual
or perceived credit quality of securities issued or guaranteed by Fannie Mae or Freddie Mac. As a result, such laws could increase
the risk of loss on our investments in Agency MBS guaranteed by Fannie Mae and/or Freddie Mac. It also is possible that such
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laws could adversely impact the market for such securities and the spreads at which they trade. All of the foregoing could materially
and adversely affect our business, operations and financial condition.
Rapid changes in the values of our residential mortgage investments and other assets may make it more difficult for us to
maintain our qualification as a REIT or exemption from registration under the Investment Company Act.
If the market value or income potential of our MBS, residential mortgage investments and other assets declines as a result
of increased interest rates, prepayment rates or other factors, we may need to increase certain real estate investments and income
and/or liquidate our non-qualifying assets in order to maintain our REIT qualification or exemption from registration under the
Investment Company Act. If the decline in real estate asset values and/or income occurs quickly, this may be especially difficult
to accomplish. This difficulty could be exacerbated by the illiquid nature of certain investments. We might have to make investment
decisions that we otherwise would not make absent our REIT qualification and Investment Company Act considerations. (See
“Regulatory Risk and Risks Related to the Investment Company Act of 1940” and “Risks Related to Our Taxation as a REIT and
the Taxation of Our Assets.”)
Our ability to sell REO on terms acceptable to us or at all may be limited.
REO properties are illiquid relative to other assets we own. Furthermore, real estate markets are affected by many factors
that are beyond our control, such as general and local economic conditions, availability of financing, interest rates and supply and
demand. We cannot predict whether we will be able to sell any REO for the price or on the terms set by us or whether any price
or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to
find a willing purchaser and to close the sale of an REO. In certain circumstances, we may be required to expend cash to correct
defects or to make improvements before a property can be sold, and we cannot assure that we will have cash available to correct
defects or make improvements. As a result, our ownership of REOs could materially and adversely affect our liquidity and results
of operations.
Our indirect investments in MSR related assets expose us to additional risks.
As of December 31, 2017, we had approximately $492.1 million of 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.
Generally, we have the right to receive certain cash flows from the owner of the MSRs that are generated from the servicing fees
and/or excess servicing spread associated with the MSRs. While we do not directly own MSRs, our investments in MSR related
assets indirectly expose us to risks associated with MSRs, such as the illiquidity of MSRs, the risks associated with servicing
MSRs (that include, for example, significant regulatory risks and costs) and the ability of the owner to successfully manage its
MSR portfolio. If these or other MSR related risks come to fruition, the value of our MSR relates assets could decline significantly.
Prepayment and Reinvestment Risk
Prepayment rates on the mortgage loans underlying our MBS may materially adversely affect our profitability or result
in liquidity shortfalls that could require us to sell assets in unfavorable market conditions.
The MBS that we acquire are secured by pools of mortgages on residential properties. In general, the mortgages collateralizing
our MBS may be prepaid at any time without penalty. Prepayments on our MBS result when borrowers satisfy (i.e., pay off) the
mortgage upon selling or refinancing their mortgaged property. When we acquire a particular MBS, we anticipate that the
underlying mortgage loans will prepay at a projected rate which, together with expected coupon income, provides us with an
expected yield on that MBS. If we purchase MBS at a premium to par value, and borrowers then prepay the underlying mortgage
loans at a faster rate than we expected, the increased prepayments on the MBS would result in a yield lower than expected on such
securities because we would be required to amortize the related premium on an accelerated basis. Conversely, if we purchase
MBS at a discount to par value, and borrowers then prepay the underlying mortgage loans at a slower rate than we expected, the
decreased prepayments on the MBS would result in a lower yield than expected on such securities and/or may result in OTTI if
the fair value of the security is less than its amortized cost.
Prepayment rates on mortgage loans are influenced by changes in mortgage and market interest rates and a variety of economic,
geographic, governmental and other factors beyond our control. Consequently, prepayment rates cannot be predicted with certainty
and no strategy can completely insulate us from prepayment risks. In periods of declining interest rates, prepayment rates on
mortgage loans generally increase. Because of prepayment risk, the market value of our MBS (and in particular our Agency MBS)
may benefit less than other fixed income securities from a decline in interest rates. If general interest rates decline at the same
time, we would likely not be able to reinvest the proceeds of the prepayments that we receive in assets yielding as much as those
yields on the assets that were prepaid.
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With respect to Agency MBS, we have, at times, purchased securities that have a higher coupon rate than the prevailing
market interest rates. In exchange for a higher coupon rate, we typically pay a premium over par value to acquire such securities.
In accordance with GAAP, we amortize premiums on our MBS over the life of the related MBS. If the underlying mortgage loans
securing these securities prepay at a more rapid rate than anticipated, we will be required to amortize the related premiums on an
accelerated basis, which could adversely affect our profitability. Defaults on the mortgages underlying Agency MBS typically
have the same effect as loan prepayments because of the underlying Agency guarantee. As of December 31, 2017, we had net
purchase premiums on our Agency MBS of $104.0 million (or 3.8% of current par value) and net purchase discounts on our Non-
Agency MBS of $808.5 million (or 21.7% of current par value).
Prepayments, which are the primary feature of MBS that distinguishes them from other types of bonds, are difficult to predict
and can vary significantly over time. As the holder of MBS, we receive a monthly payment equal to a portion of our investment
principal in a particular MBS as the underlying mortgages are prepaid. With respect to Agency MBS, we typically receive notice
of monthly principal prepayments on the fifth business day of each month (such day is commonly referred to as “factor day”) and
receive the related scheduled payment on a specified later date, which for (a) our Agency ARM-MBS and fixed-rate Agency MBS
guaranteed by Fannie Mae is the 25th day of the month (or next business day thereafter), (b) our Agency ARM-MBS guaranteed
by Freddie Mac is the 15th day of the following month (or next business day thereafter), (c) our fixed-rate Agency MBS guaranteed
by Freddie Mac is the 15th day of the month (or next business day thereafter), and (d) our Agency ARM-MBS guaranteed by
Ginnie Mae is the 20th day of that month (or next business day thereafter). With respect to our Non-Agency MBS, we typically
receive notice of monthly principal prepayments and the related scheduled payment on the 25th day of each month (or next business
day thereafter). In general, on the date each month that principal prepayments are announced (i.e., factor day for Agency MBS),
the value of our MBS pledged as collateral under our repurchase agreements is reduced by the amount of the prepaid principal
and, as a result, our lenders will typically initiate a margin call that requires us to pledge additional collateral in the form of cash
or additional MBS, in an amount equal to the prepaying principal, in order to re-establish the required ratio of borrowing to
collateral value under such repurchase agreements. Accordingly, in the case of Agency MBS, the announcement on factor day of
principal prepayments occurs prior to our receipt of the related scheduled payment. This timing differential creates a short-term
receivable for us in the amount of any such principal prepayments; however, under our repurchase agreements, we may receive
a margin call in the amount of the related reduction in value of the Agency MBS and be required to post on or about factor day
additional cash or other collateral in the amount of the prepaying principal to be received, which thereby would reduce our liquidity
during the period in which the short-term receivable is outstanding. As a result, in order to meet any such margin calls, we might
be forced to sell assets in order to maintain adequate liquidity. Forced sales, particularly under adverse market conditions, may
result in lower sales prices than sales made under ordinary market conditions in the normal course of business. If our MBS were
to be liquidated at prices below our amortized cost (i.e., our cost basis) of such assets, we would incur losses, which could materially
adversely affect our earnings. In addition, in order to continue to earn a return on this prepaid principal, we must reinvest it in
additional MBS or other assets; however, in a declining interest rate environment, we might earn a lower return on our reinvested
funds as compared to the return earned on the MBS that had prepaid.
Prepayments may have a materially negative impact on our financial results, the effects of which depend on, among other
things, the timing and amount of the prepayment delay on Agency MBS, the amount of unamortized premium on MBS prepayments,
the rate at which prepayments are made on our Non-Agency MBS, the reinvestment lag and the availability of suitable reinvestment
opportunities.
Risks Related to Our Use of Leverage
Our business strategy involves the use of leverage, and we may not achieve what we believe to be optimal levels of leverage
or we may become overleveraged, which may materially adversely affect our liquidity, results of operations or financial
condition.
Our business strategy involves the use of borrowing or “leverage.” Pursuant to our leverage strategy, we borrow against a
substantial portion of the market value of our residential mortgage investments and use the borrowed funds to finance our investment
portfolio and the acquisition of additional investment assets. Although we are not required to maintain any particular debt-to-
equity ratio, certain of our borrowing agreements contain provisions requiring us not to have a debt-to-equity ratio exceeding
specified levels. Future increases in the amount by which the collateral value is required to contractually exceed the repurchase
transaction loan amount, decreases in the market value of our residential mortgage investments, increases in interest rate volatility
and changes in the availability of acceptable financing could cause us to be unable to achieve the amount of leverage we believe
to be optimal. The return on our assets and cash available for distribution to our stockholders may be reduced to the extent that
changes in market conditions prevent us from achieving the desired amount of leverage on our investments or cause the cost of
our financing to increase relative to the income earned on our leveraged assets. If the interest income on the residential mortgage
investments that we have purchased with borrowed funds fails to cover the interest expense of the related borrowings, we will
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experience net interest losses and may experience net losses from operations. Such losses could be significant as a result of our
leveraged structure. The use of leverage to finance our residential mortgage investments involves a number of other risks, including,
among other things, the following:
•
•
•
•
Adverse developments involving major financial institutions or involving one of our lenders could result in a rapid
reduction in our ability to borrow and materially adversely affect our business, profitability and liquidity. As of
December 31, 2017, we had amounts outstanding under repurchase agreements with 31 separate lenders. A material
adverse development involving one or more major financial institutions or the financial markets in general could result
in our lenders reducing our access to funds available under our repurchase agreements or terminating such repurchase
agreements altogether. Because all of our repurchase agreements are uncommitted and renewable at the discretion of
our lenders, our lenders could determine to reduce or terminate our access to future borrowings at virtually any time,
which could materially adversely affect our business and profitability. Furthermore, if a number of our lenders became
unwilling or unable to continue to provide us with financing, we could be forced to sell assets, including MBS in an
unrealized loss position, in order to maintain liquidity. Forced sales, particularly under adverse market conditions may
result in lower sales prices than ordinary market sales made in the normal course of business. If our residential mortgage
investments were liquidated at prices below our amortized cost (i.e., the cost basis) of such assets, we would incur losses,
which could adversely affect our earnings. In addition, uncertainty in the global finance market and weak economic
conditions in Europe, including as a result of the United Kingdom’s decision to exit from the European Union (commonly
referred to as “Brexit”), could cause the conditions described above to have a more pronounced affect on our European
counterparties.
Our profitability may be materially adversely affected by a reduction in our leverage. As long as we earn a positive
spread between interest and other income we earn on our leveraged assets and our borrowing costs, we believe that we
can generally increase our profitability by using greater amounts of leverage. There can be no assurance, however, that
repurchase financing will remain an efficient source of long-term financing for our assets. The amount of leverage that
we use may be limited because our lenders might not make funding available to us at acceptable rates or they may require
that we provide additional collateral to secure our borrowings. If our financing strategy is not viable, we will have to
find alternative forms of financing for our assets which may not be available to us on acceptable terms or at acceptable
rates. In addition, in response to certain interest rate and investment environments or to changes in market liquidity, we
could adopt a strategy of reducing our leverage by selling assets or not reinvesting principal payments as MBS amortize
and/or prepay, thereby decreasing the outstanding amount of our related borrowings. Such an action could reduce interest
income, interest expense and net income, the extent of which would be dependent on the level of reduction in assets and
liabilities as well as the sale prices for which the assets were sold.
If we are unable to renew our borrowings at acceptable interest rates, it may force us to sell assets under adverse
market conditions, which may materially adversely affect our liquidity and profitability. Since we rely primarily on
borrowings under repurchase agreements to finance our residential mortgage investments, our ability to achieve our
investment objectives depends on our ability to borrow funds in sufficient amounts and on acceptable terms, and on our
ability to renew or replace maturing borrowings on a continuous basis. Our repurchase agreement credit lines are
renewable at the discretion of our lenders and, as such, do not contain guaranteed roll-over terms. Our ability to enter
into repurchase transactions in the future will depend on the market value of our residential mortgage investments pledged
to secure the specific borrowings, the availability of acceptable financing and market liquidity and other conditions
existing in the lending market at that time. If we are not able to renew or replace maturing borrowings, we could be
forced to sell assets, including MBS in an unrealized loss position, in order to maintain liquidity. Forced sales, particularly
under adverse market conditions, could result in lower sales prices than ordinary market sales made in the normal course
of business. If our residential mortgage investments were liquidated at prices below our amortized cost (i.e., the cost
basis) of such assets, we would incur losses, which could materially adversely affect our earnings.
A decline in the market value of our assets may result in margin calls that may force us to sell assets under adverse
market conditions, which may materially adversely affect our liquidity and profitability. In general, the market value
of our residential mortgage investments is impacted by changes in interest rates, prevailing market yields and other market
conditions, including general economic conditions, home prices and the real estate market generally. A decline in the
market value of our residential mortgage investments may limit our ability to borrow against such assets or result in
lenders initiating margin calls, which require a pledge of additional collateral or cash to re-establish the required ratio of
borrowing to collateral value, under our repurchase agreements. Posting additional collateral or cash to support our credit
will reduce our liquidity and limit our ability to leverage our assets, which could materially adversely affect our business.
As a result, we could be forced to sell a portion of our assets, including MBS in an unrealized loss position, in order to
maintain liquidity.
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•
•
If a counterparty to our repurchase transactions defaults on its obligation to resell the underlying security back to us
at the end of the transaction term or if we default on our obligations under the repurchase agreement, we could incur
losses. When we engage in repurchase transactions, we generally transfer securities to lenders (i.e., repurchase agreement
counterparties) and receive cash from such lenders. Because the cash we receive from the lender when we initially
transfer the securities to the lender is less than the value of those securities (this difference is referred to as the “haircut”),
if the lender defaults on its obligation to transfer the same securities back to us, we would incur a loss on the transaction
equal to the amount of the haircut (assuming there was no change in the value of the securities). See Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K, for
further discussion regarding risks related to exposure to financial institution counterparties in light of recent market
conditions. Our exposure to defaults by counterparties may be more pronounced during periods of significant volatility
in the market conditions for mortgages and mortgage-related assets as well as the broader financial markets. At
December 31, 2017, we had greater than 5% stockholders’ equity at risk to the following repurchase agreement
counterparties: Goldman Sachs (approximately 7.3%), Wells Fargo (approximately 5.8%), RBC (approximately 5.7%),
Credit Suisse (approximately 5.3%) and UBS (approximately 5.1%).
In addition, generally, if we default on one of our obligations under a repurchase transaction with a particular lender,
that lender can elect to terminate the transaction and cease entering into additional repurchase transactions with us. In
addition, some of our repurchase agreements contain cross-default provisions, so that if a default occurs under any one
agreement, the lenders under our other repurchase agreements could also declare a default. Any losses we incur on our
repurchase transactions could materially adversely affect our earnings and thus our cash available for distribution to our
stockholders.
Our use of repurchase agreements to borrow money may give our lenders greater rights in the event of bankruptcy.
Borrowings made under repurchase agreements may qualify for special treatment under the U.S. Bankruptcy Code. If
a lender under one of our repurchase agreements defaults on its obligations, it may be difficult for us to recover our assets
pledged as collateral to such lender. In the event of the insolvency or bankruptcy of a lender during the term of a repurchase
agreement, the lender may be permitted, under applicable insolvency laws, to repudiate the contract, and our claim against
the lender for damages may be treated simply as an unsecured creditor. In addition, if the lender is a broker or dealer
subject to the Securities Investor Protection Act of 1970, or an insured depository institution subject to the Federal Deposit
Insurance Act, our ability to exercise our rights to recover our securities under a repurchase agreement or to be compensated
for any damages resulting from the lender’s insolvency may be further limited by those statutes. These claims would be
subject to significant delay and, if and when received, may be substantially less than the damages we actually incur. In
addition, in the event of our insolvency or bankruptcy, certain repurchase agreements may qualify for special treatment
under the Bankruptcy Code, the effect of which, among other things, would be to allow the creditor under the agreement
to avoid the automatic stay provisions of the Bankruptcy Code and take possession of, and liquidate, our collateral under
our repurchase agreements without delay. Our risks associated with the insolvency or bankruptcy of a lender maybe
more pronounced during periods of significant volatility in the market conditions for mortgages and mortgage-related
assets as well as the broader financial markets.
An increase in our borrowing costs relative to the interest we receive on our MBS or our re-performing residential whole
loans may materially adversely affect our profitability.
Our earnings are primarily generated from the difference between the interest income we earn on our investment portfolio,
less net amortization of purchase premiums and discounts, and the interest expense we pay on our borrowings. We rely primarily
on borrowings under repurchase agreements to finance the acquisition of residential mortgage investments, which have longer-
term contractual maturities. Even though the majority of our investments have interest rates that adjust over time based on changes
in corresponding interest rate indexes, the interest we pay on our borrowings may increase at a faster pace than the interest we
earn on our investments. In general, if the interest expense on our borrowings increases relative to the interest income we earn
on our investments, our profitability may be materially adversely affected, including due to the following reasons:
•
Changes in interest rates, cyclical or otherwise, may materially adversely affect our profitability. Interest rates are
highly sensitive to many factors, including fiscal and monetary policies and domestic and international economic and
political conditions, as well as other factors beyond our control. In general, we finance the acquisition of our investments
through borrowings in the form of repurchase transactions, which exposes us to interest rate risk on the financed assets.
The cost of our borrowings is based on prevailing market interest rates. Because the terms of our repurchase transactions
typically range from one to six months at inception, the interest rates on our borrowings generally adjust more frequently
(as new repurchase transactions are entered into upon the maturity of existing repurchase transactions) than the interest
rates on our investments. During a period of rising interest rates (such as during 2017, which is expected to continue
during 2018), our borrowing costs generally will increase at a faster pace than our interest earnings on the leveraged
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portion of our investment portfolio, which could result in a decline in our net interest spread and net interest margin. The
severity of any such decline would depend on our asset/liability composition, including the impact of hedging transactions,
at the time as well as the magnitude and period over which interest rates increase. Further, an increase in short-term
interest rates could also have a negative impact on the market value of our residential mortgage investments. If any of
these events happen, we could experience a decrease in net income or incur a net loss during these periods, which may
negatively impact our distributions to stockholders.
•
•
•
Interest rate caps on the mortgages collateralizing our MBS may materially adversely affect our profitability if short-
term interest rates increase. The coupons earned on ARM-MBS adjust over time as interest rates change (typically after
an initial fixed-rate period for Hybrids). The financial markets primarily determine the interest rates that we pay on the
repurchase transactions used to finance the acquisition of our MBS; however, the level of adjustment to the interest rates
earned on our ARM-MBS is typically limited by contract (or in certain cases by state or federal law). The interim and
lifetime interest rate caps on the mortgages collateralizing our MBS limit the amount by which the interest rates on such
assets can adjust. Interim interest rate caps limit the amount interest rates on a particular ARM can adjust during the next
adjustment period. Lifetime interest rate caps limit the amount interest rates can adjust upward from inception through
maturity of a particular ARM. Our repurchase transactions are not subject to similar restrictions. Accordingly, in a
sustained period of rising interest rates or a period in which interest rates rise rapidly, we could experience a decrease in
net income or a net loss because the interest rates paid by us on our borrowings (excluding the impact of hedging
transactions) could increase without limitation (as new repurchase transactions are entered into upon the maturity of
existing repurchase transactions) while increases in the interest rates earned on the mortgages collateralizing our MBS
could be limited due to interim or lifetime interest rate caps.
Adjustments of interest rates on our borrowings may not be matched to interest rate indexes on our MBS. In general,
the interest rates on our repurchase transactions are based on LIBOR, while the interest rates on our ARM-MBS may be
indexed to LIBOR or CMT rate. Accordingly, any increase in LIBOR relative to one-year CMT rates will generally result
in an increase in our borrowing costs that is not matched by a corresponding increase in the interest earned on our ARM-
MBS tied to these other index rates. Any such interest rate index mismatch could adversely affect our profitability, which
may negatively impact our distributions to stockholders.
A flat or inverted yield curve may adversely affect ARM-MBS prepayment rates and supply. Our net interest income
varies primarily as a result of changes in interest rates as well as changes in interest rates across the yield curve. When
the differential between short-term and long-term benchmark interest rates narrows, the yield curve is said to be
“flattening.” In addition, a flatter yield curve generally leads to fixed-rate mortgage rates that are closer to the interest
rates available on ARMs, potentially decreasing the supply of ARM-MBS. At times, short-term interest rates may increase
and exceed long-term interest rates, causing an inverted yield curve. When the yield curve is inverted, fixed-rate mortgage
rates may approach or be lower than mortgage rates on ARMs, further increasing ARM-MBS prepayments and further
negatively impacting ARM-MBS supply. Increases in prepayments on our MBS portfolio cause our premium amortization
to accelerate, lowering the yield on such assets. If this happens, we could experience a decrease in net income or incur
a net loss during these periods, which may negatively impact our distributions to stockholders.
Changes in banks’ inter-bank lending rate reporting practices or the method pursuant to which LIBOR is determined may
adversely affect our profitability.
As discussed above, the interest rates on our repurchase transactions are generally based on LIBOR. LIBOR and other
indices which are deemed “benchmarks” have been the subject of recent national, international, and other regulatory guidance
and proposals for reform. Some of these reforms are already effective while others are still to be implemented. These reforms
may cause such benchmarks to perform differently than in the past, or have other consequences which cannot be predicted. In
particular, regulators and law enforcement agencies in the United Kingdom and elsewhere are conducting criminal and civil
investigations into whether the banks that contribute information to the British Bankers’ Association (the “BBA”) in connection
with the daily calculation of LIBOR may have been under-reporting or otherwise manipulating or attempting to manipulate LIBOR.
A number of BBA member banks have reached settlements with their regulators and law enforcement agencies with respect to
this alleged manipulation of LIBOR. Actions by the regulators or law enforcement agencies, as well as ICE Benchmark
Administration (the current administrator of LIBOR), may result in changes to the manner in which LIBOR is determined or the
establishment of alternative reference rates. For example, on July 27, 2017, the United Kingdom Financial Conduct Authority
announced that it intends to stop persuading or compelling banks to submit LIBOR rates after 2021.
At this time, it is not possible to predict the effect of any such changes, any establishment of alternative reference rates or
any other reforms to LIBOR that may be implemented in the United Kingdom or elsewhere. Uncertainty as to the nature of such
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potential changes, alternative reference rates or other reforms may adversely affect our profitability, which may negatively impact
our distributions to stockholders.
Certain of our current lenders require, and future lenders may require, us to enter into restrictive covenants relating to
our operations.
The various agreements pursuant to which we borrow money to finance our residential mortgage investments generally
include customary representations, warranties and covenants, but may also contain more restrictive supplemental terms and
conditions. Although specific to each master repurchase or loan agreement, typical supplemental terms include requirements of
minimum equity, leverage ratios and performance triggers relating to a decline in equity or net income over a period of time. If
we fail to meet or satisfy any covenants, supplemental terms or representations and warranties, we could be in default under the
affected agreements and those lenders could elect to declare all amounts outstanding under the agreements to be immediately due
and payable, enforce their respective interests against collateral pledged under such agreements and restrict our ability to make
additional borrowings. Certain of our financing agreements contain cross-default or cross-acceleration provisions, so that if a
default or acceleration of indebtedness occurs under any one agreement, the lenders under our other agreements could also declare
a default. Further, under our agreements, we are typically required to pledge additional assets to our lenders in the event the
estimated fair value of the existing pledged collateral under such agreements declines and such lenders demand additional collateral,
which may take the form of additional securities, loans or cash.
Future lenders may impose similar or additional restrictions and other covenants on us. If we fail to meet or satisfy any of
these covenants, we could be in default under these agreements, and our lenders could elect to declare outstanding amounts due
and payable, require the posting of additional collateral and enforce their interests against then-existing collateral. We could also
be subject to cross-default and acceleration rights and, with respect to collateralized debt, the posting of additional collateral and
foreclosure rights upon default. Further, this could also make it difficult for us to satisfy the qualification requirements necessary
to maintain our status as a REIT for U.S. federal income tax purposes.
Risks Associated with Adverse Developments in the Mortgage Finance and Credit Markets and Financial Markets
Generally
Market conditions for mortgages and mortgage-related assets as well as the broader financial markets may materially
adversely affect the value of the assets in which we invest.
Our results of operations are materially affected by conditions in the markets for mortgages and mortgage-related assets,
including MBS, as well as the broader financial markets and the economy generally. Significant adverse changes in financial
market conditions leading to the forced sale of large quantities of mortgage-related and other financial assets, would result in
significant volatility in the market for mortgages and mortgage-related assets and potentially significant losses for ourselves and
certain other market participants. In addition, concerns over actual or anticipated low economic growth rates, higher levels of
unemployment or uncertainty regarding future U.S. monetary policy (particularly in light of the current presidential administration
and related uncertainties) may contribute to increased interest rate volatility. Declines in the value of our investments, or perceived
market uncertainty about their value, may make it difficult for us to obtain financing on favorable terms or at all, or maintain our
compliance with terms of any financing arrangements already in place. Additionally, increased volatility and/or deterioration in
the broader residential mortgage and MBS markets could materially adversely affect the performance and market value of our
investments.
A lack of liquidity in our investments may materially adversely affect our business.
The assets that comprise our investment portfolio and that we acquire are not traded on an exchange. A portion of our
investments are subject to legal and other restrictions on resale and are otherwise generally less liquid than exchange-traded
securities. Any illiquidity of our investments may make it difficult for us to sell such investments if the need or desire arises. In
addition, if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the value
at which we have previously recorded our investments. Further, we may face other restrictions on our ability to liquidate an
investment in a business entity to the extent that we have or could be attributed with material, non-public information regarding
such business entity. As a result, our ability to vary our portfolio in response to changes in economic and other conditions may
be relatively limited, which could adversely affect our results of operations and financial condition.
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Actions by the U.S. Government designed to stabilize or reform the financial markets may not achieve their intended
effect or otherwise benefit our business, and could materially adversely affect our business.
In July 2010, the U.S. Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (or the Dodd-
Frank Act), in part to impose significant investment restrictions and capital requirements on banking entities and other organizations
that are significant to U.S. financial markets. For instance, the Dodd-Frank Act imposes significant restrictions on the proprietary
trading activities of certain banking entities and subjects other systemically significant entities and activities regulated by the U.S.
Federal Reserve to increased capital requirements and quantitative limits for engaging in such activities. The Dodd-Frank Act
also seeks to reform the asset-backed securitization market (including the MBS market) by requiring the retention of a portion of
the credit risk inherent in the pool of securitized assets and by imposing additional registration and disclosure requirements. The
Dodd-Frank Act also imposes significant regulatory restrictions on the origination of residential mortgage loans. The Dodd-Frank
Act’s extensive requirements, and implementation by regulatory agencies such as the Commodity Futures Trading Commission
(or CFTC), the Federal Deposit Insurance Corporation (or FDIC), Federal Reserve Board, and the SEC may have a significant
effect on the financial markets, and may affect the availability or terms of financing from our lender counterparties and the
availability or terms of MBS, both of which could have a material adverse effect on our business.
In addition, the U.S. Government, U.S. Federal Reserve, U.S. Treasury and other governmental and regulatory bodies have
taken and continue to consider additional actions in response to the 2007-2008 financial and credit crisis domestically and
internationally. International financial regulators are examining standard setting for systemically significant entities, such as those
considered by the Third Basel Accords (Basel III) to be incorporated by domestic entities. We cannot predict whether or when
such actions may occur or what effect, if any, such actions could have on our business, results of operations and financial condition.
Regulatory Risk and Risks Related to the Investment Company Act of 1940
Our business is subject to extensive regulation.
Our business is subject to extensive regulation by federal and state governmental authorities, self-regulatory organizations
and securities exchanges. We are required to comply with numerous federal and state laws. The laws, rules and regulations
comprising this regulatory framework change frequently, as can the interpretation and enforcement of existing laws, rules and
regulations. Some of the laws, rules and regulations to which we are subject are intended primarily to safeguard and protect
consumers, rather than stockholders or creditors. From time to time, we may receive requests from federal and state agencies for
records, documents and information regarding our policies, procedures and practices regarding our business activities. We incur
significant ongoing costs to comply with these government regulations.
Although we do not originate or directly service residential mortgage loans, we must comply with various federal and state
laws, rules and regulations as a result of owning MBS and residential whole loans. These rules generally focus on consumer
protection and include, among others, rules promulgated under the Dodd-Frank Act, and the Gramm-Leach-Bliley Financial
Modernization Act of 1999 (or Gramm-Leach-Bliley). These requirements can and do change as statutes and regulations are
enacted, promulgated, amended and interpreted, and the recent trend among federal and state lawmakers and regulators has been
toward increasing laws, regulations and investigative proceedings in relation to the mortgage industry generally. Although we
believe that we have structured our operations and investments to comply with existing legal and regulatory requirements and
interpretations, changes in regulatory and legal requirements, including changes in their interpretation and enforcement by
lawmakers and regulators, could materially and adversely affect our business and our financial condition, liquidity and results of
operations.
Maintaining our exemption from registration under the Investment Company Act imposes significant limits on our
operations.
We conduct our operations so that neither we nor any of our subsidiaries are required to register as an investment company
under the Investment Company Act. Section 3(a)(1)(A) of the Investment Company Act defines an investment company as any
issuer that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities. Section
3(a)(1)(C) of the Investment Company Act defines an investment company as any issuer that is engaged or proposes to engage in
the business of investing, reinvesting, owning, holding or trading in securities and owns or proposes to acquire investment securities
having a value exceeding 40% of the value of the issuer’s total assets (exclusive of U.S. Government securities and cash items)
on an unconsolidated basis (i.e., the 40% Test). Excluded from the term “investment securities” are, among other things, U.S.
Government securities and securities issued by majority-owned subsidiaries that are not themselves investment companies and
are not relying on the exception from the definition of investment company for private funds set forth in Section 3(c)(1) or Section
3(c)(7) of the Investment Company Act.
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We are a holding company and conduct our real estate businesses primarily through wholly-owned subsidiaries. We conduct
our real estate business so that we do not come within the definition of an investment company because less than 40% of the value
of our adjusted total assets on an unconsolidated basis will consist of “investment securities.” The securities issued by any wholly-
owned or majority-owned subsidiaries that we may form in the future that are excepted from the definition of “investment company”
based on Section 3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we may own,
may not have a value in excess of 40% of the value of our adjusted total assets on an unconsolidated basis. We monitor our
holdings to ensure continuing and ongoing compliance with this test. In addition, we believe we will not be considered an investment
company under Section 3(a)(1)(A) of the Investment Company Act because we will not engage primarily or hold ourselves out
as being engaged primarily in the business of investing, reinvesting or trading in securities. Rather, through our wholly-owned
subsidiaries, we will be primarily engaged in the non-investment company businesses of these subsidiaries.
If the value of securities issued by our subsidiaries that are excepted from the definition of “investment company” by Section
3(c)(1) or 3(c)(7) of the Investment Company Act, together with any other investment securities we own, exceeds 40% of our
adjusted total assets on an unconsolidated basis, or if one or more of such subsidiaries fail to maintain an exception or exemption
from the Investment Company Act, we could, among other things, be required either (a) to substantially change the manner in
which we conduct our operations to avoid being required to register as an investment company, (b) effect sales of our assets in a
manner that, or at a time when, we would not otherwise choose to do so or (c) to register as an investment company under the
Investment Company Act, any of which could have an adverse effect on us and the market price of our securities. If we were
required to register as an investment company under the Investment Company Act, we would become subject to substantial
regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with
affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to
diversification and industry concentration, and other matters.
We expect that our subsidiaries that invest in residential mortgage loans (whether through a consolidated trust or otherwise)
will rely upon the exemption from registration as an investment company under the Investment Company Act pursuant to Section
3(c)(5)(C) of the Investment Company Act, which is available for entities “primarily engaged in the business of purchasing or
otherwise acquiring mortgages and other liens on and interests in real estate.” This exemption generally requires that at least 55%
of each of these subsidiaries’ assets be comprised of qualifying real estate assets and at least 80% of each of their portfolios be
comprised of qualifying real estate assets and real estate-related assets under the Investment Company Act. Mortgage loans that
were fully and exclusively secured by real property are generally qualifying real estate assets for purposes of the exemption. All
or substantially all of our residential mortgage loans are fully and exclusively secured by real property with a loan-to-value ratio
of less than 100%. As a result, we believe our residential mortgage loans that are fully and exclusively secured by real property
meet the definition of qualifying real estate assets. To the extent we own any residential mortgage loans with a loan-to-value ratio
of greater than 100%, we intend to classify, depending on guidance from the SEC staff, only the portion of the value of such loans
that does not exceed the value of the real estate collateral as qualifying real estate assets and the excess as real estate-related assets.
In August 2011, the SEC issued a “concept release” pursuant to which they solicited public comments on a wide range of
issues relating to companies engaged in the business of acquiring mortgages and mortgage-related instruments and that rely on
Section 3(c)(5)(C) of the Investment Company Act. The concept release and the public comments thereto have not yet resulted in
SEC rulemaking or interpretative guidance and we cannot predict what form any such rulemaking or interpretive guidance may
take. There can be no assurance, however, that the laws and regulations governing the Investment Company Act status of REITs,
or guidance from the SEC or its staff regarding the exemption from registration as an investment company on which we rely, will
not change in a manner that adversely affects our operations. We expect each of our subsidiaries relying on Section 3(c)(5)(C) to
rely on guidance published by the SEC staff or on our analyses of guidance published with respect to other types of assets, if any,
to determine which assets are qualifying real estate assets and real estate-related assets. To the extent that the SEC staff publishes
new or different guidance with respect to these matters, we may be required to adjust our strategy accordingly. In addition, we
may be limited in our ability to make certain investments and these limitations could result in us holding assets we might wish to
sell or selling assets we might wish to hold.
Certain of our subsidiaries may rely on the exemption provided by Section 3(c)(6) to the extent that they hold residential
mortgage loans through majority owned subsidiaries that rely on Section 3(c)(5)(C). The SEC staff has issued little interpretive
guidance with respect to Section 3(c)(6) and any guidance published by the staff could require us to adjust our strategy accordingly.
To the extent that the SEC staff provides more specific guidance regarding any of the matters bearing upon the exceptions
we and our subsidiaries rely on from registration under the Investment Company Act, we may be required to adjust our strategy
accordingly. Any additional guidance from the SEC staff could provide additional flexibility to us, or it could further inhibit our
ability to pursue the strategies we have chosen.
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There can be no assurance that the laws and regulations governing the Investment Company Act status of REITs, including
the Division of Investment Management of the SEC providing more specific or different guidance regarding these exemptions,
will not change in a manner that adversely affects our operations.
Risks Related to Our Use of Hedging Strategies
Our use of hedging strategies to mitigate our interest rate exposure may not be effective.
In accordance with our operating policies, we pursue various types of hedging strategies, including interest rate swap
agreements (or Swaps), to seek to mitigate or reduce our exposure to losses from adverse changes in interest rates. Our hedging
activity will vary in scope based on the level and volatility of interest rates, the type of assets held and financing sources used and
other changing market conditions. No hedging strategy, however, can completely insulate us from the interest rate risks to which
we are exposed and there is no guarantee that the implementation of any hedging strategy would have the desired impact on our
results of operations or financial condition. Certain of the U.S. federal income tax requirements that we must satisfy in order to
qualify as a REIT may limit our ability to hedge against such risks. We will not enter into derivative transactions if we believe
that they will jeopardize our qualification as a REIT.
Interest rate hedging may fail to protect or could adversely affect us because, among other things:
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interest rate hedging can be expensive, particularly during periods of rising and volatile interest rates;
available interest rate hedges may not correspond directly with the interest rate risk for which protection is sought;
the duration of the hedge may not match the duration of the related liability;
the credit quality of the party owing money on the hedge may be downgraded to such an extent that it impairs our
ability to sell or assign our side of the hedging transaction; and
the party owing money in the hedging transaction may default on its obligation to pay.
We primarily use Swaps to hedge against future increases in interest rates on our repurchase agreements. Should a Swap
counterparty be unable to make required payments pursuant to such Swap, the hedged liability would cease to be hedged for the
remaining term of the Swap. In addition, we may be at risk for any collateral held by a hedging counterparty to a Swap, should
such counterparty become insolvent or file for bankruptcy. Our hedging transactions, which are intended to limit losses, may
actually adversely affect our earnings, which could reduce our cash available for distribution to our stockholders.
We may enter into hedging instruments that could expose us to contingent liabilities in the future, which could materially
adversely affect our results of operations.
Subject to maintaining our qualification as a REIT, part of our financing strategy involves entering into hedging instruments
that could require us to fund cash payments in certain circumstances (e.g., the early termination of a hedging instrument caused
by an event of default or other voluntary or involuntary termination event or the decision by a hedging counterparty to request the
posting of collateral that it is contractually owed under the terms of a hedging instrument). With respect to the termination of an
existing Swap, the amount due would generally be equal to the unrealized loss of the open Swap position with the hedging
counterparty and could also include other fees and charges. These economic losses will be reflected in our financial results of
operations and our ability to fund these obligations will depend on the liquidity of our assets and access to capital at the time. Any
losses we incur on our hedging instruments could materially adversely affect our earnings and thus our cash available for distribution
to our stockholders.
The characteristics of hedging instruments present various concerns, including illiquidity, enforceability, and counterparty
risks, which could adversely affect our business and results of operations.
As indicated above, from time to time we enter into Swaps. Entities entering into Swaps are exposed to credit losses in the
event of non-performance by counterparties to these transactions. The CFTC issued new rules that became effective in October
2012 regarding Swaps under the authority granted to it pursuant to the Dodd-Frank Act. Although the new rules do not directly
affect the negotiations and terms of individual Swap transactions between counterparties, they do require that the clearing of all
Swap transactions through registered derivatives clearing organizations, or swap execution facilities, through standardized
documents under which each Swap counterparty transfers its position to another entity whereby the centralized clearinghouse
effectively becomes the counterparty to each side of the Swap. It is the intent of the Dodd-Frank Act that the clearing of Swaps
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in this manner is designed to avoid concentration of swap risk in any single entity by spreading and centralizing the risk in the
clearinghouse and its members. In addition to greater initial and periodic margin (collateral) requirements and additional transaction
fees both by the swap execution facility and the clearinghouse, the Swap transactions are now subjected to greater regulation by
both the CFTC and the SEC. These additional fees, costs, margin requirements, documentation, and regulation could adversely
affect our business and results of operations. Additionally, for all Swaps we entered into prior to June 2013, we are not required
to clear them through the central clearinghouse and these Swaps are still subject to the risks of non-performance by any of the
individual counterparties with which we entered into these transactions. If the Swap counterparty cannot perform under the terms
of a Swap, we would not receive payments due under that agreement, we may lose any unrealized gain associated with the Swap,
and the hedged liability would cease to be hedged by the Swap. We may also be at risk for any collateral we have pledged to secure
our obligation under the Swap if the counterparty becomes insolvent or files for bankruptcy. Default by a party with whom we
enter into a hedging transaction may result in a loss and force us to cover our commitments, if any, at the then-current market
price. Although generally we will seek to reserve the right to terminate our hedging positions, it may not always be possible to
dispose of or close out a hedging position without the consent of the hedging counterparty and we may not be able to enter into
an offsetting contract in order to cover our risk. We cannot assure you that there will always be a liquid secondary market that
will exist for hedging instruments purchased or sold and we may be required to maintain a position until exercise or expiration,
which could result in losses.
Clearing facilities or exchanges upon which some of our hedging instruments are traded may increase margin requirements
on our hedging instruments in the event of adverse economic developments.
In response to events having or expected to have adverse economic consequences or which create market uncertainty, clearing
facilities or exchanges upon which some of our hedging instruments (i.e., interest rate swaps) are traded may require us to post
additional collateral against our hedging instruments. For example, in response to the U.S. approaching its debt ceiling without
resolution and the federal government shutdown, in October 2013, the Chicago Mercantile Exchange announced that it would
increase margin requirements by 12% for all over-the-counter interest rate swap portfolios that its clearinghouse guaranteed. This
increase was subsequently rolled back shortly thereafter upon the news that Congress passed legislation to temporarily suspend
the national debt ceiling and reopen the federal government, and provide a time period for broader negotiations concerning federal
budgetary issues. In the event that future adverse economic developments or market uncertainty (including those due to
governmental, regulatory, or legislative action or inaction) result in increased margin requirements for our hedging instruments,
it could materially adversely affect our liquidity position, business, financial condition and results of operations.
We may fail to qualify for hedge accounting treatment, which could materially adversely affect our results of operations.
We record derivative and hedge transactions in accordance with GAAP, specifically according to the Financial Accounting
Standards Board (or FASB) Accounting Standards Codification Topic on Derivatives. Under these standards, we may fail to
qualify for hedge accounting treatment for a number of reasons, including if we use instruments that do not meet the definition
of a derivative, we fail to satisfy hedge documentation and hedge effectiveness assessment requirements or our instruments are
not highly effective. If we fail to qualify for hedge accounting treatment, though the fundamental economic performance of our
business would be unaffected, our operating results for financial reporting purposes may be materially adversely affected because
losses on the derivatives we enter into would be recorded in net income, rather than AOCI, a component of stockholders’ equity.
Risks Related to Our Taxation as a REIT and the Taxation of Our Assets
If we fail to remain qualified as a REIT, we will be subject to tax as a regular corporation and could face a substantial tax
liability, which would reduce the amount of cash available for distribution to our stockholders.
We have elected to qualify as a REIT and intend to comply with the provisions of the Internal Revenue Code of 1986, as
amended (or the Code), related to REIT qualification. Accordingly, we will not be subject to U.S. federal income tax to the extent
we distribute 100% of our REIT taxable income (which is generally our taxable income, computed without regard to the dividends
paid deduction, any net income from prohibited transactions, and any net income from foreclosure property) to stockholders within
the timeframe permitted under the Code and provided that we comply with certain income, asset ownership and other tests applicable
to REITs. We believe that we currently meet all of the REIT requirements and intend to continue to qualify as a REIT under the
provisions of the Code. Many of the REIT requirements, however, are highly technical and complex. The determination of whether
we are a REIT requires an analysis of various factual matters and circumstances, some of which may not be totally within our
control and some of which involve interpretation. For example, if we are to qualify as a REIT, annually at least 75% of our gross
income must come from, among other sources, interest on obligations secured by mortgages on real property or interests in real
property, gain from the disposition of real property, including mortgages or interests in real property (other than sales or dispositions
of real property, including mortgages on real property, or securities that are treated as mortgages on real property, that we hold
primarily for sale to customers in the ordinary course of a trade or business (i.e., prohibited transactions)), dividends or other
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distributions on, and gains from the disposition of shares in other REITs, commitment fees received for agreements to make real
estate loans and certain temporary investment income. In addition, the composition of our assets must meet certain requirements
at the close of each quarter. There can be no assurance that we will be able to satisfy these or other requirements or that the Internal
Revenue Service (or IRS) or a court would agree with any conclusions or positions we have taken in interpreting the REIT
requirements.
Even a technical or inadvertent mistake could jeopardize our REIT qualification unless we meet certain statutory relief
provisions. If we were to fail to qualify as a REIT in any taxable year for any reason, we would be subject to U.S. federal income
tax (at a 35% tax rate through 2017 and a 21% tax rate beginning in 2018), including any applicable alternative minimum tax (for
taxable years prior to 2018), on our taxable income, and dividends paid to our stockholders would not be deductible by us in
computing our taxable income. Any resulting corporate tax liability could be substantial and would reduce the amount of cash
available for distribution to our stockholders, which in turn could have an adverse impact on the value of our common stock.
Unless we were entitled to relief under certain Code provisions, we also would be disqualified from taxation as a REIT for the
four taxable years following the year in which we failed to qualify as a REIT.
We may lose our REIT status if the IRS successfully challenges our characterization of our income from foreign TRSs.
We have elected to treat a foreign subsidiary as a TRS. We have included and will likely be required to include in our income,
even without the receipt of actual distributions, earnings from our investment in the foreign TRS. Thus, we do not expect to have
any deferred foreign income that will be deemed repatriated in 2018. Income inclusions from equity investments in foreign
corporations are technically neither actual dividends nor any of the other enumerated categories of qualifying income for the 95%
gross income test. However, the IRS, based on discretionary authority granted to it under the Code, has issued private letter rulings
to other REITs holding that income inclusions from equity investments in foreign corporations would be treated as qualifying
income for purposes of the 95% gross income test. Private letter rulings may be relied upon only by the taxpayers to whom they
are issued and the IRS may revoke a private letter ruling. Based on those private letter rulings and advice of counsel, we generally
intend to treat such income inclusions as qualifying income for purposes of the 95% gross income test. Nevertheless, no assurance
can be provided that the IRS would not successfully challenge our treatment of such income as qualifying income. In the event
that such income was determined not to qualify for the 95% gross income test, we could be subject to a penalty tax with respect
to such income to the extent it exceeds 5% of our gross income or we could fail to continue to qualify as a REIT.
REIT distribution requirements could adversely affect our ability to execute our business plan.
To maintain our qualification as a REIT, we must distribute at least 90% of our REIT taxable income (determined without
regard to the dividends paid deduction and excluding any net capital gain) to our stockholders within the timeframe permitted
under the Code. We generally must make these distributions in the taxable year to which they relate, or in the following taxable
year if declared before we timely (including extensions) file our tax return for the year and if paid with or before the first regular
dividend payment after such declaration. To the extent that we satisfy this distribution requirement, but distribute less than 100%
of our taxable income, we will be subject to U.S. federal income tax on our undistributed taxable income at regular corporate
income tax rates. In addition, if we should fail to distribute during each calendar year at least the sum of (a) 85% of our REIT
ordinary income for such year, (b) 95% of our REIT capital gain net income for such year, and (c) any undistributed taxable income
from prior periods, we would be subject to a non-deductible 4% excise tax on the excess of such required distribution over the
sum of (x) the amounts actually distributed, plus (y) the amounts of income we retained and on which we have paid corporate
income tax.
The dividend distribution requirement limits the amount of cash we have available for other business purposes, including
amounts to fund our growth. Also, it is possible that because of differences in timing between the recognition of taxable income
and the actual receipt of cash, we may have to borrow funds on unfavorable terms, sell investments at disadvantageous prices or
distribute amounts that would otherwise be invested in future acquisitions to make distributions sufficient to maintain our
qualification as a REIT or avoid corporate income tax and the 4% excise tax in a particular year. These alternatives could increase
our costs or reduce our stockholders’ equity. Thus, compliance with the REIT requirements may hinder our ability to grow, which
could adversely affect the value of our common stock.
Even if we remain qualified as a REIT, we may face other tax liabilities that reduce our cash flow.
Even if we qualify as a REIT for U.S. federal income tax purposes, we may be required to pay certain U.S. federal, state and
local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted
as a result of a foreclosure, excise taxes, state or local income, property and transfer taxes, such as mortgage recording taxes, and
other taxes. In addition, in order to meet the REIT qualification requirements, to prevent the recognition of certain types of non-
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cash income, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or
inventory (i.e., prohibited transactions tax) we may hold some of our assets through TRSs or other subsidiary corporations that
will be subject to corporate level income tax at regular rates. In addition, if we lend money to a TRS, the TRS may be unable to
deduct all or a portion of the interest paid to us, which could result in an even higher corporate level tax liability. Any of these
taxes would reduce our operating cash flow and thus our cash available for distribution to our stockholders.
If our foreign TRS is subject to U.S. federal income tax at the entity level, it would greatly reduce the amounts those entities
would have available to pay its creditors and distribute to us.
There is a specific exemption from regular U.S. federal income tax for non-U.S. corporations that restrict their activities in
the United States to trading stock and securities (or any activity closely related thereto) for their own account, whether such trading
(or such other activity) is conducted by the corporation or its employees through a resident broker, commission agent, custodian
or other agent. We intend that our foreign TRS will rely on that exemption or otherwise operate in a manner so that it will not be
subject to regular U.S. federal income tax on its net income at the entity level. If the IRS succeeded in challenging that tax
treatment, it would greatly reduce the amount that the foreign TRS would have available to pay to its creditors and to distribute
to us. In addition, even if our foreign TRS qualifies for that exemption, it may nevertheless be subject to U.S. federal withholding
tax on certain types of income.
Complying with REIT requirements may cause us to forgo otherwise attractive opportunities.
To remain qualified as a REIT for U.S. federal income tax purposes, we must continually satisfy tests concerning, among
other things, the sources of our income, the nature and diversification of our assets, the amounts that we distribute to our stockholders
and the ownership of our stock. We may be required to make distributions to stockholders at disadvantageous times or when we
do not have funds readily available for distribution, and may be unable to pursue investments that would be otherwise advantageous
to us in order to satisfy the source-of-income or asset-diversification requirements for qualifying as a REIT. In addition, in certain
cases, the modification of a debt instrument could result in the conversion of the instrument from a qualifying real estate asset to
a wholly or partially non-qualifying asset that must be contributed to a TRS or disposed of in order for us to maintain our qualification
as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make and, in certain cases, to maintain
ownership of, certain attractive investments.
Our ownership of and relationship with any TRS which we may form or acquire will be limited, and a failure to comply
with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax.
A REIT may own up to 100% of the stock of one or more TRSs. A TRS may earn income that would not be qualifying income
if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a TRS. A
corporation (other than a REIT) of which a TRS directly or indirectly owns more than 35% of the voting power or value of the
stock will automatically be treated as a TRS. Overall, no more than 20% of the value of a REIT's total assets may consist of stock
or securities of one or more TRSs. A domestic TRS will pay federal, state and local income tax at regular corporate rates on any
income that it earns. In addition, the TRS rules limit the deductibility of interest paid or accrued by a TRS to its parent REIT to
assure that the TRS is subject to an appropriate level of corporate taxation, and in certain circumstances, the ability of our TRSs
to deduct net business interest expenses generally may be limited. The rules also impose a 100% excise tax on certain transactions
between a TRS and its parent REIT that are not conducted on an arm's-length basis. Any domestic TRS that we may form will
pay federal, state and local income tax on its taxable income, and its after-tax net income will be available for distribution to us
but is not required to be distributed to us unless necessary to maintain our REIT qualification.
We may generate taxable income that differs from our GAAP income on our Non-Agency MBS and residential whole loan
investments purchased at a discount to par value, which may result in significant timing variances in the recognition of
income and losses.
We have acquired and intend to continue to acquire Non-Agency MBS and residential whole loans at prices that reflect
significant market discounts on their unpaid principal balances. For financial statement reporting purposes, we generally establish
a portion of the purchase discount on Non-Agency MBS as a Credit Reserve. This Credit Reserve is generally not accreted into
income for financial statement reporting purposes. For tax purposes, however, we are not permitted to anticipate, or establish a
reserve for, credit losses prior to their occurrence. As a result, discount on securities acquired in the primary or secondary market
is included in the determination of taxable income and is not impacted by losses until such losses are incurred. Such differences
in accounting for tax and GAAP can lead to significant timing variances in the recognition of income and losses. Taxable income
on Non-Agency MBS purchased at a discount to their par value may be higher than GAAP earnings in early periods (before losses
are actually incurred) and lower than GAAP earnings in periods during and subsequent to when realized credit losses are incurred.
Dividends will be declared and paid at the discretion of our Board and will depend on REIT taxable earnings, our financial results
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and overall financial condition, maintenance of our REIT qualification and such other factors as our Board may deem relevant
from time to time.
The tax on prohibited transactions may limit our ability to engage in transactions, including certain methods of securitizing
mortgage loans, that would be treated as sales for U.S. federal income tax purposes.
A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or
other dispositions of property, other than foreclosure property, but including mortgage loans, held primarily for sale to customers
in the ordinary course of business. We might be subject to this tax if we were to dispose of or securitize loans or MBS securities
in a manner that was treated as a sale of the loans or MBS for U.S. federal income tax purposes. Therefore, to avoid the prohibited
transactions tax, we may choose to engage in certain sales of loans through a TRS and not at the REIT level, and we may be limited
as to the structures we are able to utilize for our securitization transactions, even though the sales or structures might otherwise
be beneficial to us. We do not believe that our securitizations to date have been subject to this tax, but there can be no assurances
that the IRS would agree with such treatment. If the IRS successfully challenged such treatment, our results of operations could
be materially adversely affected.
The “taxable mortgage pool” rules may increase the taxes that we or our stockholders may incur and may limit the manner
in which we effect future securitizations.
Securitizations by us or our subsidiaries could result in the creation of taxable mortgage pools for U.S. federal income tax
purposes. The real estate mortgage investment conduit (or REMIC) provisions of the Code generally provide that REMICs are
the only form of pass-through entity permitted to issue debt obligations with two or more maturities if the payments on those
obligations bear a relationship to the mortgage obligations held by such entity. If we engage in a non-REMIC securitization
transaction, directly or indirectly through a QRS, in which the assets held by the securitization vehicle consist largely of mortgage
loans or MBS, in which the securitization vehicle issues to investors two or more classes of debt instruments that have different
maturities, and in which the timing and amount of payments on the debt instruments is determined in large part by the amounts
received on the mortgage loans or MBS held by the securitization vehicle, the securitization vehicle will be a taxable mortgage
pool. As long as we or another REIT holds a 100% interest in the equity interests in a taxable mortgage pool, either directly or
through a QRS, the taxable mortgage pool will not be subject to tax. A portion of the income that we realize with respect to the
equity interest we hold in a taxable mortgage pool will, however, be considered to be excess inclusion income and, as a result, a
portion of the dividends that we pay to our stockholders will be considered to consist of excess inclusion income. Such excess
inclusion income is treated as unrelated business taxable income (or UBTI) for tax-exempt stockholders, is subject to withholding
for foreign stockholders (without the benefit of any treaty reduction), and is not subject to reduction by net operating loss carryovers.
In addition to the extent that our stock is owned by tax-exempt “disqualified organizations,” such as certain government-related
entities and charitable remainder trusts that are not subject to tax on unrelated business income, we may incur a corporate level
tax on a portion of our income from the taxable mortgage pool. In that case, we may reduce the amount of our distributions to any
disqualified organization whose stock ownership gave rise to the tax. Historically, we have not generated excess inclusion income;
however, despite our efforts, we may not be able to avoid creating or distributing excess inclusion income to our stockholders in
the future. In addition, we could face limitations in selling equity interests to outside investors in securitization transactions that
are taxable mortgage pools or selling any debt securities issued in connection with these securitizations that might be considered
to be equity interests for tax purposes. These limitations may prevent us from using certain techniques to maximize our returns
from securitization transactions.
We have not established a minimum dividend payment level, and there is no guarantee that we will maintain current
dividend payment levels or pay dividends in the future.
In order to maintain our qualification as a REIT, we must comply with a number of requirements under U.S. federal tax law,
including that we distribute at least 90% of our REIT taxable income within the timeframe permitted under the Code, which is
calculated generally before the dividends paid deduction and excluding net capital gain. Dividends will be declared and paid at
the discretion of our Board and will depend on our REIT taxable earnings, our financial results and overall condition, maintenance
of our REIT qualification and such other factors as our Board may deem relevant from time to time. We have not established a
minimum dividend payment level for our common stock and our ability to pay dividends may be negatively impacted by adverse
changes in our operating results. Therefore, our dividend payment level may fluctuate significantly, and, under some circumstances,
we may not pay dividends at all.
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Our reported GAAP net income may differ from the amount of REIT taxable income and dividend distribution requirements
and, therefore, our GAAP results may not be an accurate indicator of future taxable income and dividend distributions.
Generally, the cumulative net income we report over the life of an asset will be the same for GAAP and tax purposes, although
the timing of this income recognition over the life of the asset could be materially different. Differences exist in the accounting
for GAAP net income and REIT taxable income which can lead to significant variances in the amount and timing of when income
and losses are recognized under these two measures. Due to these differences, our reported GAAP financial results could materially
differ from our determination of REIT taxable income and our dividend distribution requirements, and, therefore, our GAAP
results may not be an accurate indicator of future taxable income and dividend distributions.
Over time, accounting principles, conventions, rules, and interpretations may change, which could affect our reported
GAAP and taxable earnings, and stockholders’ equity.
Accounting rules for the various aspects of our business change from time to time. Changes in GAAP, or the accepted
interpretation of these accounting principles, can affect our reported income, earnings, and stockholders’ equity. In addition,
changes in tax accounting rules or the interpretations thereof could affect our REIT taxable income and our dividend distribution
requirements. These changes may materially adversely affect our results of operations.
The failure of assets subject to repurchase agreements to qualify as real estate assets could adversely affect our ability to
remain qualified as a REIT.
We enter into certain financing arrangements that are structured as sale and repurchase agreements pursuant to which we
nominally sell certain of our assets to a counterparty and simultaneously enter into an agreement to repurchase these assets at a
later date in exchange for a purchase price. Economically, these agreements are financings that are secured by the assets sold
pursuant thereto. We generally believe that we would be treated for REIT asset and income test purposes as the owner of the assets
that are the subject of any such sale and repurchase agreement notwithstanding that such agreement may transfer record ownership
of the assets to the counterparty during the term of the agreement. It is possible, however, that the IRS could assert that we did
not own the assets during the term of the sale and repurchase agreement, in which case we could fail to remain qualified as a REIT.
Complying with REIT requirements may limit our ability to hedge effectively and may cause us to incur tax liabilities.
The REIT provisions of the Code could substantially limit our ability to hedge our liabilities. Any income from a properly
designated hedging transaction we enter into to manage risk of interest rate changes with respect to borrowings made or to be
made, or ordinary obligations incurred or to be incurred, to acquire or carry real estate assets, or from certain other limited types
of hedging transactions, generally does not constitute “gross income” for purposes of the 75% or 95% gross income tests. To the
extent that we enter into other types of hedging transactions, the income from those transactions is likely to be treated as non-
qualifying income for purposes of both of the gross income tests. As a result of these rules, we may have to limit our use of
advantageous hedging techniques or implement those hedges through a TRS. This could increase the cost of our hedging activities
because a TRS would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we
would otherwise want to bear. In addition, losses in a TRS will generally not provide any tax benefit, except for being carried
forward against future taxable income in the TRS.
We may be required to report taxable income for certain investments in excess of the economic income we ultimately realize
from them.
We may acquire debt instruments in the secondary market for less than their face amount. The discount at which such debt
instruments are acquired may reflect doubts about their ultimate collectability rather than current market interest rates. The amount
of such discount will nevertheless generally be treated as “market discount” for U.S. federal income tax purposes. Accrued market
discount is reported as income when, and to the extent that, any payment of principal of the debt instrument is made, and under
the new rules regarding the timing of income on such assets that apply beginning in 2018 (or, with respect to debt securities with
original issue discount, 2019), may be included sooner based on when such income is included in our financial statements. If we
collect less on the debt instrument than our purchase price plus the market discount we had previously reported as income, we
may not be able to benefit from any offsetting loss deductions.
Some of the debt instruments that we acquire may have been issued with original issue discount. We will be required to
report such original issue discount based on a constant yield method and will be taxed based on the assumption that all future
projected payments due on such debt instruments will be made, and under the new rules regarding the timing of income on such
assets that apply in 2019 with respect to debt securities with original issue discount, may be included sooner based on when such
24
income is included in our financial statements. If such debt instruments turn out not to be fully collectible, an offsetting loss
deduction will become available only in the later year that uncollectability is provable.
In addition, we may acquire debt instruments that are subsequently modified by agreement with the borrower. If the
amendments to the outstanding instrument are “significant modifications” under the applicable Treasury regulations, the modified
instrument will be considered to have been reissued to us in a debt-for-debt exchange with the borrower. In that event, we may be
required to recognize taxable gain to the extent the principal amount of the modified instrument exceeds our adjusted tax basis in
the unmodified instrument, even if the value of the instrument or the payment expectations have not changed. Following such a
taxable modification, we would hold the modified loan with a cost basis equal to its principal amount for U.S. federal income tax
purposes.
Finally, in the event that any debt instruments acquired by us are delinquent as to mandatory principal and interest payments,
or in the event payments with respect to a particular instrument are not made when due, we may nonetheless be required to continue
to recognize the unpaid interest as taxable income as it accrues, despite doubt as to its ultimate collectability. Similarly, we may
be required to accrue interest income with respect to debt instruments at its stated rate regardless of whether corresponding cash
payments are received or are ultimately collectible. In each case, while we would in general ultimately have an offsetting loss
deduction available to us when such interest was determined to be uncollectible, the utility of that deduction could depend on our
having taxable income in that later year or thereafter.
For these and other reasons, we may have difficulty making distributions sufficient to maintain our qualification as a REIT
or avoid corporate income tax and the 4% excise tax in a particular year.
Dividends paid by REITs do not qualify for the reduced tax rates available for “qualified dividend income.”
The maximum regular U.S. federal income tax rate for qualified dividend income paid to domestic stockholders that are
individuals, trusts and estates is currently 20%. Dividends paid by REITs, however, are generally not eligible for the reduced
qualified dividend rates. For taxable years beginning after December 31, 2017 and before January 1, 2026, under the recently
enacted law informally known as the Tax Cuts and Jobs Act (or TCJA), non-corporate taxpayers may deduct up to 20% of certain
pass-through business income, including “qualified REIT dividends” (generally, dividends received by a REIT stockholder that
are not designated as capital gain dividends or qualified dividend income), subject to certain limitations, resulting in an effective
maximum U.S. federal income tax rate of 29.6% on such income. Although the reduced U.S. federal income tax rate applicable
to qualified dividend income does not adversely affect the taxation of REITs or dividends payable by REITs, the more favorable
rates applicable to regular corporate qualified dividends and the reduced corporate tax rate (currently 21%) could cause certain
non-corporate investors to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-
REIT corporations that pay dividends, which could adversely affect the value of the shares of REITs, including our common stock.
New legislation or administrative or judicial action, in each instance potentially with retroactive effect, could make it more
difficult or impossible for us to remain qualified as a REIT.
The present U.S. federal income tax treatment of REITs may be modified, possibly with retroactive effect, by legislative,
judicial or administrative action at any time, which could affect the U.S. federal income tax treatment of an investment in us.
Revisions in U.S. federal tax laws and interpretations thereof could affect or cause us to change our investments and commitments
and affect the tax considerations of an investment in us. The TCJA significantly changes the U.S. federal income tax laws applicable
to businesses and their owners, including REITs and their stockholders. Technical corrections or other amendments to the TCJA
or administrative guidance interpreting the TCJA may be forthcoming at any time. We cannot predict the long-term effect of the
TCJA or any future law changes on REITs and their stockholders. Any such changes could have an adverse effect on an investment
in our stock or on the market value or the resale potential of our assets.
Risks Related to Our Corporate Structure
Our ownership limitations may restrict business combination opportunities.
To qualify as a REIT under the Code, no more than 50% of the value of our outstanding shares of capital stock may be owned,
directly or under applicable attribution rules, by five or fewer individuals (as defined by the Code to include certain entities) during
the last half of each taxable year. To preserve our REIT qualification, among other things, our charter generally prohibits direct
or indirect ownership by any person of more than 9.8% of the number or value of the outstanding shares of our capital stock or
more than 9.8% of the number or value, whichever is more restrictive, of the outstanding shares of our preferred stock. Generally,
shares owned by affiliated owners will be aggregated for purposes of the ownership limit. Any transfer of shares of our capital
stock or other event that, if effective, would violate the ownership limit will be void as to that number of shares of capital stock
25
in excess of the ownership limit and the intended transferee will acquire no rights in such shares. Shares issued or transferred that
would cause any stockholder to own more than the ownership limit or cause us to become “closely held” under Section 856(h) of
the Code will automatically be converted into an equal number of shares of excess stock. All excess stock will be automatically
transferred, without action by the prohibited owner, to a trust for the exclusive benefit of one or more charitable beneficiaries that
we select, and the prohibited owner will not acquire any rights in the shares of excess stock. The restrictions on ownership and
transfer contained in our charter could have the effect of delaying, deferring or preventing a change in control or other transaction
in which holders of shares of common stock might receive a premium for their shares of common stock over the then current
market price or that such holders might believe to be otherwise in their best interests. The ownership limit provisions also may
make our shares of common stock an unsuitable investment vehicle for any person seeking to obtain, either alone or with others
as a group, ownership of more than 9.8% of the number or value of our outstanding shares of capital stock.
Provisions of Maryland law and other provisions of our organizational documents may limit the ability of a third party to
acquire control of the Company.
Certain provisions of the Maryland General Corporation Law (or MGCL) may have the effect of delaying, deferring or
preventing a transaction or a change in control of our company that might involve a premium price for holders of our common
stock or otherwise be in their best interests, including:
•
•
“business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an
“interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of
our outstanding voting stock or an affiliate or associate of ours who, at any time within the two-year period immediately
prior to the date in question, was the beneficial owner of 10% or more of the voting power of our then outstanding stock)
or an affiliate of an interested stockholder for five years after the most recent date on which the stockholder becomes an
interested stockholder, and thereafter impose two supermajority stockholder voting requirements to approve these
combinations (unless our common stockholders receive a minimum price, as defined under Maryland law, for their shares
in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares);
and
“control share” provisions that provide that holders of “control shares” of our company (defined as voting shares of stock
which, when aggregated with all other shares controlled by the acquiring stockholder, entitle the stockholder to exercise
one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined
as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent
approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter,
excluding all interested shares.
Our bylaws provide that we are not subject to the “control share” provisions of the MGCL. However, our Board may elect
to make the “control share” statute applicable to us at any time, and may do so without stockholder approval.
Title 3, Subtitle 8 of the MGCL permits our Board, without stockholder approval and regardless of what is currently provided
in our charter or bylaws, to elect on behalf of our company to be subject to statutory provisions that may have the effect of delaying,
deferring or preventing a transaction or a change in control of our company that might involve a premium price for holders of our
common stock or otherwise be in their best interest. Our Board may elect to opt in to any or all of the provisions of Title 3, Subtitle
8 of the MGCL without stockholder approval at any time. In addition, without our having elected to be subject to Subtitle 8, our
charter and bylaws already (1) provide for a classified board, (2) require the affirmative vote of the holders of at least 80% of the
votes entitled to be cast in the election of directors for the removal of any director from our Board, which removal will be allowed
only for cause, (3) vest in our Board the exclusive power to fix the number of directorships and (4) require, unless called by our
Chairman of the Board, Chief Executive Officer or President or our Board, the written request of stockholders entitled to cast not
less than a majority of all votes entitled to be cast at such a meeting to call a special meeting. These provisions may delay or
prevent a change of control of our company.
Future offerings of debt securities, which would rank senior to our common stock upon liquidation, and future offerings
of equity securities, which would dilute our existing stockholders and may be senior to our common stock for the purposes
of dividend and liquidating distributions, may adversely affect the market price of our common stock.
In the future, we may attempt to increase our capital resources by making offerings of debt or additional offerings of equity
securities, including commercial paper, senior or subordinated notes and series or classes of preferred stock or common stock.
Upon liquidation, holders of our debt securities and shares of preferred stock, if any, and lenders with respect to other borrowings
will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings may dilute
the holdings of our existing stockholders or reduce the market price of our common stock, or both. Preferred stock could have a
26
preference on liquidating distributions or a preference on dividend payments or both that could limit our ability to make a dividend
distribution to the holders of our common stock. Because our decision to issue securities in any future offering will depend on
market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future
offerings. Thus, holders of our common stock bear the risk of our future offerings reducing the market price of our common stock
and diluting their stock holdings in us.
Our Board may approve the issuance of capital stock with terms that may discourage a third party from acquiring the
Company.
Our charter permits our Board to issue shares of preferred stock, issuable in one or more classes or series. We may issue a
class of preferred stock to individual investors in order to comply with the various REIT requirements or to finance our operations.
Our charter further permits our Board to classify or reclassify any unissued shares of preferred or common stock and establish the
preferences and rights (including, among others, voting, dividend and conversion rights) of any such shares of stock, which rights
may be superior to those of shares of our common stock. Thus, our Board could authorize the issuance of shares of preferred or
common stock with terms and conditions that could have the effect of discouraging a takeover or other transaction in which holders
of the outstanding shares of our common stock might receive a premium for their shares over the then current market price of our
common stock.
Future issuances or sales of shares could cause our share price to decline.
Sales of substantial numbers of shares of our common stock in the public market, or the perception that such sales might
occur, could adversely affect the market price of our common stock. In addition, the sale of these shares could impair our ability
to raise capital through a sale of additional equity securities. Other issuances of our common stock could have an adverse effect
on the market price of our common stock. In addition, future issuances of our common stock may be dilutive to existing stockholders.
Other Business Risks
We are dependent on our executive officers and other key personnel for our success, the loss of any of whom may materially
adversely affect our business.
Our success is dependent upon the efforts, experience, diligence, skill and network of business contacts of our executive
officers and key personnel. The departure of any of our executive officers and/or key personnel could have a material adverse
effect on our operations and performance.
We are dependent on information systems and their failure (including in connection with cyber attacks) could significantly
disrupt our business.
Our business is highly dependent on our information and communications systems. Any failure or interruption of our systems
or cyber attacks or security breaches of our networks or systems could cause delays or other problems in our securities trading
activities, which could have a material adverse effect on operating results, the market price of our common stock and other securities
and our ability to pay dividends to our stockholders. In addition, we also face the risk of operational failure, termination or capacity
constraints of any of the third parties with which we do business or that facilitate our business activities, including clearing agents
or other financial intermediaries we use to facilitate our securities transactions.
Computer malware, viruses, and computer hacking and phishing and cyber attacks have become more prevalent in our
industry and may occur on our systems in the future. Although we are regularly working to install new, and upgrade our existing,
information technology systems and provide employee awareness training around computer malware, phishing, and other cyber
risks, there can be no assurance that we are or will be fully protected against cyber risks and security breaches and not be vulnerable
to new and evolving threats to our information technology systems. We rely heavily on financial, accounting and other data
processing systems. It is difficult to determine what, if any, negative impact may directly result from any specific interruption or
cyber attacks or security breaches of our networks or systems (or networks or systems of, among other third parties, our lenders)
or any failure to maintain performance, reliability and security of our technical infrastructure. As a result, any such computer
malware, viruses, and computer hacking and phishing attacks may negatively affect our operations.
27
We operate in a highly competitive market for investment opportunities and competition may limit our ability to acquire
desirable investments, which could materially adversely affect our results of operations.
We operate in a highly competitive market for investment opportunities. Our profitability depends, in large part, on our
ability to acquire residential mortgage assets or other investments at favorable prices. In acquiring our investments, we compete
with a variety of institutional investors, including other REITs, public and private funds, commercial and investment banks,
commercial finance and insurance companies and other financial institutions. Many of our competitors are substantially larger
and have considerably greater financial, technical, marketing and other resources than we do. Some competitors may have a lower
cost of funds and access to funding sources that are not available to us. Many of our competitors are not subject to the operating
constraints associated with REIT compliance or maintenance of an exemption from the Investment Company Act similar to ours.
In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to
consider a wider variety of investments and establish additional business relationships than us. Furthermore, government or
regulatory action and competition for investment securities of the types and classes which we acquire may lead to the price of
such assets increasing, which may further limit our ability to generate desired returns. We cannot assure you that the competitive
pressures we face will not have a material adverse effect on our business, financial condition and results of operations. Also, as
a result of this competition, desirable investments may be limited in the future and we may not be able to take advantage of
attractive investment opportunities from time to time, as we can provide no assurance that we will be able to identify and make
investments that are consistent with our investment objectives.
Deterioration in the condition of European banks and financial institutions could have a material adverse effect on our
business.
In the years following the financial and credit crisis of 2007-2008, certain of our repurchase agreement counterparties in the
United States and Europe experienced financial difficulty and were either rescued by government assistance or otherwise benefited
from accommodative monetary policy of central banks. Several European governments implemented measures to attempt to shore
up their financial sectors through loans, credit guarantees, capital infusions, promises of continued liquidity funding and interest
rate cuts. Additionally, other governments of the world’s largest economic countries also implemented interest rate cuts. Although
economic and credit conditions have stabilized in the past few years, there is no assurance that these and other plans and programs
will be successful in the longer term, and, in particular, when governments and central banks begin to significantly unwind or
otherwise reverse these programs and policies. If unsuccessful, this could materially adversely affect our financing and operations
as well as those of the entire mortgage sector in general.
Several of our financing counterparties are European banks (or their U.S. based subsidiaries) that have provided financing
to us, particularly repurchase agreement financing for the acquisition of residential mortgage assets. If European banks and
financial institutions experience a deterioration in financial condition, there is the possibility that this would also negatively affect
the operations of their U.S. banking subsidiaries. This risk could be more pronounced in light of Brexit. This could adversely
affect our financing and operations as well as those of the entire mortgage sector in general.
Any downgrade, or perceived potential of a downgrade, of U.S. sovereign credit ratings or the credit ratings of the GSEs
by the various credit rating agencies may materially adversely affect our the value of our Agency MBS and our business
more generally.
During the summer of 2011, Standard & Poor’s Ratings Services (or S&P), one of the major credit rating agencies, downgraded
the U.S. sovereign credit rating in response to the protracted debate over the “U.S. debt ceiling limit” and S&P’s perception of
the U.S. Government’s ability to address its long-term budget deficit. At the same time, S&P also lowered the credit ratings of
the GSEs in response to the downgrade in the U.S. sovereign credit rating, as the value of the Agency MBS issued by the GSEs
and their ability to meet their obligations under such Agency MBS are largely determined by the support provided to them by the
U.S. Government and market perceptions of the strength of such support and the likelihood of its continuity.
We could be adversely affected in a number of ways in the event of a default by the U.S. Government, a further downgrade
by S&P or a downgrade of the U.S. sovereign credit rating by another credit rating agency Such adverse effects could include
higher financing costs and/or a reduction in the amount of financing provided based on the market value of collateral posted under
our repurchase agreements and other financing arrangements. In addition, although the rating agencies have more recently
determined that the GSEs’ outlook is generally stable, to the extent that the credit rating of any or all of the GSEs were to be
downgraded in the future, the value of our Agency MBS could be adversely affected. These outcomes could in turn materially
adversely affect our operations and financial condition in a number of ways, including a reduction in the net interest spread between
our assets and associated repurchase agreement borrowings or a decrease in our ability to obtain repurchase agreement financing
on acceptable terms, or at all.
28
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Office Leases
We pay monthly rent pursuant to two operating leases. Our lease for our corporate headquarters in New York, New York
extends through June 30, 2020. The lease provides for aggregate cash payments ranging over time of approximately $2.6 million
per year, paid on a monthly basis, exclusive of escalation charges. In addition, as part of this lease agreement, we have provided
the landlord a $785,000 irrevocable standby letter of credit fully collateralized by cash. The letter of credit may be drawn upon
by the landlord in the event that we default under certain terms of the lease. In addition, we have a lease through December 31,
2021, for our off-site back-up facility located in Rockville Centre, New York, which provides for, among other things, lease
payments totaling $32,000, annually.
Item 3. Legal Proceedings.
There are no material legal proceedings to which we are a party or to which any of our assets are subject.
Item 4. Mine Safety Disclosures.
Not applicable.
29
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock is listed on the New York Stock Exchange, under the symbol “MFA.” On February 8, 2018, the last sales
price for our common stock on the New York Stock Exchange was $6.93 per share. The following table sets forth the high and
low sales prices per share of our common stock during each calendar quarter for the years ended December 31, 2017 and 2016:
Quarter Ended
March 31
June 30
September 30
December 31
Holders
2017
2016
High
Low
High
Low
$
$
8.18
8.66
8.90
8.86
$
7.63
7.80
8.38
7.92
$
6.98
7.38
7.86
8.05
5.61
6.69
7.21
7.03
As of February 8, 2018, we had 553 registered holders of our common stock. Such information was obtained through our
registrar and transfer agent, based on the results of a broker search.
Dividends
No dividends may be paid on our common stock unless full cumulative dividends have been paid on our preferred stock.
We have paid full cumulative dividends on our preferred stock on a quarterly basis through December 31, 2017. We have historically
declared cash dividends on our common stock on a quarterly basis. During 2017 and 2016, we declared total cash dividends to
holders of our common stock of $312.8 million ($0.80 per share) and $297.0 million ($0.80 per share), respectively. In general,
our common stock dividends have been characterized as ordinary income to our stockholders for income tax purposes. However,
a portion of our common stock dividends may, from time to time, be characterized as capital gains or return of capital. For the
years ended December 31, 2017, 2016 and 2015 a portion of our dividends were deemed to be capital gains. (For additional
dividend information, see Notes 11(a) and 11(b) to the consolidated financial statements, included under Item 8 of this Annual
Report on Form 10-K.)
We elected to be taxed as a REIT for U.S. federal income tax purposes commencing with our taxable year ended December 31,
1998 and, as such, anticipate distributing at least 90% of our REIT taxable income within the timeframe permitted by the Code.
Although we may borrow funds to make distributions, cash for such distributions has generally been, and is expected to continue
to be, largely generated from our results of our operations.
30
We declared and paid the following dividends on our common stock during the years 2017 and 2016:
Year
2017
Declaration Date
Record Date
Payment Date
December 13, 2017
December 28, 2017
January 31, 2018
$
September 14, 2017
September 28, 2017
October 31, 2017
Dividend per
Share
0.20 (1)
0.20
June 12, 2017
March 8, 2017
June 29, 2017
March 29, 2017
July 28, 2017
April 28, 2017
2016
December 14, 2016
December 28, 2016
January 31, 2017
$
September 15, 2016
September 28, 2016
October 31, 2016
June 14, 2016
March 11, 2016
June 28, 2016
March 28, 2016
July 29, 2016
April 29, 2016
0.20
0.20
0.20
0.20
0.20
0.20
(1) At December 31, 2017, we had accrued dividends and dividend equivalents payable of $79.8 million related to the common stock dividend
declared on December 13, 2017.
Dividends are declared and paid at the discretion of our Board and depend on our cash available for distribution, financial
condition, ability to maintain our qualification as a REIT, and such other factors that our Board may deem relevant. We have not
established a minimum payout level for our common stock. (See Part I, Item 1A., “Risk Factors” and Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K, for information
regarding the sources of funds used for dividends and for a discussion of factors, if any, which may adversely affect our ability to
pay dividends.)
Purchases of Equity Securities
As previously disclosed, in August 2005, our Board authorized a stock repurchase program (or Repurchase Program), to
repurchase up to 4.0 million shares of our outstanding common stock under the Repurchase Program. The Board reaffirmed such
authorization in May 2010. In December 2013, our Board increased the number of shares authorized for repurchase to an aggregate
of 10.0 million shares (under which approximately 6.6 million shares remain available for repurchase). Such authorization does
not have an expiration date and, at present, there is no intention to modify or otherwise rescind such authorization. Subject to
applicable securities laws, repurchases of common stock under the Repurchase Program are made at times and in amounts as we
deem appropriate (including, in our discretion, through the use of one or more plans adopted under Rule 10b5-1 promulgated
under the Securities Exchange Act of 1934, as amended (or 1934 Act)), using available cash resources. Shares of common stock
repurchased by us under the Repurchase Program are cancelled and, until reissued by us, are deemed to be authorized but unissued
shares of our common stock. The Repurchase Program may be suspended or discontinued by us at any time and without prior
notice.
We did not repurchase any shares of our common stock under the Repurchase Program during the years ended December 31,
2017 and 2016.
31
We engaged in no share repurchase activity during the fourth quarter of 2017 pursuant to the Repurchase Program. We did,
however, withhold restricted shares (under the terms of grants under our Equity Compensation Plan (or Equity Plan)) to offset tax
withholding obligations that occur upon the vesting and release of restricted stock awards and/or restricted stock units (or RSUs).
The following table presents information with respect to (i) such withheld restricted shares, and (ii) eligible shares remaining for
repurchase under the Repurchase Program:
Month
October 1-31, 2017:
Repurchase Program (2)
Employee Transactions (3)
November 1-30, 2017:
Repurchase Program (2)
Employee Transactions (3)
December 1-31, 2017:
Repurchase Program (2)
Employee Transactions (3)
Total Repurchase Program (2)
Total Employee Transactions (3)
Total
Number of
Shares
Purchased
Weighted
Average Price
Paid Per
Share (1)
Total Number of
Shares Repurchased as
Part of Publicly
Announced
Repurchase Program
or Employee Plan
Maximum Number of
Shares that May Yet be
Purchased Under the
Repurchase Program or
Employee Plan
— $
—
—
—
—
103,840
$
— $
$
103,840
—
—
—
—
—
8.06
—
8.06
—
N/A
—
N/A
—
N/A
—
N/A
6,616,355
N/A
6,616,355
N/A
6,616,355
N/A
6,616,355
N/A
(1) Includes brokerage commissions.
(2) As of December 31, 2017, we had repurchased an aggregate of 3,383,645 shares under the Repurchase Program.
(3) Our Equity Plan provides that the value of the shares delivered or withheld be based on the price of our common stock on the date the
relevant transaction occurs.
Discount Waiver, Direct Stock Purchase and Dividend Reinvestment Plan
In September 2003, we initiated a Discount Waiver, Direct Stock Purchase and Dividend Reinvestment Plan (or the DRSPP)
to provide existing stockholders and new investors with a convenient and economical way to purchase shares of our common
stock. Under the DRSPP, existing stockholders may elect to automatically reinvest all or a portion of their cash dividends in
additional shares of our common stock and existing stockholders and new investors may make optional cash purchases of shares
of our common stock in amounts ranging from $50 (or $1,000 for new investors) to $10,000 on a monthly basis and, with our
prior approval, in excess of $10,000. At our discretion, we may issue shares of our common stock under the DRSPP at discounts
of up to 5% from the prevailing market price at the time of purchase. Computershare Shareowner Services LLC is the administrator
of the DRSPP (or the Plan Agent). Stockholders who own common stock that is registered in their own name and who want to
participate in the DRSPP must deliver a completed enrollment form to the Plan Agent. Stockholders who own common stock that
is registered in a name other than their own (e.g., broker, bank or other nominee) and who want to participate in the DRSPP must
either request such nominee holder to participate on their behalf or request that such nominee holder re-register our common stock
in the stockholder’s name and deliver a completed enrollment form to the Plan Agent. During the years ended 2017 and 2016, we
issued 2,293,192 and 653,793 shares of common stock through the DRSPP generating net proceeds of approximately $18.5 million
and $4.7 million, respectively.
32
Securities Authorized For Issuance Under Equity Compensation Plans
During 2015, we adopted the Equity Plan, as approved by our stockholders. The Equity Plan amended and restated our 2010
Equity Compensation Plan. (For a description of the Equity Plan, see Note 13(a) to the consolidated financial statements included
under Item 8 of this Annual Report on Form 10-K.)
The following table presents certain information with respect to our equity compensation plans as of December 31, 2017:
Award (1)
RSUs
Total
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
2,046,278
2,046,278
Weighted-average
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in the
first column of this table)
(2)
6,714,900 (3)
(1) All equity based compensation is granted pursuant to plans that have been approved by our stockholders.
(2) A weighted average exercise price is not applicable for our RSUs, as such equity awards result in the issuance of shares of our common
stock provided that such awards vest and, as such, do not have an exercise price. At December 31, 2017, 861,419 RSUs were vested, 438,609
RSUs were subject to time based vesting and 746,250 RSUs will vest subject to achieving a market condition.
(3) Number of securities remaining available for future issuance under equity compensation plans excludes RSUs presented in the table which
were issued and outstanding at December 31, 2017.
33
Item 6. Selected Financial Data.
Our selected financial data set forth below is derived from our audited financial statements and should be read in conjunction
with our consolidated financial statements and the accompanying notes, included under Item 8 of this Annual Report on Form 10-
K.
(Dollars in Thousands, Except per Share Amounts)
2017
2016
2015
2014
2013
At or/For the Year Ended December 31,
Operating Data:
Interest income
Interest expense
$
433,448
$
457,450
$
492,143
$
463,817
$
482,940
(197,141)
(193,355)
(176,948)
(159,808)
(164,013)
Net impairment losses recognized in earnings (1)
Net gain on residential whole loans held at fair value
(1,032)
90,019
(485)
62,605
(705)
19,575
—
116
—
—
Net gain on sales of MBS and U.S. Treasury
securities (2)
Unrealized net gains and net interest income from
Linked Transactions
Other income/(loss), net
Operating and other expense
Net income
Preferred stock dividends
Issuance costs of redeemed preferred stock (3)
Net income available to common stock and
participating securities
Earnings per share — basic and diluted
Dividends declared per share of common stock (4)
Dividends declared per share of preferred stock (5)
Balance Sheet Data:
39,577
35,837
34,900
37,497
25,825
—
29,423
(71,901)
—
10,600
(59,984)
—
(3,310)
(52,429)
17,092
80
(45,290)
3,225
(7,298)
(37,970)
$
322,393
$
312,668
$
313,226
$
313,504
$
302,709
15,000
—
307,393
0.79
0.80
1.875
$
$
$
$
15,000
—
297,668
0.80
0.80
1.875
$
$
$
$
$
$
$
$
15,000
—
298,226
0.80
0.80
1.875
$
$
$
$
15,000
—
298,504
0.81
0.80
1.875
13,750
3,947
285,012
0.78
1.64
2.136
$
$
$
$
MBS, CRT securities and MSR related assets
$ 7,515,130
$ 10,054,963
$ 11,356,643
$ 10,762,622
$11,371,358
Residential whole loans, at carrying value
Residential whole loans, at fair value
Cash and cash equivalents
Linked Transactions
Total assets
908,516
1,325,115
449,757
—
590,540
814,682
260,112
—
271,845
623,276
165,007
—
207,923
143,472
182,437
398,336
—
—
565,370
28,181
10,954,734
12,484,022
13,162,551
12,354,242
12,469,379
Repurchase agreements and other advances
6,614,701
8,687,268
9,387,622
8,267,388
8,339,297
Securitized debt (6)
Swaps (in a liability position) (7)
Total liabilities
Preferred stock, liquidation preference
Total stockholders’ equity
Other Data:
Average total assets
Average total stockholders’ equity
Return on average total assets (8)
Return on average total stockholders’ equity (9)
Total average stockholders’ equity to total average
assets (10)
Dividend payout ratio (11)
Book value per share of common stock (12)
$
363,944
—
—
46,954
21,868
70,526
110,072
62,198
363,676
28,217
7,693,098
9,450,120
10,195,290
9,150,970
9,327,128
200,000
200,000
3,261,636
3,033,902
200,000
2,967,261
200,000
200,000
3,203,272
3,142,251
$ 11,619,174
$ 12,836,580
$ 13,669,055
$ 12,542,584
$13,192,285
$ 3,203,814
$ 2,965,570
$ 3,129,461
$ 3,230,932
$ 3,262,458
2.65%
10.06%
2.32%
10.54%
2.18%
10.01%
2.38%
9.70%
2.16%
9.28%
27.57%
23.10%
22.89%
25.75%
24.73%
1.01
7.70
$
1.00
7.62
$
1.00
7.47
$
0.99
8.12
$
1.10
8.06
34
(1) Reflects OTTI recognized through earnings related to Non-Agency MBS.
(2) 2017: We sold Non-Agency MBS for $104.0 million, realizing gross gains of $39.9 million and sold U.S. Treasury securities for $139.1
million, realizing gross losses of approximately $309,000. 2016: We sold Non-Agency MBS for $85.6 million, realizing gross gains of $35.8
million. 2015: We sold Non-Agency MBS for $70.7 million, realizing gross gains of $34.9 million. 2014: We sold Non-Agency MBS for
$123.9 million, realizing gross gains of $37.5 million. 2013: We sold Non-Agency MBS for $152.6 million, realizing gross gains of $25.8
million and sold U.S. Treasury securities for $422.2 million, realizing net losses of approximately $24,000.
(3) Issuance costs of redeemed preferred stock represent the original offering costs related to the 8.50% Series A Cumulative Redeemable
Preferred Stock (“Series A Preferred Stock”), which was redeemed on May 16, 2013.
(4) 2013: Includes special cash dividends paid totaling $0.78 per share.
(5) 2013: Reflects dividends declared per share on Series A Preferred Stock and 7.50% Series B Cumulative Redeemable Preferred Stock (“Series
B Preferred Stock”) of $0.80 and $1.33, respectively.
(6) 2017: Reflects securitized debt from our 2017 loan securitization transactions. 2015, 2014 and 2013: Reflects securitized debt from our
MBS resecuritization transactions.
(7) Beginning in January 2017, variation margin payments on our cleared Swaps 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 fair value of the Swap.
(8) Reflects net income available to common stock and participating securities divided by average total assets.
(9) Reflects net income divided by average total stockholders’ equity.
(10) Reflects total average stockholders’ equity divided by total average assets.
(11) Reflects dividends declared per share of common stock (excluding special dividends) divided by earnings per share.
(12) Reflects total stockholders’ equity less the preferred stock liquidation preference divided by total shares of common stock outstanding.
35
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read in conjunction with our financial statements and accompanying notes included in
Item 8 of this Annual Report on Form 10-K.
GENERAL
We are a REIT primarily engaged in the business of investing, on a leveraged basis, in residential mortgage assets, including
Agency MBS, Non-Agency MBS, residential whole loans, CRT securities and MSR related assets. Our principal business objective
is to deliver shareholder value through the generation of distributable income and through asset performance linked to residential
mortgage credit fundamentals. We selectively invest in residential mortgage assets with a focus on credit analysis, projected
prepayment rates, interest rate sensitivity and expected return.
At December 31, 2017, we had total assets of approximately $11.0 billion, of which $6.4 billion, or 58.0%, represented our
MBS portfolio. At such date, our MBS portfolio was comprised of $2.8 billion of Agency MBS and $3.5 billion of Non-Agency
MBS, which includes $2.6 billion of Legacy Non-Agency MBS and $923.1 million of RPL/NPL MBS that are primarily structured
with a contractual coupon step-up feature where the coupon increases up to 300 basis points at 36 months from issuance or sooner.
These RPL/NPL MBS are primarily backed by securitized re-performing and non-performing loans. In addition, at December 31,
2017, we had approximately $2.2 billion in residential whole loans acquired through interests in certain trusts established to acquire
the loans, which represented approximately 20.4% of our total assets. Residential whole loans was our fastest growing asset class
during 2017, and we continue to seek opportunities to purchase these assets subject to market conditions. Our remaining investment-
related assets were primarily comprised of collateral obtained in connection with reverse repurchase agreements, cash and cash
equivalents (including restricted cash), CRT securities, MSR related assets, REO and MBS-related receivables.
The results of our business operations are affected by a number of factors, many of which are beyond our control, and
primarily depend on, among other things, the level of our net interest income, the market value of our assets, which is driven by
numerous factors, including the supply and demand for residential mortgage assets in the marketplace, the terms and availability
of adequate financing, general economic and real estate conditions (both on a national and local level), the impact of government
actions in the real estate and mortgage sector, and the credit performance of our credit sensitive residential mortgage assets. Our
net interest income varies primarily as a result of changes in interest rates, the slope of the yield curve (i.e., the differential between
long-term and short-term interest rates), borrowing costs (i.e., our interest expense) and prepayment speeds on our MBS, the
behavior of which involves various risks and uncertainties. Interest rates and conditional prepayment rates (or CPRs) (which
measure the amount of unscheduled principal prepayment on a bond as a percentage of the bond balance), vary according to the
type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any
certainty.
With respect to our business operations, increases in interest rates, in general, may over time cause: (i) the interest expense
associated with our borrowings to increase; (ii) the value of our MBS portfolio and, correspondingly, our stockholders’ equity to
decline; (iii) coupons on our ARM-MBS to reset, on a delayed basis, to higher interest rates; (iv) prepayments on our MBS to
decline, thereby slowing the amortization of our MBS purchase premiums and the accretion of our purchase discounts; and (v)
the value of our derivative hedging instruments and, correspondingly, our stockholders’ equity to increase. Conversely, decreases
in interest rates, in general, may over time cause: (i) the interest expense associated with our borrowings to decrease; (ii) the value
of our MBS portfolio and, correspondingly, our stockholders’ equity to increase; (iii) coupons on our ARM-MBS to reset, on a
delayed basis, to lower interest rates; (iv) prepayments on our MBS to increase, thereby accelerating the amortization of our MBS
purchase premiums and the accretion of our purchase discounts; and (v) the value of our derivative hedging instruments and,
correspondingly, our stockholders’ equity to decrease. In addition, our borrowing costs and credit lines are further affected by the
type of collateral we pledge and general conditions in the credit market.
Our investments in residential mortgage assets expose us to credit risk, generally meaning that we are subject to credit losses
due to the risk of delinquency, default and foreclosure on the underlying real estate collateral. (See Part I, Item 1A., “Risk Factors
- Credit and Other Risks Related to our Investments”, of this Annual Report on Form 10-K.) We believe the discounted purchase
prices paid on certain of these investments mitigate our risk of loss in the event that, as we expect on most such investments, we
receive less than 100% of the par value of these investments. Our investment process for credit sensitive assets focuses primarily
on quantifying and pricing credit risk.
36
The table below presents the composition of our MBS portfolios with respect to repricing characteristics as of December 31,
2017:
Underlying Mortgages
(In Thousands)
Agency MBS
Fair Value (1)
Non-Agency MBS
Fair Value (2)
Total
MBS (1)(2)
Percent
of Total
December 31, 2017
Hybrids in contractual fixed-rate period
$
591,664
$
— $
591,664
10.9%
Hybrids in adjustable period
15-year fixed rate
Greater than 15-year fixed rate
Floaters
Total
1,046,166
1,142,583
—
42,378
1,695,220
2,969
880,434
32,232
2,741,386
1,145,552
880,434
74,610
50.4
21.1
16.2
1.4
$
2,822,791
$
2,610,855
$
5,433,646
100.0%
(1) Does not include principal payments receivable in the amount of $1.9 million.
(2) Does not reflect $923.1 million of RPL/NPL MBS, which are securitized financial instruments primarily backed by both fixed-rate and hybrid
re-performing and non-performing loans. These deal structures contain a step-up feature where the coupon increases up to 300 basis points
at 36 months from issuance or sooner.
As of December 31, 2017, approximately $2.6 billion, or 48.2%, of our MBS portfolio was in its contractual fixed-rate period
or were fixed-rate MBS and approximately $2.8 billion, or 51.8%, was in its contractual adjustable-rate period, or were floating
rate MBS with interest rates that reset monthly. Our ARM-MBS in their contractual adjustable-rate period primarily include MBS
collateralized by Hybrids for which the initial fixed-rate period has elapsed, such that the interest rate will typically adjust on an
annual or semiannual basis.
Premiums arise when we acquire an MBS at a price in excess of the aggregate principal balance of the mortgages securing
the MBS (i.e., par value). Conversely, discounts arise when we acquire an MBS at a price below the aggregate principal balance
of the mortgages securing the MBS or when we acquire residential whole loans at a price below their aggregate principal balance.
Premiums paid on our MBS are amortized against interest income and accretable purchase discounts on these investments are
accreted to interest income. Purchase premiums, which are primarily carried on our Agency MBS and certain CRT securities, are
amortized against interest income over the life of each security using the effective yield method, adjusted for actual prepayment
activity. An increase in the prepayment rate, as measured by the CPR, will typically accelerate the amortization of purchase
premiums, thereby reducing the internal rate of return (or IRR)/interest income earned on these assets.
CPR levels are impacted by, among other things, conditions in the housing market, new regulations, government and private
sector initiatives, interest rates, availability of credit to home borrowers, underwriting standards and the economy in general. In
particular, CPR reflects the conditional repayment rate (or CRR), which measures voluntary prepayments of mortgages
collateralizing a particular MBS, and the conditional default rate (or CDR), which measures involuntary prepayments resulting
from defaults. CPRs on Agency MBS and Legacy Non-Agency MBS may differ significantly. For the year ended December 31,
2017, our Agency MBS portfolio experienced a weighted average CPR of 15.5%, and our Legacy Non-Agency MBS portfolio
experienced a weighted average CPR of 17.5%. For the year ended December 31, 2016, our Agency MBS portfolio experienced
a weighted average CPR of 14.4%, and our Legacy Non-Agency MBS portfolio experienced a weighted average CPR of 15.6%.
Over the last consecutive eight quarters, ending with December 31, 2017, the monthly weighted average CPR on our Agency and
Legacy Non-Agency MBS portfolios ranged from a high of 18.4% experienced during the month ended July 31, 2017 to a low of
11.3%, experienced during the month ended February 29, 2016, with an average CPR over such quarters of 15.7%.
Our method of accounting for Non-Agency MBS purchased at significant discounts to par value, requires us to make
assumptions with respect to each security. These assumptions include, but are not limited to, future interest rates, voluntary
prepayment rates, default rates, mortgage modifications and loss severities. As part of our Non-Agency MBS surveillance process,
we track and compare each security’s actual performance over time to the performance expected at the time of purchase or, if we
have modified our original purchase assumptions, to our revised performance expectations. To the extent that actual performance
or our expectation of future performance of our Non-Agency MBS deviates materially from our expected performance parameters,
we may revise our performance expectations, such that the amount of purchase discount designated as credit discount may be
increased or decreased over time. Nevertheless, credit losses greater than those anticipated or in excess of the recorded purchase
discount could occur, which could materially adversely impact our operating results.
37
It is our business strategy to hold our residential mortgage assets as long-term investments. On at least a quarterly basis,
excluding investments for which the fair value option has been elected or for which specialized loan accounting is otherwise
applied, we assess our ability and intent to continue to hold each asset and, as part of this process, we monitor our MBS, CRT
securities and MSR related assets that are designated as AFS for OTTI. A change in our ability and/or intent to continue to hold
any of these securities that are in an unrealized loss position, or a deterioration in the underlying characteristics of these securities,
could result in our recognizing future impairment charges or a loss upon the sale of any such security. At December 31, 2017, we
had net unrealized gains on our Non-Agency MBS of $623.7 million, comprised of gross unrealized gains of $624.2 million and
gross unrealized losses of $453,000 and net unrealized losses of $19.7 million on our Agency MBS, comprised of gross unrealized
losses of $43.1 million and gross unrealized gains of $23.4 million. At December 31, 2017, we did not intend to sell any securities
in our portfolio that are designated as AFS and that were in an unrealized loss position, and we believe it is more likely than not
that we will not be required to sell those securities before recovery of their amortized cost basis, which may be at their maturity.
We rely primarily on borrowings under repurchase agreements to finance our residential mortgage assets. Our residential
mortgage investments have longer-term contractual maturities than our borrowings under repurchase agreements. Even though
the majority of our investments have interest rates that adjust over time based on short-term changes in corresponding interest rate
indices (typically following an initial fixed-rate period for our Hybrids), the interest rates we pay on our borrowings will typically
change at a faster pace than the interest rates we earn on our investments. In order to reduce this interest rate risk exposure, we
may enter into derivative instruments, which at December 31, 2017 were comprised of Swaps.
Our Swap derivative instruments are designated as cash-flow hedges against a portion of our current and forecasted LIBOR-
based repurchase agreements. Our Swaps do not extend the maturities of our repurchase agreements; they do, however, lock in
a fixed rate of interest over their term for the notional amount of the Swap corresponding to the hedged item. During 2017, we
did not enter into any new Swaps and had Swaps with an aggregate notional amount of $350.0 million and a weighted average
fixed-pay rate of 0.58% amortize and/or expire. At December 31, 2017, we had Swaps designated in hedging relationships with
an aggregate notional amount of $2.6 billion with a weighted average fixed-pay rate of 2.04% and a weighted average variable
interest rate received of 1.50%.
Recent Market Conditions and Our Strategy
At December 31, 2017, our residential mortgage asset portfolio, which includes MBS, residential whole loans, CRT securities
and MSR related assets was approximately $9.7 billion compared to $11.5 billion at December 31, 2016. During the year ended
December 31, 2017 we purchased, through certain entities established to acquire the loans, for approximately $1.0 billion,
residential whole loans with an unpaid principal balance of approximately $1.3 billion. In addition, we acquired approximately
$727.3 million of RPL/NPL MBS, $405.6 million of MSR related assets, $60.1 million of Legacy Non-Agency MBS and $238.8
million of CRT securities.
At December 31, 2017, $3.5 billion, or 36.3% of our residential mortgage asset portfolio, was invested in Non-Agency MBS.
During the year ended December 31, 2017, the fair value of our Non-Agency MBS holdings decreased by $2.2 billion. The primary
components of the change during the year in these Non-Agency MBS include $3.0 billion of principal repayments and other
principal reductions and the sale of Non-Agency MBS with a fair value of $103.9 million partially offset by $787.4 million of
purchases (at a weighted average purchase price of 99% of par), and an increase reflecting Non-Agency MBS price changes of
$145.1 million.
At December 31, 2017, $2.8 billion, or 29.0% of our residential mortgage asset portfolio, was invested in Agency MBS.
During the year ended 2017, the fair value of our Agency MBS decreased by $913.8 million. This was due to $855.3 million of
principal repayments, $31.3 million of premium amortization and $39.2 million in net unrealized losses partially offset by $12.0
million of asset purchases.
At December 31, 2017, our total recorded investment in residential whole loans was $2.2 billion or 22.9% of our residential
mortgage asset portfolio. Of this amount, $908.5 million is presented as Residential whole loans, at carrying value and $1.3 billion
as Residential whole loans, at fair value in our consolidated balance sheets. For the year ended December 31, 2017, we recognized
approximately $36.2 million of income on residential whole loans held at carrying value in Interest Income on our consolidated
statements of operations, representing an effective yield of 5.93% (excluding servicing costs). In addition, we recorded a net gain
on residential whole loans held at fair value of $90.0 million in Other Income, net in our consolidated statements of operations
for the year ended December 31, 2017.
During the year ended December 31, 2017, we completed two loan securitization transactions. As a part of the transactions,
we sold residential whole loans with an aggregate unpaid principal balance of $620.9 million (including $193.3 million of loans
at carrying value and $296.5 million of loans at fair value) to two entities which we consolidate as variable interest entities (or
38
VIEs). In connection with the transactions, third-party investors purchased $382.8 million face amount of senior and mezzanine
bonds (or Senior Bonds) with a weighted average fixed coupon of 3.12%. As a result of the transactions, we acquired $127.0
million face amount of rated and non-rated certificates issued by the securitization vehicle, and received $382.8 million in cash,
excluding expenses, accrued interest, and underwriting fees. Certain of the Senior Bonds sold in connection with one of our
securitization transactions contain a contractual coupon step-up feature whereby the coupon increases by 300 basis points at 36
months from issuance if the bond is not redeemed before such date.
At December 31, 2017 our total investment in MSR related assets was $492.1 million. During the year ended December 31,
2017 we acquired $405.6 million of MSR related assets and had $141.0 million of principal repayments on term notes backed by
MSR related collateral. We also acquired $238.8 million of CRT securities, bringing our total investment in these securities to
$664.4 million. During 2017 our CRT portfolio increased in value, with unrealized gains recognized in net income on this portfolio
for the year of $27.7 million. At December 31, 2017, our CRT portfolio was in an overall unrealized gain position of $56.3 million.
We will continue to seek investments in residential mortgage assets during 2018. The investment landscape is challenging,
as market pricing for all asset classes remains high, thereby making it difficult to purchase assets at attractive risk/reward levels.
In addition, unlike Agency MBS, certain of our other asset classes are not always available for purchase, as sellers offer these
investments from time to time as opposed to more liquid markets which feature active buyers and sellers at nearly all times. We
expect that our purchase focus will be primarily on additional residential whole loans, RPL/NPL MBS and MSR related assets.
We experienced significant run-off during 2017 in our RPL/NPL MBS and we could experience further reduction in this portfolio
if issuers continue to call these securities.
Our book value per common share was $7.70 as of December 31, 2017. Book value per common share increased from $7.62
as of December 31, 2016 due primarily to the impact of fair value changes of Legacy Non-Agency MBS, CRT securities and
Swaps, partially offset by a decline in fair value changes on our Agency MBS and the impact of discount accretion income on
Legacy Non-Agency MBS that was recognized and declared as dividends during the year.
At the end of 2017, the average coupon on mortgages underlying our Agency MBS was higher compared to the end of 2016,
due to upward resets on Hybrid and ARM-MBS within the portfolio. As a result, the coupon yield on our Agency MBS portfolio
increased to 2.95% for 2017 from 2.82% for 2016 and the net Agency MBS yield increased to 2.00% for 2017, from 1.95% for
2016. The net yield for our Legacy Non-Agency MBS portfolio was 8.95% for 2017 compared to 7.90% for 2016. The increase
in the net yield on our Legacy Non-Agency MBS portfolio reflects the impact of the cash proceeds received during 2016 in
connection with the settlement of litigation related to certain Countrywide and Citigroup sponsored residential mortgage backed
securitization trusts, the improved performance of loans underlying the Legacy Non-Agency MBS portfolio, which has resulted
in credit reserve releases and the impact of redemptions during 2017 of certain securities that had been previously purchased at a
discount. The net yield for our RPL/NPL MBS portfolio was 4.14% for the year ended December 31, 2017 compared to 3.88%
for the year ended December 31, 2016. The increase in the net yield primarily reflects an increase in the average coupon yield to
4.05% for 2017 from 3.80% for 2016 and higher accretion income recognized in 2017 due to the impact of redemptions of certain
securities that had been previously purchased at a discount.
We believe that our $593.2 million Credit Reserve and OTTI appropriately factors in remaining uncertainties regarding
underlying mortgage performance and the potential impact on future cash flows for our existing Legacy Non-Agency MBS
portfolio. In addition, while the majority of our Legacy Non-Agency MBS will not return their full face value due to loan defaults,
we believe that they will deliver attractive loss adjusted yields due to our discounted amortized cost of 71% of face value at
December 31, 2017. Home price appreciation and underlying mortgage loan amortization have decreased the LTV for many of
the mortgages underlying our Legacy Non-Agency portfolio. Home price appreciation during the past few years has generally
been driven by a combination of limited housing supply, low mortgage rates and demographic-driven U.S. household formation.
Lower LTVs lessen the likelihood of defaults and simultaneously decrease loss severities. Further, during 2016 and 2017, we
have also observed faster voluntary prepayment (i.e. prepayment of loans in full with no loss) speeds than originally projected.
The yields on our Legacy Non-Agency MBS that were purchased at a discount are generally positively impacted if prepayment
rates on these securities exceed our prepayment assumptions. Based on these current conditions, we have reduced estimated future
losses within our Legacy Non-Agency portfolio. As a result, during the year ended 2017, $50.8 million was transferred from Credit
Reserve to accretable discount. This increase in accretable discount is expected to increase the interest income realized over the
remaining life of our Legacy Non-Agency MBS. The remaining average contractual life of such assets is approximately 30 years,
but based on scheduled loan amortization and prepayments (both voluntary and involuntary), loan balances will decline substantially
over time. Consequently, we believe that the majority of the impact on interest income from the reduction in Credit Reserve will
occur over the next ten years.
39
At December 31, 2017, we have access to various sources of liquidity which we estimate to be in excess of $1.1 billion. This
amount includes (i) $449.8 million of cash and cash equivalents; (ii) $170.2 million in estimated financing available from unpledged
Agency MBS and from other Agency MBS collateral that is currently pledged in excess of contractual requirements; and (iii)
$452.1 million in estimated financing available from unpledged Non-Agency MBS and from other Non-Agency MBS and CRT
collateral that is currently pledged in excess of contractual requirements. Our sources of liquidity do not include restricted cash.
We believe that we are positioned to continue to take advantage of investment opportunities within the residential mortgage
marketplace.
Repurchase agreement funding for our residential mortgage investments continued to be available to us from multiple
counterparties in 2017. Typically, repurchase agreement funding involving credit sensitive investments is available at terms
requiring higher collateralization and higher interest rates, than for repurchase agreement funding involving Agency MBS. At
December 31, 2017, our debt consisted of borrowings under repurchase agreements with 31 counterparties, securitized debt, Senior
Notes outstanding and an obligation to return securities obtained as collateral, resulting in a debt-to-equity multiple of 2.3 times.
(See table on page 57 under Results of Operations that presents our quarterly leverage multiples since March 31, 2016.)
Information About Our Assets
The table below presents certain information about our asset allocation at December 31, 2017:
ASSET ALLOCATION
Agency
MBS
Legacy
Non-Agency
MBS
RPL/NPL
MBS (1)
Credit Risk
Transfer
Securities
MSR
Related
Assets
Residential
Whole Loans,
at Carrying
Value (2)
Residential
Whole Loans,
at Fair Value
Other,
net (3)
Total
(Dollars in Millions)
Fair Value/Carrying Value
$ 2,825
$
2,611
$
923
$
664
$
492
$
909
$
1,325
$
588
$ 10,337
Less Repurchase
Agreements
Less Securitized Debt
Less Senior Notes
(2,501)
(1,726)
(567)
(459)
(317)
—
—
—
—
—
—
—
—
—
—
Net Equity Allocated
$
324
$
885
$
356
$
205
$
175
$
Debt/Net Equity Ratio (4)
7.7x
2.0x
1.6x
2.2x
1.8x
(348)
(156)
—
405
1.2x
$
(696)
(208)
—
421
2.1x
—
—
(97)
(6,614)
(364)
(97)
$
491
$ 3,262
2.3x
(1) RPL/NPL MBS are backed primarily by securitized re-performing and non-performing loans. The securities are structured such that the coupon increases
up to 300 basis points at 36 months from issuance or sooner. Included with the balance of Non-Agency MBS reported on our consolidated balance sheets.
(2) The carrying value of such loans reflects the purchase price, accretion of income, cash received and provision for loan losses since acquisition. At
December 31, 2017, the fair value of such loans is estimated to be approximately $988.7 million.
(3) Includes cash and cash equivalents and restricted cash, securities obtained and pledged as collateral, other assets, obligation to return securities obtained
as collateral of and other liabilities.
(4) Represents the sum of borrowings under repurchase agreements and securitized debt as a multiple of net equity allocated. The numerator of our Total
Debt/Net Equity Ratio also includes the obligation to return securities obtained as collateral of $504.1 million and Senior Notes.
40
Agency MBS
The following table presents certain information regarding the composition of our Agency MBS portfolio as of
December 31, 2017 and 2016:
December 31, 2017
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Fair
Value (1)
Weighted
Average
Loan Age
(Months) (2)
Weighted
Average
Coupon (2)
3 Month
Average
CPR
(Dollars in Thousands)
15-Year Fixed Rate:
Low Loan Balance (3)
HARP (4)
Other (Post June 2009) (5)
Other (Pre June 2009) (6)
Total 15-Year Fixed Rate
Hybrid:
Other (Post June 2009) (5)
Other (Pre June 2009) (6)
Total Hybrid
CMO/Other
Total Portfolio
(Dollars in Thousands)
15-Year Fixed Rate:
Low Loan Balance (3)
HARP (4)
Other (Post June 2009) (5)
Other (Pre June 2009) (6)
Total 15-Year Fixed Rate
Hybrid:
Other (Post June 2009) (5)
Other (Pre June 2009) (6)
Total Hybrid
CMO/Other
Total Portfolio
Current
Face
$
948,225
91,131
81,428
303
104.3%
104.7
104.0
104.9
101.7% $
101.8
104.5
104.4
964,373
92,800
85,094
316
$ 1,121,087
104.3%
101.9% $ 1,142,583
$ 1,028,630
511,801
$ 1,540,431
76,944
$
$ 2,738,462
104.4%
101.7
103.5%
102.5%
103.8%
103.6% $ 1,065,312
104.7
535,795
103.9% $ 1,601,107
79,100
102.8% $
103.1% $ 2,822,790
Current
Face
$ 1,170,788
116,790
106,343
564
104.3%
104.7
104.0
104.9
103.0% $ 1,206,174
120,290
103.0
112,400
105.7
105.9
597
$ 1,394,485
104.3%
103.2% $ 1,439,461
$ 1,370,019
720,419
$ 2,090,438
96,379
$
$ 3,581,302
104.4%
101.7
103.5%
102.5%
103.8%
104.8% $ 1,436,184
105.6
761,052
105.1% $ 2,197,236
99,196
102.9% $
104.3% $ 3,735,893
67
66
87
103
68
78
132
96
198
88
2.95%
2.95
4.14
4.50
3.04%
3.17%
3.44
3.26%
3.16%
3.16%
10.3%
8.2
10.7
2.0
10.2%
17.7%
16.0
17.1%
9.9%
14.1%
55
54
75
91
57
67
120
86
187
77
2.97%
2.96
4.14
4.50
3.06%
2.99%
3.03
3.01%
2.81%
3.02%
11.2%
12.1
14.3
28.8
11.5%
19.9%
17.0
18.9%
14.7%
15.9%
December 31, 2016
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Fair
Value (1)
Weighted
Average
Loan Age
(Months) (2)
Weighted
Average
Coupon (2)
3 Month
Average
CPR
(1) Does not include principal payments receivable of $1.9 million and $2.6 million at December 31, 2017 and 2016, respectively.
(2) Weighted average is based on MBS current face at December 31, 2017 and 2016, respectively.
(3) Low loan balance represents MBS collateralized by mortgages with an original loan balance of less than or equal to $175,000.
(4) Home Affordable Refinance Program (or HARP) MBS are backed by refinanced loans with LTVs greater than or equal to 80% at origination.
(5) MBS issued in June 2009 or later. Majority of underlying loans are ineligible to refinance through the HARP program.
(6) MBS issued before June 2009.
41
The following table presents certain information regarding our 15-year fixed-rate Agency MBS as of December 31, 2017
and 2016:
Coupon
(Dollars in Thousands)
15-Year Fixed Rate:
2.5%
3.0%
3.5%
4.0%
4.5%
Total 15-Year Fixed Rate
Coupon
(Dollars in Thousands)
15-Year Fixed Rate:
2.5%
3.0%
3.5%
4.0%
4.5%
Total 15-Year Fixed Rate
December 31, 2017
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Weighted
Average
Loan Age
(Months) (2)
Weighted
Average
Loan Rate
Low Loan
Balance
and/or
HARP (3)
3 Month
Average
CPR
Fair
Value (1)
Current
Face
$
579,003
104.0%
100.5% $
581,866
231,325
5,402
263,447
41,910
105.9
103.5
103.5
105.2
102.2
103.4
104.3
105.1
236,316
5,587
274,783
44,031
$ 1,121,087
104.3%
101.9% $ 1,142,583
60
66
86
85
89
68
3.04%
100%
9.3%
3.49
4.18
4.40
4.88
100
100
80
34
9.5
23.0
12.4
10.2
3.52%
93%
10.2%
December 31, 2016
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Weighted
Average
Loan Age
(Months) (2)
Weighted
Average
Loan Rate
Low Loan
Balance
and/or
HARP (3)
3 Month
Average
CPR
Fair
Value (1)
Current
Face
$
700,388
104.0%
101.6% $
711,696
288,648
7,244
343,105
55,100
105.9
103.5
103.5
105.2
103.3
104.6
105.9
106.4
298,311
7,576
363,258
58,620
$ 1,394,485
104.3%
103.2% $ 1,439,461
48
54
74
73
77
57
3.04%
100%
9.9%
3.49
4.18
4.40
4.88
100
100
80
34
11.3
15.7
14.2
14.5
3.54%
92%
11.5%
(1) Does not include principal payments receivable of $1.9 million and $2.6 million at December 31, 2017 and 2016, respectively.
(2) Weighted average is based on MBS current face at December 31, 2017 and 2016, respectively.
(3) Low Loan Balance represents MBS collateralized by mortgages with an original loan balance less than or equal to $175,000. HARP MBS are backed by
refinanced loans with LTVs greater than or equal to 80% at origination.
42
The following table presents certain information regarding our Hybrid Agency MBS as of December 31, 2017 and 2016:
(Dollars in Thousands)
Hybrid Post June 2009:
Agency 5/1
Agency 7/1
Agency 10/1
Total Hybrids Post June 2009
Hybrid Pre June 2009:
Coupon < 4.5% (5)
Coupon >= 4.5% (6)
Total Hybrids Pre June 2009
Total Hybrids
(Dollars in Thousands)
Hybrid Post June 2009:
Agency 5/1
Agency 7/1
Agency 10/1
Total Hybrids Post June 2009
Hybrid Pre June 2009:
Coupon < 4.5% (5)
Coupon >= 4.5% (6)
Total Hybrids Pre June 2009
Total Hybrids
Current
Face
$
398,801
456,295
173,534
$ 1,028,630
$
509,290
2,511
$
511,801
$ 1,540,431
Current
Face
$
551,736
618,414
199,869
$ 1,370,019
$
691,572
28,847
$
720,419
$ 2,090,438
December 31, 2017
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Fair
Value (1)
Weighted
Average
Coupon (2)
Weighted
Average
Loan Age
(Months) (2)
Weighted
Average
Months to
Reset (3)
Interest
Only (4)
3 Month
Average
CPR
104.3%
104.4
104.6
104.4%
101.6%
103.2
101.7%
103.5%
416,978
104.6% $
471,142
103.3
102.1
177,192
103.6% $ 1,065,312
533,183
104.7% $
2,612
104.0
104.7% $
535,795
103.9% $ 1,601,107
December 31, 2016
3.47%
2.94
3.08
3.17%
3.43%
5.13
3.44%
3.26%
89
73
68
78
132
119
132
96
5
13
51
16
6
2
5
13
27%
25
64
32%
19%
42
19%
28%
16.7%
20.8
11.8
17.7%
16.1%
1.0
16.0%
17.1%
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Fair
Value (1)
Weighted
Average
Coupon (2)
Weighted
Average
Loan Age
(Months) (2)
Weighted
Average
Months to
Reset (3)
Interest
Only (4)
3 Month
Average
CPR
104.3%
104.5
104.7
104.4%
101.7%
101.4
101.7%
103.5%
583,318
105.7% $
645,200
104.3
103.9
207,666
104.8% $ 1,436,184
730,626
105.6% $
30,426
105.5
105.6% $
761,052
105.1% $ 2,197,236
2.93%
3.00
3.13
2.99%
2.92%
5.71
3.03%
3.01%
76
62
58
67
121
112
120
86
6
21
61
21
6
7
6
15
25%
24
64
30%
33%
69
34%
32%
17.7%
22.8
17.1
19.9%
16.9%
18.1
17.0%
18.9%
(1) Does not include principal payments receivable of $1.9 million and $2.6 million at December 31, 2017 and 2016, respectively.
(2) Weighted average is based on MBS current face at December 31, 2017 and 2016, respectively.
(3) Weighted average months to reset is the number of months remaining before the coupon interest rate resets. At reset, the MBS coupon will adjust based upon
the underlying benchmark interest rate index, margin and periodic or lifetime caps. The months to reset do not reflect scheduled amortization or prepayments.
(4) Interest only represents MBS backed by mortgages currently in their interest only period. Percentage is based on MBS current face at December 31, 2017
and 2016, respectively.
(5) Agency 3/1, 5/1, 7/1 and 10/1 Hybrid ARM-MBS with coupon less than 4.5%.
(6) Agency 3/1, 5/1, 7/1 and 10/1 Hybrid ARM-MBS with coupon greater than or equal to 4.5%.
43
Non-Agency MBS
The following table presents information with respect to our Non-Agency MBS at December 31, 2017 and 2016:
(In Thousands)
Non-Agency MBS
Face/Par
Fair Value
Amortized Cost
Purchase Discount Designated as Credit Reserve and OTTI
Purchase Discount Designated as Accretable
Purchase Premiums
December 31,
2017
2016
$
3,718,743
$
6,065,618
3,533,966
5,684,836
2,910,241
(593,227) (1)
(215,325)
50
5,093,243
(694,241) (2)
(278,191)
57
(1) Includes discount designated as Credit Reserve of $579.0 million and OTTI of $14.2 million.
(2) Includes discount designated as Credit Reserve of $675.6 million and OTTI of $18.6 million.
Purchase Discounts on Non-Agency MBS
The following table presents the changes in the components of purchase discount on Non-Agency MBS with respect to
purchase discount designated as Credit Reserve and OTTI, and accretable purchase discount for the years ended December 31,
2017 and 2016:
(In Thousands)
Balance at beginning of period
Impact of RMBS Issuer settlement (2)
Accretion of discount
Realized credit losses
Purchases
Sales
Net impairment losses recognized in earnings
Transfers/release of credit reserve
Balance at end of period
$
For the Year Ended December 31,
2017
2016
Discount
Designated as
Credit Reserve
and OTTI
Accretable
Discount (1)
Discount
Designated as
Credit Reserve
and OTTI
Accretable
Discount (1)
$
(694,241) $
(278,191) $
(787,541) $
—
—
49,291
(29,810)
31,730
(1,032)
50,835
(593,227) $
—
77,513
—
18,386
17,802
—
(50,835)
(215,325) $
—
—
64,217
(25,999)
17,863
(485)
37,704
(694,241) $
(312,182)
(59,900)
80,548
—
13,094
37,953
—
(37,704)
(278,191)
(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 $61.8 million and $7.0 million of cash proceeds (a one-time payment) received by us during the year
ended December 31, 2016 in connection with the settlements of litigation related to certain Countrywide and Citigroup sponsored residential
mortgage backed securitization trusts, respectively.
44
The following table presents information with respect to the yield components of our Non-Agency MBS for the periods
presented:
For the Year Ended December 31,
2017
2016
2015
Legacy
Non-Agency
MBS
RPL/NPL MBS
Legacy
Non-Agency
MBS
RPL/NPL MBS
Legacy
Non-Agency
MBS
RPL/NPL MBS
Non-Agency MBS
Coupon Yield (1)
Effective Yield Adjustment (2)
Net Yield
5.61%
3.34
8.95%
4.05%
0.09
4.14%
5.24%
2.66
7.90%
3.80%
0.08
3.88%
5.08%
2.54
7.62%
3.61%
0.07
3.68%
(1) Reflects coupon interest income divided by the average amortized cost. The discounted purchase price on Legacy Non-Agency MBS causes
the coupon yield to be higher than the pass-through coupon interest rate.
(2) The effective yield adjustment is the difference between the net yield, calculated utilizing management’s estimates of timing and amount of
future cash flows for Legacy Non-Agency MBS and RPL/NPL MBS, less the current coupon yield.
Actual maturities of MBS are generally shorter than stated contractual maturities because actual maturities of MBS are
affected by the contractual lives of the underlying mortgage loans, periodic payments of principal and prepayments of principal.
The following table presents certain information regarding the amortized costs, weighted average yields and contractual maturities
of our MBS at December 31, 2017 and does not reflect the effect of prepayments or scheduled principal amortization on our MBS:
Within One Year
One to Five Years
Five to Ten Years
Over Ten Years
Total MBS
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Total
Amortized
Cost
Total Fair
Value
Weighted
Average
Yield
$
$
$
$
—
—
—
—
—
—
—% $
141
2.33% $586,126
2.22% $ 1,666,938
2.24% $ 2,253,205
$ 2,246,600
2.23%
—
—
—
—
—
—
249,277
98
1.98
2.32
335,643
6,156
1.87
2.01
584,920
571,748
6,254
6,333
—% $
141
2.33% $835,501
2.15% $ 2,008,737
2.17% $ 2,844,379
$ 2,824,681
—% $271,115
3.90% $
2,904
3.88% $ 2,636,222
8.35% $ 2,910,241
$ 3,533,966
—% $271,256
3.90% $838,405
2.15% $ 4,644,959
5.68% $ 5,754,620
$ 6,358,647
1.91
2.02
2.17%
7.93%
5.08%
(Dollars in Thousands)
Agency MBS:
Fannie Mae
Freddie Mac
Ginnie Mae
Total Agency MBS
Non-Agency MBS
Total MBS
CRT Securities
At December 31, 2017, our CRT securities had an amortized cost of $608.1 million, a fair value of $664.4 million, a weighted
average yield of 6.02% and weighted average time to maturity of 9.2 years. At December 31, 2016, our CRT securities had an
amortized cost of $382.7 million, a fair value of $404.9 million, a weighted average yield of 5.86% and weighted average time to
maturity of 9.0 years.
45
Residential Whole Loans
The following table presents the contractual maturities of our residential whole loans held by consolidated trusts and certain
entities established in connection with our loan securitization transactions at December 31, 2017 and does not reflect estimates of
prepayments or scheduled amortization. For residential whole loans at carrying value, amounts presented are estimated based on
the underlying loan contractual amounts.
(In Thousands)
Amount due:
Within one year
After one year:
Over one to five years
Over five years
Total due after one year
Total residential whole loans
Residential Whole
Loans,
at Carrying Value
Residential Whole
Loans,
at Fair Value
$
$
$
43,418
$
9,985
18,646
846,452
865,098
908,516
$
$
14,559
1,300,571
1,315,130
1,325,115
The following table presents at December 31, 2017, the dollar amount of our residential whole loans held at fair value,
contractually maturing after one year, and indicates whether the loans have fixed interest rates or adjustable interest rates:
(In Thousands)
Interest rates:
Fixed
Adjustable
Total
Residential Whole
Loans
at Fair Value (1)
$
$
695,145
619,985
1,315,130
(1) Includes loans on which borrowers have defaulted and are not making payments of principal and/or interest as of December 31, 2017.
Information is not presented for purchase credit impaired residential whole loans at carrying value as income is recognized
based on pools of assets with similar risk characteristics using an estimated yield based on cash flows expected to be collected
over the lives of the loans in such pools rather than on the contractual coupons of the underlying loans.
The following table presents additional information regarding our residential whole loans held at fair value at December 31,
2017 and 2016:
(Dollars in Thousands)
Loans 90 days or more past due:
Number of Loans
Aggregate Amount Outstanding
Residential Whole Loans
at Fair Value
December 31, 2017
December 31, 2016
3,984
$
840,572
$
2,560
570,025
Income on credit impaired residential whole loans held at carrying value is recognized based on pools of assets with similar
credit risk characteristics using an estimated yield based on cash flows expected to be collected over the lives of the loans in such
pools rather than the contractual coupons of the underlying loans. As the unit of account is at the pool level rather than the
individual loan level, none of our residential whole loans held at carrying value are currently considered 90 days or more past due.
46
Exposure to Financial Counterparties
We finance a significant portion of our residential mortgage assets with repurchase agreements and other advances. In
connection with these financing arrangements, we pledge our assets as collateral to secure the borrowing. The amount of collateral
pledged will typically exceed the amount of the financing with the extent of over-collateralization ranging from 1% - 8% of the
amount borrowed (U.S. Treasury and Agency MBS collateral) to up to 35% (Non-Agency MBS collateral). Consequently, while
repurchase agreement financing results in us recording a liability to the counterparty in our consolidated balance sheets, we are
exposed to the counterparty, if during the term of the repurchase agreement financing, a lender should default on its obligation
and we are not able to recover our pledged assets. The amount of this exposure is the difference between the amount loaned to
us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest
receivable on such collateral.
The table below summarizes our exposure to our counterparties at December 31, 2017, by country:
Country
(Dollars in Thousands)
European Countries: (2)
Switzerland (3)
France
United Kingdom
Holland
Total European
Other Countries:
United States
Canada (4)
Japan (5)
China (5)
South Korea
Total Other
Total
Number of
Counterparties
Repurchase
Agreement
Financing and
Other Advances
Exposure (1)
Exposure as a
Percentage of
MFA Total Assets
3
2
3
1
9
15
3
3
1
1
23
32
$
$
$
1,030,090
617,536
414,361
120,220
2,182,207
3,180,405
732,278
441,160
398,187
180,670
4,932,700
7,114,907 (6)
373,254
157,368
135,147
9,488
675,257
775,617
189,163
35,928
13,993
12,490
1,027,191
1,702,448
3.41%
1.44
1.23
0.09
6.17%
7.08%
1.73
0.33
0.13
0.11
9.38%
15.55%
(1) Represents for each counterparty the amount of cash and/or securities pledged as collateral less the aggregate of repurchase agreement
financing and net interest receivable/payable on all such instruments.
(2) Includes European-based counterparties as well as U.S.-domiciled subsidiaries of the European parent entity.
(3) Includes London branch of one counterparty and Cayman Islands branch of the other counterparty.
(4) Includes Canada-based counterparties as well as U.S.-domiciled subsidiaries of Canadian parent entities. In the case of one counterparty,
also includes exposure of $168.6 million to Barbados-based affiliate of the Canadian parent entity.
(5) Exposure is to U.S.-domiciled subsidiary of the Japanese or Chinese parent entity, as the case may be.
(6) Includes $500.0 million of repurchase agreements entered into in connection with contemporaneous repurchase and reverse repurchase
agreements with a single counterparty.
At December 31, 2017, we did not use credit default swaps or other forms of credit protection to hedge the exposures
summarized in the table above.
Uncertainty in the global financial market and weak economic conditions in Europe, including as a result of the United
Kingdom’s recent vote to leave the European Union (commonly known as “Brexit”), could potentially impact our major European
financial counterparties, with the possibility that this would also impact the operations of their U.S. domiciled subsidiaries. This
could adversely affect our financing and operations as well as those of the entire mortgage sector in general. Management monitors
our exposure to our repurchase agreement counterparties on a regular basis, using various methods, including review of recent
rating agency actions or other developments and by monitoring the amount of cash and securities collateral pledged and the
associated loan amount under repurchase agreements with our counterparties. We intend to make reverse margin calls on our
counterparties to recover excess collateral as permitted by the agreements governing our financing arrangements, or take other
necessary actions to reduce the amount of our exposure to a counterparty when such actions are considered necessary.
47
Tax Considerations
Current period estimated taxable income and items expected to impact future taxable income
We estimate that for 2017, our taxable income was approximately $331.4 million. Based on dividends paid or declared
during 2017, we have undistributed taxable income of approximately $57.9 million, or $0.15 per share. We have until the filing
of our 2017 tax return (due not later than October 15, 2018) to declare the distribution of any 2017 REIT taxable income not
previously distributed.
During the first quarter of 2017 we unwound our remaining MBS resecuritization transaction. We currently estimate that
the unwind will generate taxable income (but not GAAP income) of an amount in excess of $0.13 per share. During the second
quarter of 2017 we entered into our first securitization of residential whole loans. As part of this transaction, loans deemed to be
sold for tax purposes are estimated to generate 2017 taxable income in excess of $0.01 per share.
Key differences between GAAP net income and REIT Taxable Income for Non-Agency MBS and Residential Whole Loans
Our total Non-Agency MBS portfolio for tax differs from our portfolio reported for GAAP primarily due to the fact that for
tax purposes; (i) certain of the MBS contributed to the VIEs used to facilitate MBS resecuritization transactions were deemed to
be sold; and (ii) the tax basis of underlying MBS considered to be reacquired in connection with the unwind of such transactions
becomes the fair value of such securities at the time of the unwind. For GAAP reporting purposes the underlying MBS that were
included in these MBS resecuritization transactions were not considered to be sold. Similarly, for tax purposes the residential
whole loans contributed to the VIE used to facilitate our second quarter 2017 loan securitization transaction were deemed to be
sold for tax purposes, but not for GAAP reporting purposes. In addition, for our Non-Agency MBS and residential whole loan
tax portfolios, potential timing differences arise with respect to the accretion of market discount into income and recognition of
realized losses for tax purposes as compared to GAAP. Consequently, our REIT taxable income calculated in a given period may
differ significantly from our GAAP net income.
The determination of taxable income attributable to Non-Agency MBS and residential whole loans is dependent on a number
of factors, including principal payments, defaults, loss mitigation efforts and loss severities. In estimating taxable income for
Non-Agency MBS and residential whole loans during the year, management considers estimates of the amount of discount expected
to be accreted. Such estimates require significant judgment and actual results may differ from these estimates. Moreover, the
deductibility of realized losses from Non-Agency MBS and residential whole loans, and their effect on market discount accretion
is analyzed on an asset-by-asset basis and while they will result in a reduction of taxable income, this reduction tends to occur
gradually and primarily for Non-Agency MBS in periods after the realized losses are reported. In addition, for MBS resecuritization
transactions that were treated as sale of the underlying MBS for tax purposes, taxable gain or loss, if any, resulting from the unwind
of such transactions is not recognized in GAAP net income.
Securitization transactions result in differences between GAAP net income and REIT Taxable Income
For tax purposes, depending on the transaction structure, a securitization and/or resecuritization transaction may be treated
either as a sale or a financing of the underlying collateral. Income recognized from securitization and resecuritization transactions
will differ for tax and GAAP purposes. For tax purposes, we own and may in the future acquire interests in securitization and /
or resecuritization trusts, in which several of the classes of securities are or will be issued with Original Issue Discount (or OID).
As the holder of the retained interests in the trust, we generally will be required to include OID in our current gross interest income
over the term of the applicable securities as the OID accrues. The rate at which the OID is recognized into taxable income is
calculated using a constant rate of yield to maturity, with realized losses impacting the amount of OID recognized in REIT taxable
income once they are actually incurred. Under the TCJA, the timing of such income may be affected by when we include such
income for financial accounting purposes. For tax purposes, REIT taxable income may be recognized in excess of economic
income (i.e., OID) or in advance of the corresponding cash flow from these assets, thereby affecting our dividend distribution
requirement to stockholders. In addition, for securitization and/or resecuritization transactions that were treated as a sale of the
underlying collateral for tax purposes, the unwind of any such transaction will likely result in a taxable gain or loss that is likely
not recognized in GAAP net income since securitization and resecuritization transactions are typically accounted for as financing
transactions for GAAP purposes. The tax basis of underlying residential whole loans or MBS re-acquired in connection with the
unwind of such transactions becomes the fair market value of such assets at the time of the unwind.
48
Regulatory Developments
The U.S. Congress, Board of Governors of the Federal Reserve System, U.S. Treasury, FDIC, SEC and other governmental
and regulatory bodies have taken and continue to consider additional actions in response to the 2007-2008 financial crisis. In
particular, the Dodd-Frank Act created a new regulator, an independent bureau housed within the Federal Reserve System, and
known as the Consumer Financial Protection Bureau (or the CFPB). The CFPB has broad authority over a wide range of consumer
financial products and services, including mortgage lending and servicing. One portion of the Dodd-Frank Act, the Mortgage
Reform and Anti-Predatory Lending Act (or Mortgage Reform Act), contains underwriting and servicing standards for the mortgage
industry, restrictions on compensation for mortgage loan originators, and various other requirements related to mortgage origination.
In addition, the Dodd-Frank Act grants broad discretionary regulatory authority to the CFPB to prohibit or condition terms, acts
or practices relating to residential mortgage loans that the CFPB finds abusive, unfair, deceptive or predatory, as well as to take
other actions that the CFPB finds are necessary or proper to ensure responsible affordable mortgage credit remains available to
consumers. The Dodd-Frank Act also affects the securitization of mortgages (and other assets) with requirements for risk retention
by securitizers and requirements for regulating rating agencies.
The Dodd-Frank Act requires that numerous regulations be issued, many of which (including those mentioned above regarding
servicing, underwriting and mortgage loan originator compensation) have only recently been implemented and operationalized.
As a result, we are unable to fully predict at this time how the Dodd-Frank Act, as well as other laws or regulations that may be
adopted in the future, will affect our business, results of operations and financial condition, or the environment for repurchase
financing and other forms of borrowing, the investing environment for Agency MBS, Non-Agency MBS and/or residential mortgage
loans, the securitization industry, Swaps and other derivatives. However, at a minimum, we believe that the Dodd-Frank Act and
the regulations promulgated thereunder are likely to continue to increase the economic and compliance costs for participants in
the mortgage and securitization industries, including us.
In addition to the regulatory actions being implemented under the Dodd-Frank Act, on August 31, 2011, the SEC issued a
concept release under which it is reviewing interpretive issues related to Section 3(c)(5)(C) of the Investment Company Act.
Section 3(c)(5)(C) excludes from the definition of “investment company” entities that are primarily engaged in, among other
things, “purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” Many companies that engage
in the business of acquiring mortgages and mortgage-related instruments seek to rely on existing interpretations of the SEC Staff
with respect to Section 3(c)(5)(C) so as not to be deemed an investment company for the purpose of regulation under the Investment
Company Act. In connection with the concept release, the SEC requested comments on, among other things, whether it should
reconsider its existing interpretation of Section 3(c)(5)(C). To date the SEC has not taken or otherwise announced any further
action in connection with the concept release. (For additional discussion of the SEC’s concept release and its potential impact on
us, please see Part I, Item 1A. “Risk Factors” of this Annual Report on Form 10-K.)
The FHFA and both houses of Congress have discussed and considered separate measures intended to restructure the U.S.
housing finance system and the operations of Fannie Mae and Freddie Mac. Congress may continue to consider legislation that
would significantly reform the country’s mortgage finance system, including, among other things, eliminating Freddie Mac and
Fannie Mae and replacing them with a single new MBS insurance agency. Many details remain unsettled, including the scope
and costs of the agencies’ guarantee and their affordable housing mission, some of which could be addressed even in the absence
of large-scale reform. While the likelihood of enactment of major mortgage finance system reform in the short term remains
uncertain, it is possible that the adoption of any such reforms could adversely affect the types of assets we can buy, the costs of
these assets and our business operations. As the FHFA and both houses of Congress continue to consider various measures intended
to dramatically restructure the U.S. housing finance system and the operations of Fannie Mae and Freddie Mac, we expect debate
and discussion on the topic to continue throughout 2018. However, we cannot be certain if any housing and/or mortgage-related
legislation will emerge from committee, or be approved by Congress, and if so, what the effect will be on our business.
Additional Material U.S. Federal Income Tax Considerations
The following is a summary of certain additional material federal income tax considerations with respect to the ownership
of our stock. This summary supplements and should be read together with “Material U.S. Federal Income Tax Considerations”
in the prospectus dated November 16, 2016 and filed as part of our registration statement on Form S-3 (No. 333-214659).
Recent Legislation
The recently passed tax law informally known as the TCJA made many significant changes to the U.S. federal income tax
laws applicable to businesses and their owners, including REITs and their stockholders, and may lessen the relative competitive
advantage of operating as a REIT rather than as a C corporation. Pursuant to this legislation, as of January 1, 2018, (1) the federal
income tax rate applicable to corporations is reduced to 21%, (2) the highest marginal individual income tax rate is reduced to
49
37%, (3) the corporate alternative minimum tax is repealed and (4) the backup withholding rate for Domestic Owners is reduced
to 24%. In addition, individuals, estates and trusts may deduct up to 20% of certain pass-through income, including ordinary
REIT dividends that are not “capital gain dividends” or “qualified dividend income,” subject to certain limitations. For taxpayers
qualifying for the full deduction, the effective maximum tax rate on ordinary REIT dividends would be 29.6% (through taxable
years ending in 2025). The maximum rate of withholding with respect to our distributions to Foreign Owners that are treated as
attributable to gains from the sale or exchange of U.S. real property interests is also reduced from 35% to 21%. The deduction of
net interest expense is limited for all businesses; provided that certain businesses, including real estate businesses, may elect not
to be subject to such limitations and instead to depreciate their real property related assets over longer depreciable lives. To the
extent that a taxable REIT subsidiary has interest expense that exceeds its interest income, the net interest expense limitation could
potentially apply to such taxable REIT subsidiary. The reduced corporate tax rate will apply to our taxable REIT subsidiaries.
Under the TCJA, we generally will be required to take certain amounts in income no later than the time such amounts are
reflected on certain financial statements. The application of this rule may require the accrual of income with respect to our debt
instruments or MBS, such as original issue discount or market discount, earlier than would be the case under the general tax rules,
although the precise application of this rule is unclear at this time. This rule generally will be effective for tax years beginning
after December 31, 2017 or, for debt instruments or MBS issued with original issue discount, for tax years beginning after December
31, 2018. To the extent that this rule requires the accrual of income earlier than under the general tax rules, it could increase our
“phantom income,” which may make it more likely that we could be required to borrow funds or take other action to satisfy the
REIT distribution requirements for the taxable year in which this “phantom income” is recognized.
Under the TCJA, deferred foreign income of our foreign TRSs that has not previously been subject to tax would be deemed
repatriated and would be included in income. Any income deemed repatriated would be excluded from both the 75% and 95%
gross income tests, but would increase our REIT distribution requirement. REITs are permitted to elect to include such income
in taxable income over an eight year period. Because we have included earnings of our foreign TRS in our income, we do not
expect our foreign TRS to have any deferred foreign income.
We urge you to consult your tax advisors regarding the impact of the TCJA on the purchase, ownership and sale of our stock.
Taxation of Foreign Owners
Foreign Owners that are “qualified shareholders” or “qualified foreign pension funds” may be eligible for additional
exemptions from Foreign Investment in Real Property Tax Act of 1980 (or FIRPTA) withholding. REIT distributions that are
exempt from FIRPTA withholding may still be subject to regular U.S. withholding tax.
50
Results of Operations
Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016
General
For 2017, we had net income available to our common stock and participating securities of $307.4 million, or $0.79 per basic
and diluted common share, compared to net income available to common stock and participating securities for 2016 of $297.7
million, or $0.80 per basic and diluted common share. The increase in net income available to common stock and participating
securities primarily reflects higher other income, driven primarily by higher net gains realized on residential whole loans held at
fair value, unrealized gains on CRT securities accounted for at fair value, gains on the liquidation of certain residential whole loans
accounted for at carrying value and higher gains on sales of Legacy Non-Agency MBS. This increase was partially offset by a
decrease in our net interest income primarily on our Agency and Non-Agency MBS portfolios. In addition, operating and other
expenses where higher primarily due to increases in loan servicing and other related operating expenses, and non-recurring expenses
in relation to our contractual obligation to accelerate the vesting of certain share based awards and to make a death benefit payment
to the estate of our former Chief Executive Officer. The decrease in net income available to common stock and participating
securities on a per share basis primarily reflects an increase in our common shares issued through a public offering during the
second quarter of 2017.
Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing
liabilities. Net interest income depends primarily upon the volume of interest-earning assets and interest-bearing liabilities and
the corresponding interest rates earned or paid. Our net interest income varies primarily as a result of changes in interest rates,
the slope of the yield curve (i.e., the differential between long-term and short-term interest rates), borrowing costs (i.e., our interest
expense) and prepayment speeds on our MBS. Interest rates and CPRs (which measure the amount of unscheduled principal
prepayment on a bond as a percentage of the bond balance) vary according to the type of investment, conditions in the financial
markets, and other factors, none of which can be predicted with any certainty.
The changes in average interest-earning assets and average interest-bearing liabilities and their related yields and costs are
discussed in greater detail below under “Interest Income” and “Interest Expense.”
For 2017, our net interest spread and margin were 2.09% and 2.55%, respectively, compared to a net interest spread and
margin of 2.12% and 2.45%, respectively, for 2016. Our net interest income decreased by $27.8 million, or 10.5%, to $236.3
million from $264.1 million for 2016. For 2017 net interest income from Agency MBS and Legacy Non-Agency MBS declined
compared to 2016 by approximately $36.7 million, primarily due to lower average amounts invested in these securities and higher
funding costs, partially offset by higher yields earned on these securities. In addition, net interest income on RPL/NPL MBS was
approximately $21.2 million lower compared to 2016 primarily due to lower average amounts invested in these securities and
higher funding costs partially offset by higher yields earned on these securities. These decreases were partially offset by higher
net interest income on MSR related assets, CRT securities, and residential whole loans at carrying value of approximately $32.4
million compared to 2016, primarily due to higher average amounts invested in these assets and higher yields earned on CRT
securities. In addition, net interest income for 2017 also includes $19.7 million of interest expense associated with residential
whole loans at fair value, reflecting a $5.8 million increase in borrowing costs related to these investments compared to 2016.
Coupon interest income received from residential whole loans at fair value is presented as a component of the total income earned
on these investments and therefore is included in Other Income, net rather than net interest income.
51
Analysis of Net Interest Income
The following table sets forth certain information about the average balances of our assets and liabilities and their related
yields and costs for the years ended December 31, 2017, 2016 and 2015. Average yields are derived by dividing interest income
by the average amortized cost of the related assets, and average costs are derived by dividing interest expense by the daily average
balance of the related liabilities, for the periods shown. The yields and costs include premium amortization and purchase discount
accretion which are considered adjustments to interest rates.
(Dollars in Thousands)
Assets:
Interest-earning assets:
Agency MBS (1)
For the Year Ended December 31,
2017
2016
2015
Average
Balance
Interest
Average
Yield/
Cost
Average
Balance
Interest
Average
Yield/
Cost
Average
Balance
Interest
Average
Yield/
Cost
$ 3,272,766
$ 65,355
2.00% $
4,258,744
$ 83,069
1.95% $ 5,282,198
$105,835
2.00%
Legacy Non-Agency MBS (1)
2,276,247
203,650
RPL/NPL MBS (1)
Total MBS
CRT securities (1)
MSR related assets (1)
Residential whole loans, at
carrying value (2)
Cash and cash equivalents (3)
1,629,573
67,462
7,178,586
336,467
543,360
392,948
610,420
546,579
31,715
24,830
36,187
4,249
Total interest-earning assets
9,271,893
433,448
8.95
4.14
4.69
5.84
6.32
5.93
0.78
4.67
2,941,507
2,586,495
9,786,746
271,566
36,013
232,500
100,321
415,890
14,770
2,100
389,910
291,064
23,916
774
10,775,299
457,450
7.90
3.88
4.25
5.44
5.83
6.13
0.27
4.25
3,600,339
274,352
2,423,808
89,218
11,306,345
469,405
133,458
—
241,801
212,917
6,572
—
16,036
130
11,894,521
492,143
Total non-interest-earning assets (2)
2,347,281
Total assets
$ 11,619,174
2,061,281
$ 12,836,580
1,774,534
$ 13,669,055
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Total repurchase agreements and
other advances (4)
Securitized debt (5)
Senior Notes
$ 7,441,607
$186,347
96,311
96,751
2,755
8,039
Total interest-bearing liabilities
7,634,669
197,141
Total non-interest-bearing liabilities
Total liabilities
Stockholders’ equity
780,691
8,415,360
3,203,814
Total liabilities and stockholders’ equity
$ 11,619,174
2.50
2.86
8.31
2.58
$
8,972,475
$184,986
6,700
96,714
333
8,036
9,075,889
193,355
2.06
4.97
8.31
2.13
$ 9,596,407
$166,918
65,319
96,680
1,996
8,034
9,758,406
176,948
795,121
9,871,010
2,965,570
$ 12,836,580
781,188
10,539,594
3,129,461
$ 13,669,055
7.62
3.68
4.15
4.92
—
6.63
0.06
4.14
1.74
3.06
8.31
1.81
Net interest income/net interest
rate spread (6)
Net interest-earning assets/net
interest margin (7)
Ratio of interest-earning assets to
interest-bearing liabilities
$236,307
2.09%
$264,095
2.12%
$315,195
2.33%
$ 1,637,224
2.55% $
1,699,410
2.45% $ 2,136,115
2.65%
1.21x
1.19x
1.22x
(1) Yields presented throughout this Annual Report on Form 10-K are calculated using average amortized cost data for securities which excludes unrealized
gains and losses and includes principal payments receivable on securities. For GAAP reporting purposes, purchases and sales are reported on the trade
date. Average amortized cost data used to determine yields is calculated based on the settlement date of the associated purchase or sale as interest income is
not earned on purchased assets and continues to be earned on sold assets until settlement date. Includes Non-Agency MBS transferred to consolidated VIEs.
(2) Excludes residential whole loans held at fair value that are reported as a component of total non-interest-earning assets.
(3) Includes average interest-earning cash, cash equivalents and restricted cash.
(4) Average cost of repurchase agreements includes the cost of Swaps allocated based on the proportionate share of the overall estimated weighted average
portfolio duration.
(5) Securitized debt for 2017 reflects securitized debt from our 2017 loan securitization transactions. Securitized debt for 2016 and 2015 reflects securitized debt
from our MBS resecuritization transactions.
(6) Net interest rate spread reflects the difference between the yield on average interest-earning assets and average cost of funds.
(7) Net interest margin reflects net interest income divided by average interest-earning assets.
52
Rate/Volume Analysis
The following table presents the extent to which changes in interest rates (yield/cost) and changes in the volume (average
balance) of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during
the periods indicated. Information is provided in each category with respect to: (i) the changes attributable to changes in volume
(changes in average balance multiplied by prior rate); (ii) the changes attributable to changes in rate (changes in rate multiplied
by prior average balance); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been
allocated proportionately, based on absolute values, to the changes due to rate and volume.
(In Thousands)
Interest-earning assets:
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
CRT securities
MSR related assets
Residential whole loans, at carrying value (1)
Cash and cash equivalents
Year Ended December 31, 2017
Compared to
Year Ended December 31, 2016
Year Ended December 31, 2016
Compared to
Year Ended December 31, 2015
Increase/
(Decrease) due to
Volume
Rate
Total Net
Change in
Interest
Income/
Expense
Increase/
(Decrease) due to
Volume
Rate
Total Net
Change in
Interest
Income/
Expense
$ (19,762) $
2,048
$
(17,714)
$ (20,028) $ (2,738) $
(22,766)
(57,019)
(39,233)
15,790
22,539
13,097
1,088
28,169
6,374
1,155
191
(826)
2,387
(28,850)
(32,859)
16,945
22,730
12,271
3,475
(51,758)
6,148
7,446
2,100
9,166
64
9,906
4,955
752
—
(1,286)
580
(41,852)
11,103
8,198
2,100
7,880
644
Total net change in income from interest-earning assets
$ (63,500) $ 39,498
$
(24,002)
$ (46,862) $ 12,169
$
(34,693)
Interest-bearing liabilities:
Agency repurchase agreements and FHLB advances
$ (13,779) $ 11,470
$
(2,309)
$ (11,046) $
8,578
$
(2,468)
Legacy Non-Agency repurchase agreements
RPL/NPL MBS repurchase agreements
CRT securities repurchase agreements
MSR related assets repurchased agreements
Residential whole loan at carrying value repurchase
agreements
Residential whole loan at fair value repurchase
agreements
Securitized debt
Senior Notes
(13,682)
(18,944)
4,507
7,332
6,456
7,260
891
85
3,919
1,133
3,337
2,621
3
1,376
(199)
—
(7,226)
(11,684)
5,398
7,417
5,052
4,713
2,422
3
(8,937)
1,551
2,102
632
3,562
8,036
(2,452)
2
3,646
8,356
375
—
327
886
789
—
(5,291)
9,907
2,477
632
3,889
8,922
(1,663)
2
Total net change in expense from interest-bearing
liabilities
Net change in net interest income
$ (24,686) $ 28,472
$ (38,814) $ 11,026
$
$
3,786
$
(6,550) $ 22,957
$
16,407
(27,788)
$ (40,312) $ (10,788) $
(51,100)
(1) Excludes residential whole loans held at fair value which are reported as a component of non-interest-earning assets.
53
The following table presents certain quarterly information regarding our net interest spread and net interest margin for the
quarterly periods presented:
Quarter Ended
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
Total Interest-Earning Assets and Interest-
Bearing Liabilities
Net Interest
Spread (1)
Net Interest
Margin (2)
2.08%
2.54%
2.02
2.10
2.27
2.12
2.13
2.14
2.18
2.54
2.58
2.63
2.46
2.46
2.46
2.51
(1) Reflects the difference between the yield on average interest-earning assets and average cost of funds.
(2) Reflects annualized net interest income divided by average interest-earning assets.
The following table presents the components of the net interest spread earned on our Agency MBS, Legacy Non-Agency
MBS and RPL/NPL MBS for the quarterly periods presented:
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
Total MBS
Quarter Ended
Net
Yield
(1)
Cost of
Funding
(2)
Net
Interest
Spread
(3)
Net
Yield
(1)
Cost of
Funding
(2)
Net
Interest
Spread
(3)
Net
Yield
(1)
Cost of
Funding
(2)
Net
Interest
Spread
(3)
Net
Yield
(1)
Cost of
Funding
(2)
Net
Interest
Spread
(3)
December 31, 2017
2.08%
1.79%
0.29%
9.12%
3.29%
5.83%
4.27%
2.72%
1.55%
4.85%
2.44%
2.41%
September 30, 2017
June 30, 2017
March 31, 2017
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
1.97
1.96
1.98
1.92
1.83
1.96
2.07
1.75
1.57
1.49
1.41
1.28
1.26
1.27
0.22
0.39
0.49
0.51
0.55
0.70
0.80
8.93
8.85
8.90
8.24
8.09
7.72
7.61
3.26
3.28
3.05
3.01
2.98
2.88
2.86
5.67
5.57
5.85
5.23
5.11
4.84
4.75
4.43
4.18
3.87
3.85
3.86
3.83
3.97
2.69
2.46
2.27
2.14
2.05
2.01
2.07
1.74
1.72
1.60
1.71
1.81
1.82
1.90
4.74
4.68
4.58
4.35
4.24
4.19
4.23
2.41
2.29
2.15
2.07
1.96
1.91
1.91
2.33
2.39
2.43
2.28
2.28
2.28
2.32
(1) Reflects annualized interest income on MBS divided by average amortized cost of MBS.
(2) Reflects annualized interest expense divided by average balance of repurchase agreements and other advances, including the cost of Swaps
allocated based on the proportionate share of the overall estimated weighted average portfolio duration and securitized debt. Agency cost
of funding includes 43, 44, 49, 60, 65, 62, 63 and 65 basis points and Legacy Non-Agency cost of funding includes 45, 45, 58, 58, 69, 74, 69
and 65 basis points associated with Swaps to hedge interest rate sensitivity on these assets for the quarters ended December 31, 2017,
September 30, 2017, June 30, 2017, March 31, 2017, December 31, 2016, September 30, 2016, June 30, 2016 and March 31, 2016, respectively.
(3) Reflects the difference between the net yield on average MBS and average cost of funds on MBS.
54
Interest Income
Interest income on our Agency MBS for 2017 decreased by $17.7 million, or 21.3% to $65.4 million from $83.1 million for
2016. This change primarily reflects a $986.0 million decrease in the average amortized cost of our Agency MBS portfolio to
$3.3 billion for 2017 from $4.3 billion for 2016 partially offset by an increase in the net yield on our Agency MBS to 2.00% for
2017 from 1.95% for 2016. At the end of 2017, the average coupon on mortgages underlying our Agency MBS was higher
compared to the end of 2016. However, during 2017, our Agency MBS portfolio experienced a 15.5% CPR and we recognized
a $31.3 million of net premium amortization compared to a CPR of 14.4% and $36.9 million of net premium amortization in 2016.
At December 31, 2017, we had net purchase premiums on our Agency MBS of $104.0 million, or 3.8% of current par value,
compared to net purchase premiums of $135.1 million, or 3.8% of par value at December 31, 2016.
Interest income on our Non-Agency MBS (which includes Non-Agency MBS transferred to consolidated VIEs) decreased
$61.7 million, or 18.5%, for 2017 to $271.1 million compared to $332.8 million for 2016, primarily due to the decrease in the
average amortized cost of our Non-Agency portfolio of $1.6 billion or 29.3%, to $3.9 billion for 2017, from $5.5 billion for 2016.
This decrease more than offset that impact of the higher yields generated on our Legacy Non-Agency MBS portfolio, which were
8.95% for 2017 compared to 7.90% for 2016. The increase in the net yield on our Legacy Non-Agency MBS reflects the impact
of the cash proceeds received during 2016 in connection with the settlement of litigation related to certain Countrywide and
Citigroup sponsored residential mortgage backed securitization trusts, the improved performance of loans underlying the Legacy
Non-Agency MBS portfolio, which has resulted in credit reserve releases and the impact of redemptions during 2017 of certain
securities that had been previously purchased at a discount. Our RPL/NPL MBS portfolio yielded 4.14% for 2017 compared to
3.88% for 2016. The increase in the net yield reflects an increase in the average coupon yield to 4.05% for 2017 from 3.80% for
2016 and higher accretion income recognized in the current year due to the impact of redemptions of certain securities that had
been previously purchased at a discount.
During 2017, we recognized net purchase discount accretion of $77.5 million on our Non-Agency MBS, compared to $80.6
million for 2016. At December 31, 2017, we had net purchase discounts of $806.5 million, including Credit Reserve and previously
recognized OTTI of $593.2 million, on our Legacy Non-Agency MBS, or 28.8% of par value. During 2017, we reallocated $50.8
million of purchase discount designated as Credit Reserve to accretable purchase discount.
The following table presents the coupon yield and net yields earned on our Agency MBS, Legacy Non-Agency MBS and
RPL/NPL MBS and weighted average CPRs experienced for such MBS for the quarterly periods presented:
Quarter Ended
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
Coupon
Yield (1)
Net
Yield (2)
3 Month
Average
CPR (3)
Coupon
Yield (1)
Net
Yield (2)
3 Month
Average
CPR (3)
Coupon
Yield (1)
Net
Yield (2)
3 Month
Average
Bond
CPR (4)
3.00%
2.08%
14.1%
5.82%
9.12%
16.3%
4.24%
4.27%
20.1%
2.98
2.94
2.90
2.86
2.83
2.80
2.78
1.97
1.96
1.98
1.92
1.83
1.96
2.07
16.2
16.3
15.1
15.9
16.7
13.9
11.7
5.63
5.52
5.50
5.40
5.28
5.19
5.09
8.93
8.85
8.90
8.24
8.09
7.72
7.61
18.7
18.2
16.8
17.3
15.9
16.1
13.3
4.24
4.03
3.84
3.82
3.83
3.81
3.73
4.43
4.18
3.87
3.85
3.86
3.83
3.97
26.2
36.2
27.1
25.8
32.2
25.4
23.0
(1) Reflects the annualized coupon interest income divided by the average amortized cost. The discounted purchase price on Legacy Non-Agency
MBS causes the coupon yield to be higher than the pass-through coupon interest rate.
(2) Reflects annualized interest income on MBS divided by average amortized cost of MBS.
(3) 3 month average CPR weighted by positions as of the beginning of each month in the quarter.
(4) All principal payments are considered to be prepayments for CPR purposes.
55
Interest Expense
Our interest expense for 2017 increased by $3.8 million or 1.96% to $197.1 million, from $193.4 million for 2016. This
increase primarily reflects an increase in financing rates on our repurchase agreement financings, an increase in our average
borrowings to finance residential whole loans, MSR related assets and CRT securities, which was partially offset by a decrease
in our average repurchase agreement borrowings and other advances to finance Agency MBS and Non-Agency MBS. The effective
interest rate paid on our borrowings increased to 2.58% for the year ended December 31, 2017, from 2.13% for the year ended
December 31, 2016.
At December 31, 2017, we had repurchase agreement borrowings of $6.6 billion of which $2.6 billion was hedged with
Swaps. At December 31, 2017, our Swaps designated in hedging relationships had a weighted average fixed-pay rate of 2.04%
and extended 27 months on average with a maximum remaining term of approximately 68 months.
Payments made and/or received on our Swaps are a component of our borrowing costs and accounted for interest expense
of $24.5 million or 32 basis points, for 2017, compared to interest expense of $40.9 million, or 45 basis points, for 2016. The
weighted average fixed-pay rate on our Swaps designated as hedges increased to 1.98% for 2017 from 1.82% for 2016. The
weighted average variable interest rate received on our Swaps designated as hedges increased to 1.07% for 2017 from 0.48% for
2016. During 2017, we did not enter into any new Swaps and had Swaps with an aggregate notional amount of $350.0 million
and a weighted average fixed-pay rate of 0.58% amortize and/or expire.
We expect that our interest expense and funding costs for 2018 will be impacted by market interest rates, the amount of our
borrowings and incremental hedging activity, existing and future interest rates on our hedging instruments and the extent to which
we execute additional longer-term structured financing transactions. As a result of these variables, our borrowing costs cannot be
predicted with any certainty. (See Notes 5(b), 6 and 14 to the accompanying consolidated financial statements, included under
Item 8 of this Annual Report on Form 10-K.)
OTTI
During 2017 and 2016, we recognized OTTI charges through earnings against certain of our Non-Agency MBS of $1.0
million and $485,000, respectively. These impairment charges reflected changes in our estimated cash flows for such securities
based on an updated assessment of the estimated future performance of the underlying collateral, including the expected principal
loss over the term of the securities and changes in the expected timing of receipt of cash flows. At December 31, 2017, we had
433 Agency MBS with a gross unrealized loss of $43.1 million and 15 Non-Agency MBS with a gross unrealized loss of $453,000.
Impairments on Agency MBS in an unrealized loss position at December 31, 2017 are considered temporary and not credit related.
Unrealized losses on Non-Agency MBS for which no OTTI was recorded during the year are considered temporary based on an
assessment of changes in the expected cash flows for such securities, which considers recent bond performance and expected
future performance of the underlying collateral. Significant judgment is used both in our analysis of expected cash flows for our
Legacy Non-Agency MBS and any determination of the credit component of OTTI. (See “Critical Accounting Policies and
Estimates” for more information regarding OTTI.)
56
Other Income, net
For 2017, Other Income, net, increased by $50.0 million, or 45.8% to $159.0 million compared to $109.0 million for 2016.
Other Income, net for 2017 primarily reflects a $90.0 million net gain recorded on residential whole loans held at fair value, $39.6
million of net gains realized on the sale of $243.1 million Non-Agency MBS and U.S. Treasury securities and $27.7 million of
unrealized gains on CRT securities accounted for at fair value. Other Income, net for 2016 primarily reflects a net gain of $62.6
million on residential whole loans held at fair value, $35.8 million, of gross gains realized on the sale of $85.6 million of Non-
Agency MBS and $13.0 million of unrealized gains on CRT securities accounted for at fair value.
Operating and Other Expense
For 2017, we had compensation and benefits and other general and administrative expenses of $49.6 million, or 1.55% of
average equity, compared to $45.6 million, or 1.54% of average equity, for 2016. Compensation and benefits expense increased
$2.4 million to $31.7 million for 2017, compared to $29.3 million for 2016, primarily reflecting non-recurring expenses recorded
in relation to our contractual obligation to accelerate the vesting of certain share based awards and to make a death benefit payment
to the estate of our former Chief Executive Officer. Our other general and administrative expenses increased by $1.6 million to
$18.0 million for 2017 compared to $16.3 million for 2016. The increase was primarily due to higher costs related to stock-based
compensation awards to Directors, higher professional services related costs and higher costs associated with the loan securitization
transactions and other structured financing transactions completed during 2017.
Operating and Other Expense during 2017 also includes $22.3 million of loan servicing and other related operating expenses
related to our residential whole loan activities. These expenses increased compared to the prior year period by approximately $7.9
million, primarily due to increases in non-recoverable advances on REO, increased loan servicing and modification fees and higher
loan acquisition related expenses, which were partially offset by a decrease in the provision for loan losses recognized for 2017.
Selected Financial Ratios
The following table presents information regarding certain of our financial ratios at or for the dates presented:
At or for the Quarter Ended
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
Return on
Average Total
Assets (1)
Return on
Average Total
Stockholders’
Equity (2)
Total Average
Stockholders’
Equity to Total
Average Assets (3)
3.47%
12.29%
29.33%
2.10
2.63
2.42
2.18
2.47
2.33
2.29
7.78
10.01
10.19
9.52
11.05
10.83
10.82
28.60
27.59
24.95
24.19
23.46
22.58
22.19
Dividend
Payout
Ratio (4)
Leverage
Multiple (5)
Book Value
per Share
of Common
Stock (6)
0.83
1.33
1.00
1.00
1.11
0.95
1.00
1.00
$
2.3
2.4
2.5
2.9
3.1
3.1
3.3
3.4
7.70
7.70
7.76
7.66
7.62
7.64
7.41
7.17
(1) Reflects annualized net income available to common stock and participating securities divided by average total assets.
(2) Reflects annualized net income divided by average total stockholders’ equity.
(3) Reflects total average stockholders’ equity divided by total average assets.
(4) Reflects dividends declared per share of common stock divided by earnings per share.
(5) Represents the sum of borrowings under repurchase agreements, FHLB advances, securitized debt, payable for unsettled purchases, and
obligations to return securities obtained as collateral and Senior Notes divided by stockholders’ equity.
(6) Reflects total stockholders’ equity less the preferred stock liquidation preference divided by total shares of common stock outstanding.
57
Results of Operations
Year Ended December 31, 2016 Compared to the Year Ended December 31, 2015
General
For 2016, we had net income available to our common stock and participating securities of $297.7 million, or $0.80 per basic
and diluted common share, unchanged compared to net income available to common stock and participating securities for 2015
of $298.2 million, or $0.80 per basic and diluted common share.
Net Interest Income
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing
liabilities. Net interest income depends primarily upon the volume of interest-earning assets and interest-bearing liabilities and
the corresponding interest rates earned or paid. Our net interest income varies primarily as a result of changes in interest rates,
the slope of the yield curve (i.e., the differential between long-term and short-term interest rates), borrowing costs (i.e., our interest
expense) and prepayment speeds on our MBS. Interest rates and CPRs (which measure the amount of unscheduled principal
prepayment on a bond as a percentage of the bond balance) vary according to the type of investment, conditions in the financial
markets, and other factors, none of which can be predicted with any certainty.
The changes in average interest-earning assets and average interest-bearing liabilities and their related yields and costs are
discussed in greater detail below under “Interest Income” and “Interest Expense.”
For 2016, our net interest spread and margin were 2.12% and 2.45%, respectively, compared to a net interest spread and
margin of 2.33% and 2.65%, respectively, for 2015. Our net interest income decreased by $51.1 million, or 16.2%, to $264.1
million from $315.2 million for 2015. For 2016 net interest income from Agency MBS and Legacy Non-Agency MBS declined
compared to 2015 by approximately $55.2 million, primarily due to lower average amounts invested in these securities and higher
funding costs, partially offset by higher yields earned on Legacy Non-Agency MBS. This decrease was partially offset by higher
net interest income on residential whole loans at carrying value, RPL/NPL MBS and CRT securities of approximately $10.9
million, primarily due to higher average balances and yields on RPL/NPL MBS and CRT securities and higher average balances
of residential loans at carrying value. In addition, net interest income also included $13.9 million of interest expense associated
with residential whole loans at fair value, reflecting an $8.9 million increase in borrowing costs related to these investments
compared to 2015, consistent with the overall growth of this asset class during 2016. Coupon interest income received from
residential whole loans at fair value is presented as a component of the total income earned on these investment and therefore is
included in Other income, net interest income.
The following table presents certain quarterly information regarding our net interest spread and net interest margin for the
quarterly periods presented:
Quarter Ended
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
December 31, 2015
September 30, 2015
June 30, 2015
March 31, 2015
Total Interest-Earning Assets and Interest-
Bearing Liabilities
Net Interest
Spread (1)
Net Interest
Margin (2)
2.12%
2.46%
2.13
2.14
2.18
2.22
2.24
2.33
2.44
2.46
2.46
2.51
2.54
2.58
2.66
2.77
(1) Reflected the difference between the yield on average interest-earning assets and average cost of funds.
(2) Reflected annualized net interest income divided by average interest-earning assets.
58
The following table presents the components of the net interest spread earned on our Agency MBS, Legacy Non-Agency
MBS and RPL/NPL MBS for the quarterly periods presented:
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
Total MBS
Quarter Ended
Net
Yield
(1)
Cost of
Funding
(2)
Net
Interest
Spread
(3)
Net
Yield
(1)
Cost of
Funding
(2)
Net
Interest
Spread
(3)
Net
Yield
(1)
Cost of
Funding
(2)
Net
Interest
Spread
(3)
Net
Yield
(1)
Cost of
Funding
(2)
Net
Interest
Spread
(3)
December 31, 2016
1.92%
1.41%
0.51%
8.24%
3.01%
5.23%
3.85%
2.14%
1.71%
4.35%
2.07%
2.28%
September 30, 2016
June 30, 2016
March 31, 2016
December 31, 2015
September 30, 2015
June 30, 2015
March 31, 2015
1.83
1.96
2.07
2.04
1.84
1.89
2.22
1.28
1.26
1.27
1.17
1.13
1.06
1.13
0.55
0.70
0.80
0.87
0.71
0.83
1.09
8.09
7.72
7.61
7.64
7.60
7.59
7.64
2.98
2.88
2.86
2.90
2.76
2.77
2.85
5.11
4.84
4.75
4.74
4.84
4.82
4.79
3.86
3.83
3.97
3.70
3.74
3.66
3.62
2.05
2.01
2.07
1.81
1.73
1.60
1.52
1.81
1.82
1.90
1.89
2.01
2.06
2.10
4.24
4.19
4.23
4.17
4.08
4.09
4.26
1.96
1.91
1.91
1.81
1.73
1.65
1.69
2.28
2.28
2.32
2.36
2.35
2.44
2.57
(1) Reflected annualized interest income on MBS divided by average amortized cost of MBS.
(2) Reflected annualized interest expense divided by average balance of repurchase agreements and other advances, including the cost of Swaps
allocated based on the proportionate share of the overall estimated weighted average portfolio duration and securitized debt. Agency cost
of funding included 65, 62, 63, 65, 74, 74, 70 and 78 basis points and Legacy Non-Agency cost of funding included 69, 74, 69, 65, 69, 66,
68 and 78 basis points associated with Swaps to hedge interest rate sensitivity on these assets for the quarters ended December 31, 2016,
September 30, 2016, June 30, 2016, March 31, 2016, December 31, 2015, September 30, 2015, June 30, 2015 and March 31, 2015, respectively.
(3) Reflected the difference between the net yield on average MBS and average cost of funds on MBS.
Interest Income
Interest income on our Agency MBS for 2016 decreased by $22.8 million, or 21.5% to $83.1 million from $105.8 million
for 2015. This change primarily reflected a $1.0 billion decrease in the average amortized cost of our Agency MBS portfolio to
$4.3 billion for 2016 from $5.3 billion for 2015. In addition, the net yield on our Agency MBS decreased to 1.95% for 2016 from
2.00% for 2015. At the end of 2016, the average coupon on mortgages underlying our Agency MBS was slightly higher compared
to the end of 2015. However, during 2016, our Agency MBS portfolio experienced a 14.4% CPR and we recognized a $36.9
million of net premium amortization compared to a CPR of 13.2% and $41.2 million of net premium amortization in 2015, which
resulted in the year on year decline in net yield. At December 31, 2016, we had net purchase premiums on our Agency MBS of
$135.1 million, or 3.8% of current par value, compared to net purchase premiums of $172.0 million, or 3.8% of par value at
December 31, 2015.
Interest income on our Non-Agency MBS (which included Non-Agency MBS transferred to consolidated VIEs) decreased
$30.7 million, or 8.5%, for 2016 to $332.8 million compared to $363.6 million for 2015, primarily due to the decrease in the
average amortized cost of our Non-Agency portfolio of $496.1 million or 8.2%, to $5.5 billion for 2016, from $6.0 billion for
2015. This decrease more than offset that impact of the higher yields generated on our Legacy Non-Agency MBS portfolio, which
were 7.90% for 2016 compared to 7.62% for 2015. The increase in the yield on our Legacy Non-Agency MBS reflected the impact
of the cash proceeds (a one-time payment) received during the quarter ended June 30, 2016 in connection with the settlements of
litigation related to certain Countrywide and Citigroup sponsored residential mortgage backed securitization trusts and the improved
performance of loans underlying the Legacy Non-Agency MBS portfolio, resulting in credit reserve releases, in the current and
prior year. Our RPL/NPL MBS portfolio yielded 3.88% for 2016 compared to 3.68% for 2015. The increase in the net yield on
this portfolio was primarily due to the addition of higher yielding securities since 2015 and the impact of redemptions during 2016
of certain securities that had been previously purchased at a discount.
During 2016, we recognized net purchase discount accretion of $80.6 million on our Non-Agency MBS, compared to $92.8
million for 2015. At December 31, 2016, we had net purchase discounts of $970.8 million, including Credit Reserve and previously
recognized OTTI of $694.2 million, on our Legacy Non-Agency MBS, or 27.3% of par value. During 2016, we reallocated $37.7
million of purchased discount designated as Credit Reserve to accretable purchase discount.
59
The following table presents the coupon yield and net yields earned on our Agency MBS, Legacy Non-Agency MBS and
RPL/NPL MBS and weighted average CPRs experienced for such MBS for the quarterly periods presented:
Quarter Ended
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
December 31, 2015
September 30, 2015
June 30, 2015
March 31, 2015
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
Coupon
Yield (1)
Net
Yield (2)
3 Month
Average
CPR (3)
Coupon
Yield (1)
Net
Yield (2)
3 Month
Average
CPR (3)
Coupon
Yield (1)
Net
Yield (2)
3 Month
Average
Bond
CPR (4)
2.86%
1.92%
15.9%
5.40%
8.24%
17.3%
3.82%
3.85%
25.8%
2.83
2.80
2.78
2.76
2.74
2.77
2.99
1.83
1.96
2.07
2.04
1.84
1.89
2.22
16.7
13.9
11.7
11.8
15.4
14.8
10.9
5.28
5.19
5.09
5.09
5.10
5.06
5.11
8.09
7.72
7.61
7.64
7.60
7.59
7.64
15.9
16.1
13.3
14.6
16.3
14.8
11.1
3.83
3.81
3.73
3.68
3.62
3.57
3.56
3.86
3.83
3.97
3.70
3.74
3.66
3.62
32.2
25.4
23.0
21.5
29.5
28.6
19.6
(1) Reflected the annualized coupon interest income divided by the average amortized cost. The discounted purchase price on Legacy Non-
Agency MBS causes the coupon yield to be higher than the pass-through coupon interest rate.
(2) Reflects annualized interest income on MBS divided by average amortized cost of MBS.
(3) 3 month average CPR weighted by positions as of the beginning of each month in the quarter.
(4) All principal payments are considered to be prepayments for CPR purposes.
Interest Expense
Our interest expense for 2016 increased by $16.4 million, or 9.3% to $193.4 million, from $176.9 million for 2015. This
increase primarily reflected an increase in financing rates on our repurchase agreement financings, an increase in our average
borrowings to finance residential whole loans, CRT securities and RPL/NPL MBS, which was partially offset by a decrease in our
average repurchase agreement borrowings to finance Agency MBS and Legacy Non-Agency MBS, and a decrease in the average
balance of FHLB advances and securitized debt.
At December 31, 2016, we had repurchase agreement borrowings of $8.5 billion of which $2.9 billion was hedged with
Swaps and FHLB advances of $215.0 million. At December 31, 2016, our Swaps designated in hedging relationships had a
weighted average fixed-pay rate of 1.87% and extended 35 months on average with a maximum remaining term of approximately
80 months.
The effective interest rate paid on our borrowings increased to 2.13% for 2016 from 1.81% for 2015. This increase reflected
higher financing rates on our repurchase agreement financings, the increase in our average balance of repurchase agreements to
finance residential whole loans, CRT securities and RPL/NPL MBS, partially offset by the lower average balance of Agency and
Legacy Non-Agency repurchase agreements, FHLB advances and securitized debt.
Payments made and/or received on our Swaps are a component of our borrowing costs and accounted for interest expense
of $40.9 million or 45 basis points, for 2016, compared to interest expense of $53.8 million, or 57 basis points, for 2015. The
weighted average fixed-pay rate on our Swaps designated as hedges decreased to 1.82% for 2016 from 1.86% for 2015. The
weighted average variable interest rate received on our Swaps designated as hedges increased to 0.48% for 2016 from 0.19% for
2015. During 2016, we did not enter into any new Swaps and had Swaps with an aggregate notional amount of $150.0 million
and a weighted average fixed-pay rate of 1.03% amortize and/or expire.
OTTI
During 2016 and 2015, we recognized OTTI charges through earnings against certain of our Non-Agency MBS of $485,000
and $705,000, respectively. These impairment charges reflected changes in our estimated cash flows for such securities based on
an updated assessment of the estimated future performance of the underlying collateral, including the expected principal loss over
the term of the securities and changes in the expected timing of receipt of cash flows. At December 31, 2016, we had 344 Agency
MBS with a gross unrealized loss of $31.2 million and 55 Non-Agency MBS with a gross unrealized loss of $5.2 million.
Impairments on Agency MBS in an unrealized loss position at December 31, 2016 are considered temporary and not credit related.
60
Unrealized losses on Non-Agency MBS for which no OTTI was recorded during the year are considered temporary based on an
assessment of changes in the expected cash flows for such securities, which considers recent bond performance and expected
future performance of the underlying collateral. Significant judgment is used both in our analysis of expected cash flows for our
Legacy Non-Agency MBS and any determination of the credit component of OTTI. (See “Critical Accounting Policies and
Estimates” for more information regarding OTTI.)
Other Income, net
For 2016, Other income, net, increased by $57.9 million, or 113.1% to $109.0 million from $51.2 million for 2015. Other
income, net for 2016 primarily reflected a $62.6 million net gain recorded on residential whole loans held at fair value and $35.8
million of gross gains realized on the sale of $85.6 million Non-Agency MBS and $13.0 million of unrealized gains on CRT
securities accounted for at fair value. During 2015, we sold Non-Agency MBS for $70.7 million, realizing gross gains of $34.9
million and recorded a net gain on residential whole loans held at fair value of $19.6 million.
Operating and Other Expense
For 2016, we had compensation and benefits and other general and administrative expenses of $45.6 million, or 1.54% of
average equity, compared to $42.0 million, or 1.34% of average equity, for 2015. Compensation and benefits expense increased
$3.0 million to $29.3 million for 2016, compared to $26.3 million for 2015, which primarily reflected higher headcount and
recognition for accounting purposes of additional expense associated with long term incentive awards. Our other general and
administrative expenses increased by $579,000 to $16.3 million for 2016 compared to $15.8 million for 2015. The increase was
primarily due to higher IT development and related expenses.
Operating and Other Expense during 2016 also included $14.4 million of loan servicing and other related operating expenses
related to our residential whole loan activities. These expenses increased compared to the prior year period by approximately $4.0
million, consistent with the overall growth in this asset class during 2016. The overall increase was primarily due to increased
loan servicing and modification fees and non-recoverable advances on REO which were partially offset by a decrease in the
provision for loan losses recognized and lower loan acquisition related expenses for 2016.
Selected Financial Ratios
The following table presents information regarding certain of our financial ratios at or for the dates presented:
At or for the Quarter Ended
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
December 31, 2015
September 30, 2015
June 30, 2015
March 31, 2015
Return on
Average Total
Assets (1)
Return on
Average Total
Stockholders’
Equity (2)
Total Average
Stockholders’
Equity to Total
Average Assets (3)
2.18%
9.52%
24.19%
2.47
2.33
2.29
2.10
2.22
2.16
2.25
11.05
10.83
10.82
9.80
10.21
9.78
10.26
23.46
22.58
22.19
22.56
22.85
23.18
22.97
Dividend Payout
Ratio (4)
Leverage
Multiple (5)
Book Value
per Share
of Common
Stock (6)
1.11
0.95
1.00
1.00
1.05
1.00
1.00
0.95
$
3.1
3.1
3.3
3.4
3.4
3.3
3.3
3.3
7.62
7.64
7.41
7.17
7.47
7.70
7.96
8.13
(1) Reflected annualized net income available to common stock and participating securities divided by average total assets.
(2) Reflected annualized net income divided by average total stockholders’ equity.
(3) Reflected total average stockholders’ equity divided by total average assets.
(4) Reflected dividends declared per share of common stock divided by earnings per share.
(5) Represented the sum of borrowings under repurchase agreements, FHLB advances, securitized debt, payable for unsettled purchases, and
obligations to return securities obtained as collateral and Senior Notes divided by stockholders’ equity.
(6) Reflected total stockholders’ equity less the preferred stock liquidation preference divided by total shares of common stock outstanding.
61
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements include our accounts and all majority owned and controlled subsidiaries. In addition,
we consolidate the special purpose entities (or SPEs) created to facilitate the resecuritization transactions completed in prior years
and the acquisition of residential whole loans. The preparation of consolidated financial statements in accordance with GAAP
requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements.
In preparing these consolidated financial statements, management has made estimates and judgments of certain amounts included
in the consolidated financial statements, giving due consideration to materiality. Application of these accounting policies involves
the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these
estimates.
Our accounting policies are described in Note 2 to the consolidated financial statements, included under Item 8 of this Annual
Report on Form 10-K. Management believes the more significant of these to be as follows:
Classifications of Investment Securities and Assessment for Other-Than-Temporary Impairments
Our investments in securities are primarily comprised of Agency MBS and Non-Agency MBS, as discussed and detailed in
Notes 2(b) and 3 to the consolidated financial statements, included under Item 8 of this Annual Report on Form 10-K. All of our
MBS are designated as available-for-sale (or AFS) and, accordingly, are carried on our consolidated balance sheets at their fair
value with unrealized gains and losses excluded from earnings (except when an OTTI is recognized, as discussed below) and
reported in AOCI, a component of Stockholders’ Equity. We do not intend to hold any of our investment securities for trading
purposes; however, if available-for-sale securities were classified as trading securities, there could be substantially greater volatility
in our earnings.
When the fair value of an AFS security is less than its amortized cost at the balance sheet date, the security is considered
impaired. We assess our impaired securities on at least a quarterly basis and designates such impairments as either “temporary”
or “other-than-temporary.” If we intend to sell an impaired security, or it is more likely than not that we will be required to sell
the impaired security before its anticipated recovery, then we 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 we do not expect to sell
an other-than-temporarily impaired security, only the portion of the OTTI related to credit losses is recognized through charges
to earnings with the remainder recognized through AOCI on the consolidated balance sheets.
In making our assessments about OTTIs, we review and consider certain information relating to our financial position and
the impaired securities, including the nature of such securities, the contractual collateral requirements impacting us and our
investment and leverage strategies, as well as subjective information, including our current and targeted liquidity position, the
credit quality and expected cash flows of the underlying assets collateralizing such securities, and current and anticipated market
conditions. 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, we compare 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 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 management’s estimates of the future performance and cash flow projections. As a result, the timing and amount of
OTTIs constitute material estimates that may be susceptible to significant change.
During 2017, we recognized credit-related OTTI losses through earnings related to our Non-Agency MBS of $1.0 million.
At December 31, 2017, we did not intend to sell any MBS that were in an unrealized loss position, and it is “more likely than not”
that we will not be required to sell these MBS before recovery of their amortized cost basis, which may be at their maturity.
Gross unrealized losses on our Agency MBS were $43.1 million at December 31, 2017. Agency MBS are issued by GSEs
and enjoy either the implicit or explicit backing of the full faith and credit of the U.S. Government. While our 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, we do 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 we will be required to sell any impaired security before its anticipated recovery, which may be at its
maturity, we consider for each impaired security, the significance of each investment, the amount of impairment, the projected
future performance of such impaired securities, as well as our current and anticipated leverage capacity and liquidity position.
Based on these analyses, we determined that at December 31, 2017 any unrealized losses on its Agency MBS were temporary.
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The payments of principal and interest we receive on our Agency MBS, which depend directly upon payments on the
mortgages underlying such securities, are guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. Fannie Mae and Freddie
Mac are GSEs, but their guarantees are not explicitly backed by the full faith and credit of the United States. Ginnie Mae is part
of a U.S. Government agency and its guarantees are explicitly backed by the full faith and credit of the United States. We believe
that the stronger backing for the guarantors of Agency MBS resulting from the conservatorship of Fannie Mae and Freddie Mac
has further strengthened their credit worthiness; however, there can be no assurance that these actions will be adequate for their
needs. Accordingly, if these government actions are inadequate and the GSEs suffer losses in the future or cease to exist, our view
of the credit worthiness of our Agency MBS could materially change, which may affect our assessment of OTTI for Agency MBS
in future periods. (See Part I, Item 1A., Risk Factors, “The federal conservatorship of Fannie Mae and Freddie Mac and related
efforts, along with any changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the
U.S. Government, may materially adversely affect our business.”)
Gross unrealized losses on our Non-Agency MBS were $453,000 at December 31, 2017. Based upon the most recent
evaluation, we do not consider these unrealized losses to be indicative of OTTI and do not believe that these unrealized losses are
credit related, but are rather a reflection of current market yields and/or marketplace bid-ask spreads. We have reviewed our Non-
Agency MBS that are in an unrealized loss position to identify those securities with losses that 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.
Our expectations with respect to our securities in an unrealized loss position may change over time, given, among other
things, the dynamic nature of markets and other variables. Future sales or changes in our expectations with respect to securities
in an unrealized loss position could result in us recognizing OTTI charges or realizing losses on sales of MBS in the future. (See
Notes 2(b) and 3 to the consolidated financial statements, included under Item 8 of this Annual Report on Form 10-K.)
Fair Value Measurements
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant
to the fair value measurement. The three levels of valuation hierarchy are defined as follows:
Level 1 — Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active
markets.
Level 2 — Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and
inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial
instrument.
Level 3 — Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The following describes the valuation methodologies used for our financial instruments measured at fair value on a recurring
basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.
Securities Obtained and Pledged as Collateral/Obligation to Return Securities Obtained as Collateral
The fair value of U.S. Treasury securities obtained as collateral and the associated obligation to return securities obtained as
collateral are based upon prices obtained from a third-party pricing service, which are indicative of market activity. Securities
obtained as collateral are classified as Level 1 in the fair value hierarchy.
MBS and CRT Securities
We determine the fair value of our Agency MBS, based upon prices obtained from third-party pricing services, which are
indicative of market activity and repurchase agreement counterparties.
For Agency MBS, the valuation methodology of our third-party pricing services incorporate commonly used market pricing
methods, trading activity observed in the marketplace and other data inputs. The methodology also considers the underlying
characteristics of each security, which are also observable inputs, including: collateral vintage, coupon, maturity date, loan age,
reset date, collateral type, periodic and life cap, geography, and prepayment speeds. Management analyzes pricing data received
from third-party pricing services and compares it to other indications of fair value including data received from repurchase
agreement counterparties and its own observations of trading activity observed in the marketplace.
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In determining the fair value of our Non-Agency MBS and CRT securities, management considers a number of observable
market data points, including prices obtained from pricing services and brokers as well as dialogue with market participants. In
valuing Non-Agency MBS, we understand that pricing services use observable inputs that include, in addition to trading activity
observed in the marketplace, loan delinquency data, credit enhancement levels and vintage, which are taken into account to assign
pricing factors such as spread and prepayment assumptions. For tranches of Legacy Non-Agency MBS that are cross-collateralized,
performance of all collateral groups involved in the tranche are considered. We collect and consider current market intelligence
on all major markets, including benchmark security evaluations and bid-lists from various sources, when available.
Our Legacy Non-Agency MBS, RPL/NPL MBS and CRT securities are valued using various market data points as described
above, which management considers directly or indirectly observable parameters. Accordingly, these securities are classified as
Level 2 in the fair value hierarchy.
Term Notes Backed by MSR Related Collateral
Our valuation process for term notes backed by MSR related collateral 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
used to derive an indicative market value for the security. This indicative market value is further reviewed by us and may be
adjusted to ensure it reflects a realistic exit price at the valuation date given the structural features of these securities. At
December 31, 2017, the indicative implied yields used in the valuation of these securities ranged from 5.8% to 6.6%. The weighted
average indicative yield to maturity was 6.12%. 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, who 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. As this process includes significant unobservable inputs, these securities are classified as Level 3 in the
fair value hierarchy.
Residential Whole Loans, at Fair Value
We determine the fair value of our residential whole loans held at fair value after considering valuations obtained from a
third-party who specializes in providing valuations of residential mortgage loans trading activity observed in the marketplace.
Our residential whole loans held at fair value are classified as Level 3 in the fair value hierarchy.
Swaps
As of December 31, 2017, all of our Swaps are cleared by a central clearing house. Valuations provided by the clearing
house are used for purposes of determining the fair value of our Swaps. Such valuations obtained are tested with internally
developed models that apply readily observable market parameters. As our Swaps are subject to the clearing house’s margin
requirements, no credit valuation adjustment was considered necessary in determining the fair value of such instruments. Beginning
in January 2017, variation margin payments on our cleared Swaps 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 fair value of the Swap. Swaps are classified as Level 2
in the fair value hierarchy.
Interest Income on our Non-Agency MBS
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 IRR. The IRR is
determined using management’s estimate of the projected cash flows for each security, which are based on our 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, we review and, if appropriate, make adjustments to our 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.
Based on the projected cash flows from our Non-Agency MBS purchased at a discount to par value, a portion of the purchase
discount may be designated as Credit Reserve, which effectively mitigates our 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
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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 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.
Residential Whole Loans
Residential whole loans included in our consolidated balance sheets are comprised of pools of fixed and adjustable rate
residential mortgage loans acquired through consolidated trusts in secondary market transactions, with the majority at discounted
purchase prices. The accounting model utilized by us 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 under “Residential Whole Loans at Carrying Value” is typically utilized by us for loans where the underlying
borrower has a delinquency status of less than 60 days at the acquisition date. The accounting model described below under
“Residential Whole Loans at Fair Value” is typically utilized by us 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.
Our residential whole loans pledged as collateral against repurchase agreements are included in the consolidated balance
sheets with the 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.
Residential Whole Loans at Carrying Value
We have generally 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 the underlying borrowers have previously experienced
payment delinquencies and the amount owed on the mortgage loan 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. We believe 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 our 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 credit impaired loans, we 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 loans
basis for loans not aggregated into pools, we estimate 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 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.
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Residential Whole Loans at Fair Value
Certain of our residential whole loans are presented at fair value on our consolidated balance sheets as a result of a fair value
election made at 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, we consider 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. We determine the fair value of our 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 held at fair value on our consolidated
statements of operations.
Cash received reflecting coupon payments on residential whole loans held at fair value is not included in Interest Income,
but rather is presented in Net gain on residential whole loans held at fair value on our consolidated statements of operations. Cash
outflows associated with loan related advances made by us on behalf of the borrower are included in the basis of the loan and are
reflected in Net gain on residential whole loans held at fair value.
Hedging Activities
We may use a variety of derivative instruments to economically hedge a portion of our exposure to market risks, including
interest rate risk and prepayment risk. The objective of our risk management strategy is to reduce fluctuations in net book value
over a range of interest rate scenarios. In particular, we attempt to mitigate the risk of the cost of our variable rate liabilities
increasing during a period of rising interest rates. Our derivative instruments are currently comprised of Swaps, which are designated
as cash flow hedges against the interest rate risk associated with our borrowings.
Our Swaps designated as hedging transactions have the effect of modifying the repricing characteristics of our repurchase
agreements and cash flows for such liabilities. To date, no cost has been incurred at the inception of a Swap (except for certain
transaction fees related to entering into Swaps cleared though a central clearing house), pursuant to which we agree to pay a fixed
rate of interest and receive a variable interest rate, generally based on one-month or three-month LIBOR, on the notional amount
of the Swap. We document our risk-management policies, including objectives and strategies, as they relate to our hedging activities
and the relationship between the hedging instrument and the hedged liability for all Swaps designated as hedging transactions.
We assess, both at inception of a hedge and on a quarterly basis thereafter, whether or not the hedge is “highly effective.”
Swaps are carried on our 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 our 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 fair value of the Swap. Changes in the fair value of our Swaps designated in hedging transactions
are recorded in OCI provided that the hedge remains effective. Changes in fair value for any ineffective amount of a Swap are
recognized in earnings. We have not recognized any change in the value of our existing Swaps designated as hedges through
earnings as a result of hedge ineffectiveness.
We discontinue 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.
As of December 31, 2017, all of our Swaps have been novated to a central clearing house.
Income Taxes
We believe that we operate in, and intend to continue to operate in, a manner that allows and will continue to allow us to be
taxed as a REIT. Provided that we distribute all of our REIT taxable income (including net long-term capital gains) to stockholders
in the timeframe permitted by the Code, we do not generally expect to pay corporate level taxes and/or excise taxes. However,
such taxes may arise from time to time in the normal course of our business. Many of the REIT requirements, however, are highly
technical and complex. In addition, REIT taxable income calculated at the time our financial statements are prepared is based on
certain estimates that may be revised as our tax return, which is not required to be filed until October in the following year, is
66
completed. If we were to fail to meet certain of the REIT requirements, we would be subject to U.S. federal, state and local income
taxes.
In addition, we have elected to treat certain of our subsidiaries as a TRS. In general, a TRS may hold assets and engage in
activities that we cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business.
Generally, a TRS is subject to U.S. federal, state and local corporate income taxes. Since a portion of our business may be conducted
through one or more TRS, our income earned by TRS may be subject to corporate income taxation. To maintain our REIT election,
no more than 20% of the value of our 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, our 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 deferred tax benefit was recorded by us in 2017 or 2016, as a valuation allowance for
the full amount of the associated deferred tax asset was recognized as its recovery is not considered more likely than not.
Accounting for Equity-Based Compensation
We expense our equity-based compensation awards that are subject to vesting conditions, 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 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 us on January 1, 2017, we made a
policy election to account for forfeitures as they occur. (See Notes 2(m) and 13 to the consolidated financial statements, included
under Item 8 of this Annual Report on Form 10-K.)
From 2011 through 2013, we granted certain RSUs that vested annually over a one or three-year period, provided that certain
criteria were met, which were based on a formula tied to our achievement of average total stockholder return during that three-
year period. Starting in 2014, we have made annual grants of RSUs certain of which cliff vest after a three-year period and others
of which cliff vest after a three-year period, subject to the achievement of certain performance criteria based on a formula tied to
our achievement of average total stockholder return during that three-year period. The features in these awards related to the
attainment of total stockholder 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.
We have awarded dividend equivalents in connection with our equity-based awards. 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 do
not or are not expected to vest and grantees are not required to return payments of dividends or dividend equivalents to us.
RECENT ACCOUNTING STANDARDS TO BE ADOPTED IN FUTURE PERIODS
Derivatives and Hedging - Targeted Improvements to Accounting for Hedging Activities
In August 2017, the FASB issued Accounting Standards Update (or ASU) 2017-12, Targeted Improvements to Accounting
for Hedging Activities (or 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.
ASU 2017-12 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after
December 15, 2018. Early application is permitted in any interim period or fiscal year before the effective date. An entity should
apply the amendments of this ASU to cash flow and net investment hedge relationships that exist on the date of adoption using a
modified retrospective approach. The presentation and disclosure requirements of ASU 2017-12 should be applied prospectively.
In addition, certain transition elections may be made by an entity upon adoption to allow for existing hedging relationships to
transition to the newly allowable alternatives within this ASU. We are currently evaluating our adoption timing and the effect that
ASU 2017-12 will have on our consolidated financial statements and related disclosures, but do not anticipate that adoption of
the new standard would have a significant impact.
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Compensation - Stock Compensation - Scope of Modification Accounting
In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting (or ASU 2017-09). The amendments in
ASU 2017-09 provide guidance about which changes to the terms or conditions of a share-based payment award require an entity
to apply modification accounting. Pursuant to this ASU, an entity should account for the effects of a modification unless all of
the following are met: (1) the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used)
of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement
method is used) of the original award immediately before the original award is modified; (2) the vesting conditions of the modified
award are the same as the vesting conditions of the original award immediately before the original award is modified; and (3) the
classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original
award immediately before the original award date is modified. ASU 2017-09 is effective for all entities for annual periods, and
interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption
in any interim period for which financial statements have not yet been issued or made available for issuance. The amendments
of this ASU should be applied prospectively to an award modified on or after the adoption date. We adopted the ASU on January
1, 2018 and its adoption did not have a significant impact on our financial position or financial statement disclosures.
Statement of Cash Flows - Restricted Cash
In November 2016, the FASB issued ASU 2016-18, Restricted Cash (or ASU 2016-18). ASU 2016-18 clarifies how entities
should present restricted cash and restricted cash equivalents in the statement of cash flows with the objective of reducing the
existing diversity in practice. The amendments in ASU 2016-18 require restricted cash and restricted cash equivalents to be
included with cash and cash equivalents when reconciling the beginning-of-period and end-of period total amounts shown on the
statement of cash flows. ASU 2016-18 is effective for public business entities for fiscal years, and interim periods within those
fiscal years, beginning after December 15, 2017. Early application is permitted, provided that all of the amendments are adopted
in the same period. The amendments of this ASU should generally be applied using a retrospective transition method to each
period presented. We adopted ASU 2016-18 on January 1, 2018 and its adoption did not have a significant impact on our financial
position or financial statement disclosures.
Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments
In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments (or ASU
2016-15). The amendments in ASU 2016-15 provide guidance for eight specific cash flow classification issues, certain cash
receipts and cash payments on the statement of cash flows with the objective of reducing the existing diversity in practice. ASU
2016-15 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after
December 15, 2017. Early application is permitted, provided that all of the amendments are adopted in the same period. The
amendments of this ASU should generally be applied using a retrospective transition method to each period presented. We adopted
ASU 2016-15 on January 1, 2018 and its adoption did not have a significant impact on our financial position or financial statement
disclosures.
Financial Instruments - Credit Losses - Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued ASU 2016-13, Measurements of Credit Losses on Financial Instruments (or ASU 2016-13).
The amendments in ASU 2016-13 require entities to measure all expected credit losses for financial assets held at the reporting
date based on historical experience, current conditions and reasonable and supportable forecasts. Entities will now use forward-
looking information to better inform their credit loss estimates. ASU 2016-13 also requires enhanced financial statement disclosures
to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as
the credit quality and underwriting standards of an entity’s portfolio. Under ASU 2016-13 credit losses for available-for-sale debt
securities should be measured in a manner similar to current GAAP. However, the amendments in this ASU require that credit
losses be recorded through an allowance for credit losses, which will allow subsequent reversals in credit loss estimates to be
recognized in current income. In addition, the allowance on available-for-sale debt securities will be limited to the extent that the
fair value is less than the amortized cost.
ASU 2016-13 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning
after December 15, 2019. Early adoption is permitted for all entities for annual periods beginning after December 15, 2018, and
interim periods therein. The amendments in this ASU are required to be applied by recording a cumulative-effect adjustment to
equity as of the beginning of the first reporting period in which the guidance is effective. A prospective transition approach is
required for debt securities for which an OTTI had been recognized before the effective date. Based on our initial evaluation of
the amendments in this ASU, we anticipate being required to make changes to the way we account for credit impairment losses
on our available-for-sale debt securities. Under our current accounting, credit impairment losses are generally required to be
68
recorded as OTTI, which directly reduce the carrying amount of impaired securities, and are recorded in earnings and are not
reversed if expected cash flows subsequently recover. Under the new guidance, credit impairments on such securities will be
recorded as an allowance for credit losses that are also recorded in earnings, but the allowance can be reversed through earnings
in a subsequent period if expected cash flows subsequently recover. In addition, we expect that the new guidance will also result
in changes to the accounting and presentation of our residential whole loans held at carrying value. We currently anticipate that
upon adoption, the guidance will result in an increase in the gross carrying amount of our residential whole loans at carrying value
by the amount of the allowance for loan losses calculated under the new guidance. Thereafter, changes in the expected cash flows
of such assets are expected to result in the recognition (or reversal) of an allowance for loan losses that will impact earnings. We
will continue to monitor and evaluate the potential effects that ASU 2016-13 will have on our consolidated financial statements
and related disclosures.
Leases
In February 2016, the FASB issued ASU 2016-02, Leases (or 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. ASU 2016-02 is effective for public business entities for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2018. A modified retrospective transition approach is required for lessees
for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the
financial statements, with certain practical expedients available. Our significant lease contracts are discussed in Note 10(a) of the
accompanying consolidated financial statements included under Item 8 of this Annual Report on Form 10-K. While we continue
to evaluate the potential impact that adoption of ASU 2016-02 will have on our financial reporting, given the relatively limited
nature and extent of lease financing transactions that we have entered into, we do not expect that the adoption of ASU 2016-02
will have a significant impact on our financial position or financial statement disclosures.
Financial Instruments - Overall - Recognition and Measurement of Financial Assets and Financial Liabilities
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities
(or ASU 2016-01). The amendments in this ASU affect all entities that hold financial assets or owe financial liabilities, and address
certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The classification and
measurement guidance of investments in debt securities and loans are not affected by the amendments in this ASU. ASU 2016-01
is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December
15, 2017. Early adoption is not permitted for public business entities, except for a provision related to financial statements of
fiscal years or interim periods that have not yet been issued, to recognize in other comprehensive income, the change in fair value
of a liability resulting from a change in the instrument-specific credit risk measured using the fair value option. The amendments
in this ASU are required to be applied by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year
of adoption. We adopted the ASU on January 1, 2018 and its adoption did not have a significant impact on our financial position
or financial statement disclosures as the classification and measurement of our investments in debt securities and loans were not
affected by the amendments in this ASU.
Revenue from Contracts with Customers
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (or ASU 2014-09). The ASU requires
an entity to recognize revenue in an amount that reflects the consideration to which it expects to be entitled for the transfer of
promised goods or services to customers. ASU 2014-09 will replace most existing revenue recognition guidance in GAAP when
it becomes effective. ASU 2014-09 originally would have been effective for public business entities for annual periods, and interim
periods within those annual periods, beginning after December 15, 2016. Early application is not permitted. The standard permits
the use of either the retrospective or cumulative effect transition method. On April 29, 2015, the FASB proposed a one-year
deferral of the effective date for ASU 2014-09. On July 9, 2015 the FASB affirmed its proposal to defer the effective date of the
new revenue standard for all entities by one year. As a result, public entities would apply the new revenue standard to annual
reporting periods beginning after December 15, 2017 and interim periods therein. The FASB also permitted entities to adopt the
standard early, but not before the original public entity effective date. We adopted the ASU on January 1, 2018 and its adoption
did not have a material impact on our financial position or financial statement disclosures as the majority of our revenues are
generated by financial instruments that are explicitly scoped out of this ASU.
69
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of cash generally consist of borrowings under repurchase agreements and other collateralized financings,
payments of principal and interest we receive on our investment portfolio, cash generated from our operating results and, to the
extent such transactions are entered into, proceeds from capital market and structured financing transactions. Our most significant
uses of cash are generally to pay principal and interest on our financing transactions, to purchase residential mortgage assets, to
make dividend payments on our capital stock, to fund our operations and to make other investments that we consider appropriate.
We seek to employ a diverse capital raising strategy under which we may issue capital stock and other types of securities.
To the extent we raise additional funds through capital market transactions, we currently anticipate using the net proceeds from
such transactions to acquire additional residential mortgage-related assets, consistent with our investment policy, and for working
capital, which may include, among other things, the repayment of our financing transactions. There can be no assurance, however,
that we will be able to access the capital markets at any particular time or on any particular terms. We have available for issuance
an unlimited amount (subject to the terms and limitations of our charter) of common stock, preferred stock, depositary shares
representing preferred stock, warrants, debt securities, rights and/or units pursuant to our automatic shelf registration statement
and, at December 31, 2017, we had 12.0 million shares of common stock available for issuance pursuant to our DRSPP shelf
registration statement. During 2017, we issued 2,293,192 shares of common stock through our DRSPP, raising net proceeds of
approximately $18.5 million. On May 10, 2017, we closed on the sale of 23,000,000 shares of common stock, including 3,000,000
shares purchased pursuant to the exercise of the underwriters’ option to purchase additional shares, for gross proceeds of
approximately $178.7 million before deducting estimated offering expenses.
Our borrowings under repurchase agreements are uncommitted and renewable at the discretion of our lenders and, as such,
our lenders could determine to reduce or terminate our access to future borrowings at virtually any time. The terms of the repurchase
transaction borrowings under our master repurchase agreements, as such terms relate to repayment, margin requirements and the
segregation of all securities that are the subject of repurchase transactions, generally conform to the terms contained in the standard
master repurchase agreement published by the Securities Industry and Financial Markets Association (or SIFMA) or the global
master repurchase agreement published by SIFMA and the International Capital Market Association. In addition, each lender
typically requires that we include supplemental terms and conditions to the standard master repurchase agreement. Typical
supplemental terms and conditions, which differ by lender, may include changes to the margin maintenance requirements, required
haircuts (as defined below), purchase price maintenance requirements, requirements that all controversies related to the repurchase
agreement be litigated in a particular jurisdiction and cross default and setoff provisions.
With respect to margin maintenance requirements for repurchase agreements secured by harder to value assets, such as Non-
Agency MBS and residential whole loans, margin calls are typically determined by our counterparties based on their assessment
of changes in the fair value of the underlying collateral and in accordance with the agreed upon haircuts specified in the transaction
confirmation with the counterparty. We address margin call requests in accordance with the required terms specified in the
applicable repurchase agreement and such requests are typically satisfied by posting additional cash or collateral on the same
business day. We review margin calls made by counterparties and assess them for reasonableness by comparing the counterparty
valuation against our valuation determination. When we believe that a margin call is unnecessary because our assessment of
collateral value differs from the counterparty valuation, we typically hold discussions with the counterparty and are able to resolve
the matter. In the unlikely event that resolution cannot be reached, we will look to resolve the dispute based on the remedies
available to us under the terms of the repurchase agreement, which in some instances may include the engagement of a third party
to review collateral valuations. For other agreements that do not include such provisions, we could resolve the matter by substituting
collateral as permitted in accordance with the agreement or otherwise request the counterparty to return the collateral in exchange
for cash to unwind the financing.
70
The following table presents information regarding the margin requirements, or the percentage amount by which the collateral
value is contractually required to exceed the loan amount (this difference is referred to as the “haircut”), on our repurchase
agreements at December 31, 2017 and 2016:
At December 31, 2017
Repurchase agreement borrowings secured by:
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
U.S. Treasury securities
CRT securities
MSR related assets
Residential whole loans
At December 31, 2016
Repurchase agreement borrowings secured by:
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
U.S. Treasury securities
CRT securities
MSR related assets
Residential whole loans
Weighted
Average
Haircut
Low
High
4.65%
3.00%
8.00%
21.87
22.05
1.47
22.16
33.19
26.10
Weighted
Average
Haircut
15.00
20.00
1.00
15.00
30.00
20.00
35.00
27.50
2.00
25.00
50.00
35.00
Low
High
4.67%
3.00%
6.00%
24.01
20.98
1.60
23.22
41.40
25.03
15.00
15.00
1.00
20.00
35.00
20.00
60.00
30.00
2.00
25.00
50.00
35.00
Over the course of 2017, the weighted average haircut requirements for the respective underlying collateral types for our
repurchase agreements have remained fairly consistent compared to the end of 2016. Weighted average haircuts have decreased
on MSR related assets, Legacy Non-Agency MBS and CRT securities and have increased on Residential whole loans and RPL/
NPL MBS.
Repurchase agreement funding for our residential mortgage investments has been available to us at generally attractive market
terms from multiple counterparties. Typically, due to the risks inherent in credit sensitive residential mortgage investments,
repurchase agreement funding involving such investments is available at terms requiring higher collateralization and higher interest
rates, than repurchase agreement funding secured by Agency MBS and U.S. Treasury securities. Therefore, we generally expect
to be able to finance our acquisitions of Agency MBS on more favorable terms than financing for credit sensitive investments.
We maintain cash and cash equivalents, unpledged Agency and Non-Agency MBS and collateral in excess of margin
requirements held by our counterparties (or collectively, “cash and other unpledged collateral”) to meet routine margin calls and
protect against unforeseen reductions in our borrowing capabilities. Our ability to meet future margin calls will be impacted by
our ability to use cash or obtain financing from unpledged collateral, which can vary based on the market value of such collateral,
our cash position and margin requirements. Our cash position fluctuates based on the timing of our operating, investing and
financing activities and is managed based on our anticipated cash needs. (See “Interest Rate Risk” included under Item 7A. of
this Annual Report on Form 10-K and our Consolidated Statements of Cash Flows, included under Item 8 of this Annual Report
on Form 10-K.)
At December 31, 2017, we had a total of $8.1 billion of MBS, U.S. Treasury securities, CRT securities, residential whole
loans and MSR related assets and $13.3 million of restricted cash pledged against our repurchase agreements and Swaps. At
December 31, 2017 we have access to various sources of liquidity which we estimate exceeds $1.1 billion. This includes (i) $449.8
million of cash and cash equivalents; (ii) $170.2 million in estimated financing available from unpledged Agency MBS and other
Agency MBS collateral that is currently pledged in excess of contractual requirements; and (iii) $452.1 million in estimated
financing available from unpledged Non-Agency MBS and from other Non-Agency MBS and CRT collateral that is currently
pledged in excess of contractual requirements. Our sources of liquidity do not include restricted cash.
71
The table below presents certain information about our borrowings under repurchase agreements and other advances, and
securitized debt:
Quarter Ended (2)
(In Thousands)
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
December 31, 2015
September 30, 2015
June 30, 2015
March 31, 2015
Repurchase Agreements and Other Advances
Securitized Debt (1)
Quarterly
Average
Balance
End of Period
Balance
Maximum
Balance at Any
Month-End
Quarterly
Average
Balance
End of Period
Balance
Maximum
Balance at Any
Month-End
$ 6,661,020
$ 6,614,701
$ 6,760,360
$
212,445
$
363,944
$
363,944
7,022,913
7,612,393
8,494,853
8,684,803
8,868,173
9,102,457
9,238,772
9,428,211
9,422,882
9,720,193
9,820,548
6,871,443
7,040,844
8,137,102
8,687,268
8,697,756
9,038,087
9,143,645
9,387,622
9,475,834
9,635,035
9,809,587
7,023,702
7,763,860
8,564,493
8,815,846
8,917,550
9,114,859
9,205,547
9,413,189
9,486,357
9,746,825
9,863,779
139,276
30,414
137,327
143,698
141,088
143,698
—
—
—
8,520
18,425
28,009
50,691
80,343
103,218
—
—
—
—
11,821
21,868
31,940
61,965
90,842
—
—
—
8,568
18,247
27,686
49,941
80,331
103,827
(1) Securitized debt amounts presented for 2017 reflect our 2017 loan securitization transactions. Securitized debt amounts presented for 2016
and 2015 reflect our MBS resecuritization transactions.
(2) The information presented in the table above excludes Senior Notes issued in April 2012. The outstanding balance of Senior Notes has been
unchanged at $100.0 million since issuance.
Cash Flows and Liquidity for the Year Ended December 31, 2017
Our cash and cash equivalents increased by $189.6 million during the year ended December 31, 2017, reflecting: $1.8 billion
provided by our investing activities, primarily from payments on our MBS; $176.1 million provided by our operating activities;
and $1.8 billion used by our financing activities.
At December 31, 2017, our debt-to-equity multiple was 2.3 times compared to 3.1 times at December 31, 2016. At
December 31, 2017, we had borrowings under repurchase agreements of $6.6 billion with 31 counterparties, of which $2.5 billion
were secured by Agency MBS, $1.3 billion were secured by Legacy Non-Agency MBS, $567.1 million were secured by RPL/
NPL MBS, $470.3 million were secured by U.S. Treasuries, $459.1 million were secured by CRT securities, $317.3 million were
secured by MSR related assets and $1.0 billion were secured by residential whole loans. We continue to have available capacity
under our repurchase agreement credit lines. In addition, at December 31, 2017, we had securitized debt of $363.9 million in
connection with our 2017 loan securitization transactions. At December 31, 2016, we had borrowings under repurchase agreements
of $8.5 billion with 31 counterparties, of which $3.1 billion were secured by Agency MBS, $1.7 billion were secured by Legacy
Non-Agency MBS, $1.9 billion were secured by RPL/NPL MBS, $504.6 million were secured by U.S. Treasuries, $271.2 million
were secured by CRT securities, $135.1 million were secured by MSR related assets and $832.1 million were secured by residential
whole loans. In addition, at December 31, 2016, we had $215.0 million in outstanding FHLB advances, secured by Agency MBS,
all of which were repaid in January 2017.
During 2017, $1.8 billion was provided through our investing activities. We received cash of $4.0 billion from prepayments
and scheduled amortization on our MBS, CRT securities and MSR related assets of which $855.3 million was attributable to
Agency MBS, $3.0 billion was from Non-Agency MBS, $17.4 million was from CRT securities and $141.0 million was attributable
to MSR related assets. We purchased $787.4 million of Non-Agency MBS, $238.8 million of CRT securities, $405.6 million of
MSR related assets and $12.0 million of Agency MBS funded with cash and repurchase agreement borrowings. While we generally
intend to hold our MBS as long-term investments, we may sell certain of our securities in order to manage our interest rate risk
72
and liquidity needs, meet other operating objectives and adapt to market conditions. In addition, during 2017 we sold certain of
our Non-Agency MBS and U.S. Treasury securities for $243.1 million, realizing net gains of $39.6 million.
In connection with our repurchase agreement borrowings and Swaps, we routinely receive margin calls/reverse margin calls
from our counterparties and make margin calls to our counterparties. Margin calls and reverse margin calls, which requirements
vary over time, may occur daily between us and any of our counterparties when the value of collateral pledged changes from the
amount contractually required. The value of securities pledged as collateral fluctuates reflecting changes in: (i) the face (or par)
value of our MBS; (ii) market interest rates and/or other market conditions; and (iii) the market value of our Swaps. Margin calls/
reverse margin calls are satisfied when we pledge/receive additional collateral in the form of additional securities and/or cash.
The table below summarizes our margin activity with respect to our repurchase agreement financings and derivative hedging
instruments for the quarterly periods presented:
For the Quarter Ended
(In Thousands)
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
Collateral Pledged to Meet Margin Calls
Fair Value of
Securities
Pledged
Cash Pledged
Aggregate
Assets Pledged
For Margin
Calls
Cash and
Securities
Received For
Reverse
Margin Calls
Net Assets
Received/
(Pledged) For
Margin Activity
$
87,960
$
— $
87,960
$
80,105
$
83,513
106,432
150,264
—
500
1,500
83,513
106,932
151,764
53,499
75,996
246,168
(7,855)
(30,014)
(30,936)
94,404
We are subject to various financial covenants under our repurchase agreements and derivative contracts, which include
minimum net worth and/or profitability requirements, maximum debt-to-equity ratios and minimum market capitalization
requirements. We have maintained compliance with all of our financial covenants through December 31, 2017.
During 2017, we paid $308.6 million for cash dividends on our common stock and dividend equivalents and paid cash
dividends of $15.0 million on our preferred stock. On December 13, 2017, we declared our fourth quarter 2017 dividend on our
common stock of $0.20 per share; on January 31, 2018, we paid this dividend, which totaled $79.8 million, including dividend
equivalents of approximately $205,000.
We believe that we have adequate financial resources to meet our current obligations, including margin calls, as they come
due, to fund dividends we declare and to actively pursue our investment strategies. However, should the value of our MBS suddenly
decrease, significant margin calls on our repurchase agreement borrowings could result and our liquidity position could be materially
and adversely affected. Further, should market liquidity tighten, our repurchase agreement counterparties may increase our margin
requirements on new financings, reducing our ability to use leverage. Access to financing may also be negatively impacted by
the ongoing volatility in the world financial markets, potentially adversely impacting our current or potential lenders’ ability or
willingness to provide us with financing. In addition, there is no assurance that favorable market conditions will continue to permit
us to consummate additional securitization transactions if we determine to seek that form of financing.
OFF-BALANCE SHEET ARRANGEMENTS
We have not participated in transactions that create relationships with unconsolidated entities or financial partnerships which
would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited
purposes.
73
AGGREGATE CONTRACTUAL OBLIGATIONS
The following table summarizes the effect on our liquidity and cash flows in future periods related to principal and interest
owed on contractual financing obligations:
(In Thousands)
Repurchase agreements
Interest expense on repurchase agreements (1)
Securitized debt (2)
Interest expense on securitized debt (1)
Senior Notes (3)
Interest expense on Senior Notes (1)
Long-term lease obligations
2018
2019
2020
2021
2022
Thereafter
Total
Due During the Year Ending December 31,
$ 6,614,907
$
38,566
23,217
11,312
—
8,000
2,553
— $
—
— $
—
— $
—
— $
—
164,990
115,878
8,305
—
8,000
2,553
3,658
—
8,000
1,082
23,333
1,570
—
8,000
32
20,454
988
—
8,000
—
— $
6,614,907
—
18,413
360
100,000
155,911
—
38,566
366,285
26,193
100,000
195,911
6,220
Total
$ 6,698,555
$
183,848
$
128,618
$
32,935
$
29,442
$
274,684
$
7,348,082
(1) Interest expense based on the interest rate in effect at December 31, 2017.
(2) Securitized debt is contractually scheduled to mature by 2057. However, the weighted average life of the securitized debt is estimated to be 2.28 years.
(3) Senior Notes mature April 2042 but may be redeemed, in whole or in part, at any time on or after April 15, 2017. Excludes debt issuance costs of $3.2 million.
Substantially all of our assets and liabilities are financial in nature. As a result, changes in interest rates and other factors
impact our performance far more than does inflation. Our results of operations and reported assets, liabilities and equity are
measured with reference to historical cost or fair value without considering inflation.
INFLATION
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We seek to manage our risks related to interest rates, liquidity, prepayment speeds, market value and the credit quality of our
assets while, at the same time, seeking to provide an opportunity to stockholders to realize attractive total returns through ownership
of our capital stock. While we do not seek to avoid risk, we seek, consistent with our investment policies, to: assume risk that
can be quantified based on management’s judgment and experience and actively manage such risk; earn sufficient returns to justify
the taking of such risks; and maintain capital levels consistent with the risks that we undertake.
INTEREST RATE RISK
We generally acquire interest-rate sensitive assets and fund them with interest-rate sensitive liabilities, a portion of which
are hedged with Swaps. We are exposed to interest rate risk on our residential mortgage assets, as well as on our liabilities. Changes
in interest rates can affect our net interest income and the fair value of our assets and liabilities.
We finance the majority of our investments in residential mortgage assets with short-term repurchase agreements. In general,
when interest rates change, the borrowing costs of our repurchase agreements (net of the impact of Swaps) change more quickly
than the yield on our assets. In a rising interest rate environment the borrowing costs of our repurchase agreements may increase
faster than the interest income on our assets, thereby reducing our net income. In order to mitigate compression in net income
based on such interest rate movements, we use Swaps to lock in a portion of the net interest spread between assets and liabilities.
When interest rates change, the fair value of our residential mortgage assets could change at a different rate than the fair
value of our liabilities. We measure the sensitivity of our portfolio to changes in interest rates by estimating the duration of our
assets and liabilities. Duration is the approximate percentage change in fair value for a 100 basis point parallel shift in the yield
curve. In general, our assets have higher duration than our liabilities and in order to reduce this exposure we use Swaps to reduce
the gap in duration between our assets and liabilities.
In calculating the duration of our Agency MBS we take into account the characteristics of the underlying mortgage loans
including whether the underlying loans are fixed rate, adjustable or hybrid; coupon, expected prepayment rates and lifetime and
periodic caps. We use third-party financial models, combined with management’s assumptions and observed empirical data when
estimating the duration of our Agency MBS.
74
In analyzing the interest rate sensitivity of our Legacy Non-Agency MBS we take into account the characteristics of the
underlying mortgage loans, including credit quality and whether the underlying loans are fixed-rate, adjustable or hybrid. We
estimate the duration of our Legacy Non-Agency MBS using management’s assumptions.
The majority of our RPL/NPL MBS deal structures contain a contractual coupon step-up feature where the coupon increases
up to 300 basis points at 36 months from issuance or sooner. Therefore, we believe their fair value exhibits little sensitivity to
changes in interest rates. We estimate the duration of these securities using management’s assumptions.
The fair value of our re-performing residential whole loans is dependent on the value of the underlying real estate collateral,
past and expected delinquency status of the borrower as well as the level of interest rates. Because the borrower is not delinquent
on their mortgage payments but is less likely to prepay the loan due to weak credit history and/or high LTV, we believe our re-
performing residential whole loans exhibit positive duration. We estimate the duration of our re-performing residential whole loans
using management’s assumptions.
The fair value of our non-performing residential whole loans is primarily dependent on the value of the underlying real estate
collateral and the time required for collateral liquidation. Since neither the value of the collateral nor the liquidation timeline is
generally sensitive to interest rates, we believe their fair value exhibits little sensitivity to interest rates. We estimate the duration
of our non-performing residential whole loans using management’s assumptions.
We use Swaps as part of our overall interest rate risk management strategy. Such derivative financial instruments are intended
to act as a hedge against future interest rate increases on our repurchase agreement financings, which rates are typically highly
correlated with LIBOR. While our derivatives do not extend the maturities of our borrowings under repurchase agreements, they
do, in effect, lock in a fixed rate of interest over their term for a corresponding amount of our repurchase agreement financings
that are hedged.
75
At December 31, 2017, MFA’s $5.4 billion of Agency MBS and Legacy Non-Agency MBS were backed by Hybrid, adjustable
and fixed-rate mortgages. Additional information about these MBS, including average months to reset and three-month average
CPR, is presented below:
Agency MBS
Legacy Non-Agency MBS (1)
Total (1)
Time to Reset
Fair Value (2)
(Dollars in Thousands)
< 2 years (5)
$
1,483,445
2-5 years
> 5 years
ARM-MBS Total
15-year fixed (6)
30-year fixed (6)
40-year fixed (6)
Fixed-Rate Total
MBS Total
152,135
44,627
1,680,207
1,142,583
—
—
1,142,583
2,822,790
$
$
$
$
Average
Months to
Reset (3)
3 Month
Average
CPR (4)
Fair Value
Average
Months to
Reset (3)
3 Month
Average
CPR (4)
Fair Value (2)
Average
Months to
Reset (3)
3 Month
Average
CPR (4)
7
45
70
12
17.4% $
1,727,453
12.3
9.9
—
—
16.8% $
1,727,453
10.2% $
2,969
—
—
841,344
39,089
10.2% $
883,402
14.1% $
2,610,855
5
—
—
5
16.5% $
3,210,898
—
—
152,135
44,627
16.5% $
3,407,660
2.8% $
1,145,552
15.9
14.2
841,344
39,089
15.8% $
2,025,985
16.3% $
5,433,645
6
45
70
8
16.9%
12.3
9.9
16.7%
10.2%
15.9
14.2
12.7%
15.2%
(1) Excludes $923.1 million of RPL/NPL MBS. Refer to table below for further information.
(2) Does not include principal payments receivable of $1.9 million.
(3) Months to reset is the number of months remaining before the coupon interest rate resets. At reset, the MBS coupon will adjust based upon the underlying
benchmark interest rate index, margin and periodic and/or lifetime caps. The months to reset do not reflect scheduled amortization or prepayments.
(4) 3 month average CPR weighted by positions as of the beginning of each month in the quarter.
(5) Includes floating-rate MBS that may be collateralized by fixed-rate mortgages.
(6) Information presented based on data available at time of loan origination.
The following table presents certain information about our RPL/NPL MBS portfolio at December 31, 2017:
(Dollars in Thousands)
Re-Performing loans
Non-Performing loans
Total RPL/NPL MBS
Fair Value
Net Coupon
Months to
Step-Up (1)
3 Month
Average
Bond CPR (2)
$
$
78,046
845,065
923,111
3.64%
4.39
4.32%
29
21
22
22.2%
20.0
20.1%
(1) Months to step-up is the weighted average number of months remaining before the coupon interest rate increases pursuant to the first coupon
reset. We anticipate that the securities will be redeemed prior to the step-up date.
(2) All principal payments are considered to be prepayments for CPR purposes.
At December 31, 2017, our CRT securities and MSR related assets had a fair value of $664.4 million and $492.1 million,
respectively, and their coupons reset monthly based on one-month LIBOR.
76
Shock Table
The information presented in the following “Shock Tables” projects the potential impact of sudden parallel changes in interest
rates on our net interest income and portfolio value, including the impact of Swaps, over the next 12 months based on the assets
in our investment portfolio at December 31, 2017 and 2016. All changes in income and value are measured as the percentage
change from the projected net interest income and portfolio value under the base interest rate scenario at December 31, 2017 and
2016.
December 31, 2017
Change in Interest Rates
(Dollars in Thousands)
+100 Basis Point Increase
+ 50 Basis Point Increase
Actual at December 31, 2017
- 50 Basis Point Decrease
-100 Basis Point Decrease
Change in Interest Rates
(Dollars in Thousands)
+100 Basis Point Increase
+ 50 Basis Point Increase
Actual at December 31, 2016
- 50 Basis Point Decrease
-100 Basis Point Decrease
$
$
$
$
$
$
$
$
$
$
Estimated
Value
of Assets (1)
Estimated
Value of Swaps
Estimated
Value of
Financial
Instruments
Change in
Estimated Value
Percentage
Change in Net
Interest
Income
Percentage
Change in
Portfolio
Value
10,293,874
10,370,948
10,445,764
10,518,322
10,588,622
$
$
$
$
$
40,938
14,757
$
$
10,334,812
10,385,705
(11,424) $
10,434,340
(37,606) $
10,480,716
(63,787) $
10,524,835
$
$
$
$
$
(99,528)
(48,635)
—
46,376
90,495
(2.83)%
(1.53)%
—
(1.33)%
(1.61)%
(0.95)%
(0.47)%
—
0.44 %
0.87 %
December 31, 2016
Estimated
Value
of Assets (1)
Estimated
Value of Swaps
Estimated
Value of
Financial
Instruments
Change in
Estimated Value
Percentage
Change in Net
Interest
Income
Percentage
Change in
Portfolio
Value
11,724,000
11,809,837
11,891,751
11,969,743
12,043,812
$
$
$
$
$
29,484
$
11,753,484
(8,618) $
11,801,219
(46,721) $
11,845,030
(84,823) $
11,884,920
(122,925) $
11,920,887
$
$
$
$
$
(91,546)
(43,811)
—
39,890
75,857
(8.94)%
(4.48)%
—
1.24 %
(1.27)%
(0.77)%
(0.37)%
—
0.34 %
0.64 %
(1) Such assets include MBS and CRT securities, residential whole loans and REO, MSR related assets, cash and cash equivalents and restricted cash.
Certain assumptions have been made in connection with the calculation of the information set forth in the Shock Table and,
as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes.
The base interest rate scenario assumes interest rates at December 31, 2017 and 2016. The analysis presented utilizes assumptions
and estimates based on management’s judgment and experience. Furthermore, while we generally expect to retain the majority
of our assets and the associated interest rate risk to maturity, future purchases and sales of assets could materially change our
interest rate risk profile. It should be specifically noted that the information set forth in the above table and all related disclosure
constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (or 1933 Act)
and Section 21E of the 1934 Act. Actual results could differ significantly from those estimated in the Shock Table above.
The Shock Table quantifies the potential changes in net interest income and portfolio value, which includes the value of our
Swaps (which are carried at fair value), should interest rates immediately change (i.e., are shocked). The Shock Table presents
the estimated impact of interest rates instantaneously rising 50 and 100 basis points, and falling 50 and 100 basis points. The cash
flows associated with our portfolio of MBS for each rate shock are calculated based on assumptions, including, but not limited
to, prepayment speeds, yield on replacement assets, the slope of the yield curve and composition of our portfolio. Assumptions
made with respect to the interest rate sensitive liabilities include anticipated interest rates, collateral requirements as a percent of
repurchase agreement financings, and the amounts and terms of borrowing. At December 31, 2017 and 2016, we applied a floor
of 0% for all anticipated interest rates included in our assumptions. Due to this floor, it is anticipated that any hypothetical interest
rate shock decrease would have a limited positive impact on our funding costs; however, because prepayments speeds are unaffected
by this floor, it is expected that any increase in our prepayment speeds (occurring as a result of any interest rate shock decrease
or otherwise) could result in an acceleration of premium amortization on our Agency MBS and discount accretion on our Non-
Agency MBS and in the reinvestment of principal repayments in lower yielding assets. As a result, because the presence of this
floor limits the positive impact of interest rate decrease on our funding costs, hypothetical interest rate shock decreases could
cause a decline in the fair value of our financial instruments and our net interest income.
77
At December 31, 2017, the impact on portfolio value was approximated using estimated net effective duration (i.e., the price
sensitivity to changes in interest rates), including the effect of Swaps, of 0.91, which is the weighted average of 1.72 for our Agency
MBS, 1.41 for our Non-Agency investments, (2.06) for our Swaps, and 0.06 for our Other assets and cash and cash equivalents.
Estimated convexity (i.e., the approximate change in duration relative to the change in interest rates) of the portfolio was (0.09),
which is the weighted average of (0.32) for our Agency MBS, zero for our Swaps, zero for our Non-Agency MBS, and zero for
our Other assets and cash and cash equivalents. At December 31, 2016, the impact on portfolio value was approximated using
estimated net effective duration (i.e., the price sensitivity to changes in interest rates), including the effect of Swaps, of 0.71 which
is the weighted average of 1.84 for our Agency MBS, 1.19 for our Non-Agency investments, (2.67) for our Swaps and 0.05 for
our Other assets and cash and cash equivalents. Estimated convexity (i.e., the approximate change in duration relative to the change
in interest rates) of the portfolio was (0.13), which is the weighted average of (0.42) for our Agency MBS, zero for our Swaps,
zero for our Non-Agency MBS and zero for our Other assets and cash and cash equivalents. The impact on our net interest income
is driven mainly by the difference between portfolio yield and cost of funding of our repurchase agreements, which includes the
cost and/or benefit from Swaps. Our asset/liability structure is generally such that an increase in interest rates would be expected
to result in a decrease in net interest income, as our borrowings are generally shorter in term than our interest-earning assets. When
interest rates are shocked, prepayment assumptions are adjusted based on management’s expectations along with the results from
the prepayment model.
CREDIT RISK
Although we do not believe that we are exposed to credit risk in our Agency MBS portfolio, we are exposed to credit risk
through our credit sensitive residential mortgage investments, in particular Legacy Non-Agency MBS and residential whole loans
and to a lesser extent our investments in RPL/NPL MBS, CRT securities and MSR related assets. Our exposure to credit risk from
our credit sensitive investments is discussed in more detail below:
Legacy Non-Agency MBS
In the event of the return of less than 100% of par on our Legacy Non-Agency MBS, credit support contained in the MBS
deal structures and the discounted purchase prices we paid mitigate our risk of loss on these investments. Over time, we expect
the level of credit support remaining in certain MBS deal structures to decrease, which will result in an increase in the amount of
realized credit loss experienced by our Legacy Non-Agency MBS portfolio. Our investment process for Legacy Non-Agency
MBS involves analysis focused primarily on quantifying and pricing credit risk. When we purchase Legacy Non-Agency MBS,
we assign certain assumptions to each of the MBS, including but not limited to, future interest rates, voluntary prepayment rates,
mortgage modifications, default rates and loss severities, and generally allocate a portion of the purchase discount as a Credit
Reserve which provides credit protection for such securities. As part of our surveillance process, we review our Legacy Non-
Agency MBS by tracking their actual performance compared to the securities’ expected performance at purchase or, if we have
modified our original purchase assumptions, compared to our revised performance expectations. To the extent that actual
performance of a Legacy Non-Agency MBS is less favorable than its expected performance, we may revise our performance
expectations. As a result, we could reduce the accretable discount on the security and/or recognize an other-than-temporary
impairment through earnings, either of which could have a material adverse impact on our operating results.
In evaluating our asset/liability management and Legacy Non-Agency MBS credit performance, we consider the credit
characteristics of the mortgage loans underlying our Legacy Non-Agency MBS. The following table presents certain information
about our Legacy Non-Agency MBS portfolio at December 31, 2017. Information presented with respect to the weighted average
Fair Isaac Corporation (or FICO) scores and other information aggregated based on information reported at the time of mortgage
origination are historical and, as such, do not reflect the impact of the general changes in home prices or changes in borrowers’
credit scores or the current use of the mortgaged properties.
78
The information in the table below is presented as of December 31, 2017:
Year of Securitization (2)
2007
2006
2005
and Prior
2007
2006
2005
and Prior
Total
Securities with Average Loan FICO
of 715 or Higher (1)
Securities with Average Loan FICO
Below 715 (1)
(Dollars in Thousands)
Number of securities
MBS current face (3)
$ 781,840
$
471,127
Total purchase discounts, net (3)
$ (226,545)
$ (133,910)
Purchase discount designated as
Credit Reserve and OTTI (3)(4)
$ (161,493)
$
(68,011)
85
65
86
32
55
62
385
$
$
$
$
$
526,807
$ 170,453
$ 426,474
$ 420,001
$ 2,796,702
(98,813)
$ (56,032)
$ (164,262)
$ (126,978)
$ (806,540)
(55,300)
$ (47,030)
$ (159,127)
$ (102,266)
$ (593,227)
10.5%
27.6%
37.3%
24.3%
21.2%
427,994
509,931
$ 114,421
$ 262,212
$ 293,023
$ 1,990,162
$ 156,556
$ 375,791
$ 394,596
$ 2,610,855
20.7%
14.4%
$ 555,295
$ 731,297
$
$
337,217
442,684
Purchase discount designated as
Credit Reserve and OTTI as
percentage of current face
MBS amortized cost (3)
MBS fair value (3)
Weighted average fair value to
current face
Weighted average coupon (5)
Weighted average loan age
(months) (5)(6)
Weighted average current loan
size (5)(6)
Percentage amortizing (7)
Weighted average FICO score at
origination (5)(8)
Owner-occupied loans
Rate-term refinancings
Cash-out refinancings
3 Month CPR (6)
3 Month CRR (6)(9)
3 Month CDR (6)(9)
3 Month loss severity
60+ days delinquent (8)
Percentage of always current
borrowers (Lifetime) (10)
Percentage of always current
borrowers (12M) (11)
Weighted average credit
enhancement (8)(12)
93.5%
4.18%
94.0%
3.58%
96.8%
3.76%
91.8%
5.00%
88.1%
5.03%
94.0%
4.78%
129
138
152
134
139
151
$
502
$
491
$
297
$
335
$
246
$
235
$
100%
729
91.0%
30.5%
34.8%
18.9%
16.3%
3.2%
56.5%
13.3%
99%
100%
99%
99%
100%
728
91.2%
22.0%
35.5%
16.0%
13.6%
3.1%
33.1%
11.6%
726
86.0%
14.9%
27.8%
18.3%
15.4%
3.5%
39.5%
9.1%
706
85.0%
21.9%
44.8%
15.0%
11.5%
4.0%
60.3%
16.2%
702
86.3%
15.4%
45.2%
14.0%
11.0%
3.5%
64.4%
15.6%
704
85.0%
14.6%
39.9%
15.8%
13.6%
2.6%
51.5%
13.8%
30.6%
31.3%
38.6%
26.6%
22.6%
27.8%
74.1%
76.1%
78.6%
68.6%
67.7%
70.6%
0.2%
0.2%
4.7%
0.0%
1.3%
2.8%
93.4%
4.27%
140
372
100%
719
88.1%
20.9%
36.6%
16.9%
14.1%
3.3%
50.3%
12.8%
30.3%
73.5%
1.6%
(1) FICO score is used by major credit bureaus to indicate a borrower’s creditworthiness at time of loan origination.
(2)
Information presented based on the initial year of securitization of the underlying collateral. Certain of our Non-Agency MBS have been resecuritized.
The historical information presented in the table is based on the initial securitization date and data available at the time of original securitization
(and not the date of resecuritization). No information has been updated with respect to any MBS that have been resecuritized.
(3) Excludes Non-Agency MBS issued since 2012 in which the underlying collateral consists of RPL/NPL MBS. These Non-Agency MBS have a current
face of $922.0 million amortized cost of $920.1 million, fair value of $923.1 million and purchase discounts of $2.0 million at December 31, 2017.
Information provided is based on loans for individual groups owned by us.
(4) Purchase discounts designated as Credit Reserve and OTTI are not expected to be accreted into interest income.
(5) Weighted average is based on MBS current face at December 31, 2017.
(6)
(7) Percentage of face amount for which the original mortgage note contractually calls for principal amortization in the current period.
(8)
(9) CRR represents voluntary prepayments and CDR represents involuntary prepayments.
(10) Percentage of face amount of loans for which the borrower has not been delinquent since origination.
(11) Percentage of face amount of loans for which the borrower has not been delinquent in the last twelve months.
(12) Credit enhancement for a particular security is expressed as a percentage of all outstanding mortgage loan collateral. A particular security will
Information provided is based on loans for all groups that provide credit enhancement for MBS with credit enhancement.
not be subject to principal loss as long as its credit enhancement is greater than zero.
79
The mortgages securing our Legacy Non-Agency MBS are located in many geographic regions across the United States.
The following table presents the five largest geographic concentrations by state of the mortgages collateralizing our Legacy Non-
Agency MBS at December 31, 2017:
Property Location
California
Florida
New York
New Jersey
Maryland
RPL/NPL MBS
Percent of Unpaid
Principal Balance
42.4%
8.1%
6.8%
4.0%
3.9%
These securities are backed by re-performing and non-performing loans, were purchased primarily at prices around par and
represent the senior and mezzanine tranches of the related securitizations. The majority of these securities are structured with
significant credit enhancement (typically approximately 50%) and the subordinate tranches absorb all credit losses (until those
tranches are extinguished) and typically receive no cash flow (interest or principal) until the senior tranche is paid off. Prior to
purchase, we analyze the deal structure in order to assess the associated credit risk. Subsequent to purchase, the ongoing credit
risk associated with the deal is evaluated by analyzing the extent to which actual credit losses occur that result in a reduction in
the amount of subordination enjoyed by our bond.
CRT Securities
We are exposed to potential credit losses from our investments in CRT securities issued by Fannie Mae and Freddie Mac.
While CRT securities are debt obligations of these GSEs, payment of principal on these securities is not guaranteed. As an investor
in a CRT security, we may incur a loss if losses on the mortgage loans in the reference pool exceed the credit enhancement on the
underlying CRT security owned by us. We assess the credit risk associated with our investments in CRT securities by assessing
the current and expected future performance of the associated reference pool.
MSR Related Assets
Term Notes
We have invested in certain term notes that are issued by special purpose vehicles (or 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 by us 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. In addition, 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.
Corporate Loan
We have entered into a loan agreement with an entity that originates loans and owns MSRs. We assess the credit risk associated
with this loan by considering various factors, including the current status of the loan, changes in fair value of the MSRs that secure
the loan and the recent financial performance of the borrower.
Residential Whole Loans
We are also exposed to credit risk from our investments in residential whole loans. Our investment process for residential
whole loans is generally similar to that used for Legacy Non-Agency MBS and is likewise focused on quantifying and pricing
credit risk. Consequently, these loans are acquired at purchase prices that are generally discounted (often substantially) to the
contractual loan balances based on a number of factors, including the impaired credit history of the borrower and the value of the
collateral securing the loan. In addition, as we generally own the master-servicing rights associated with loans in our portfolio,
our process is also focused on selecting a sub-servicer with the appropriate expertise to mitigate losses and maximize our overall
80
return. This involves, among other things, performing due diligence on the sub-servicer prior to their engagement as well as
ongoing oversight and surveillance. To the extent that loan delinquencies and defaults are higher than our expectation at the time
the loans were purchased, the discounted purchase price at which the asset is acquired is intended to provide a level of protection
against financial loss.
The following table presents the five largest geographic concentrations by state of our residential whole loan portfolio at
December 31, 2017:
Property Location
California
New York
Florida
New Jersey
Maryland
Percent of Interest-Bearing
Unpaid Principal Balance
20.4%
14.9%
9.0%
7.9%
4.7%
LIQUIDITY RISK
The primary liquidity risk we face arises from financing long-maturity assets with shorter-term borrowings primarily in the
form of repurchase agreement financings. We pledge residential mortgage assets and cash to secure our repurchase agreements
and Swaps. At December 31, 2017, we had access to various sources of liquidity which we estimate to be in excess of $1.1 billion,
an amount which includes (i) $449.8 million of cash and cash equivalents; (ii) $170.2 million in estimated financing available
from unpledged Agency MBS and other Agency MBS collateral that are currently pledged in excess of contractual requirements;
and (iii) $452.1 million in estimated financing available from currently unpledged Non-Agency MBS and from other Non-Agency
MBS and CRT collateral that is currently pledged in excess of contractual requirements. Our sources of liquidity do not include
restricted cash. Should the value of our residential mortgage assets pledged as collateral suddenly decrease, margin calls under
our repurchase agreements would likely increase, causing an adverse change in our liquidity position. Additionally, if one or more
of our financing counterparties chose not to provide ongoing funding, our ability to finance our long-maturity assets would decline
or be available on possibly less advantageous terms. As such, we cannot assure you that we will always be able to roll over our
repurchase agreement financings and other advances. Further, should market liquidity tighten, our repurchase agreement
counterparties may increase our margin requirements on new financings, including repurchase agreement borrowings that we roll
with the same counterparty, reducing our ability to use leverage.
PREPAYMENT RISK
Premiums arise when we acquire a MBS at a price in excess of the aggregate principal balance of the mortgages securing
the MBS (i.e., par value). Conversely, discounts arise when we acquire an MBS at a price below the aggregate principal balance
of the mortgages securing the MBS or when we acquire residential whole loans at a price below their aggregate principal balance.
Premiums paid on our MBS are amortized against interest income and accretable purchase discounts on these investments are
accreted to interest income. Purchase premiums, which are primarily carried on our Agency MBS and certain CRT securities, are
amortized against interest income over the life of each security using the effective yield method, adjusted for actual prepayment
activity. An increase in the prepayment rate, as measured by the CPR, will typically accelerate the amortization of purchase
premiums, thereby reducing the IRR/interest income earned on these assets. Generally, if prepayments on Non-Agency MBS and
residential whole loans purchased at significant discounts and not accounted for at fair value are less than anticipated, we expect
that the income recognized on these assets will be reduced and impairments and/or loan loss reserves may result.
81
Item 8. Financial Statements and Supplementary Data.
Index to Financial Statements and Schedule
Report of Independent Registered Public Accounting Firm
Financial Statements:
Consolidated Balance Sheets at December 31, 2017 and December 31, 2016
Consolidated Statements of Operations for the years ended December 31, 2017, 2016 and 2015
Consolidated Statements of Comprehensive Income/(Loss) for the years ended December 31, 2017, 2016 and 2015
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2017, 2016 and 2015
Consolidated Statements of Cash Flows for the years ended December 31, 2017, 2016 and 2015
Notes to the Consolidated Financial Statements
Schedule IV - Mortgage Loans on Real Estate
All other financial statement schedules are omitted because the required information is not applicable or deemed not
material, or the required information is included in the consolidated financial statements and/or notes thereto.
Page
83
84
85
86
87
89
91
142
82
Report of Independent Registered Public Accounting Firm
To the stockholders and board of directors
MFA Financial, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of MFA Financial, Inc. and subsidiaries (the “Company”) as of
December 31, 2017 and 2016, the related consolidated statements of operations, comprehensive income/(loss), changes in
stockholders’ equity, and cash flows for each of the years in the three year period ended December 31, 2017, and the related
notes and Schedule IV - Mortgage Loans on Real Estate (collectively, the “consolidated financial statements”). In our opinion,
the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of
December 31, 2017 and 2016, and the results of their operations and their cash flows for each of the years in the three year
period ended December 31, 2017, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in
Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission, and our report dated February 15, 2018 expressed an unqualified opinion on the effectiveness of the Company’s
internal control over financial reporting.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the
PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws
and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement,
whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the
consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such
procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by management,
as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a
reasonable basis for our opinion.
/s/ KPMG LLP
We have served as the Company’s auditor since 2011.
New York, New York
February 15, 2018
83
MFA FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Per Share Amounts)
Assets:
Mortgage-backed securities (“MBS”) and credit risk transfer (“CRT”) securities:
December 31,
2017
December 31,
2016
Agency MBS, at fair value ($2,727,510 and $3,540,401 pledged as collateral, respectively)
$
2,824,681
$
3,738,497
Non-Agency MBS, at fair value ($2,379,523 and $4,751,419 pledged as collateral, respectively) (1)
CRT securities, at fair value ($595,900 and $357,488 pledged as collateral, respectively)
Mortgage servicing rights (“MSR”) related assets ($482,158 and $226,780 pledged as collateral, respectively)
Residential whole loans, at carrying value ($448,689 and $427,880 pledged as collateral, respectively) (2)
Residential whole loans, at fair value ($996,226 and $734,331 pledged as collateral, respectively) (2)
Securities obtained and pledged as collateral, at fair value
Cash and cash equivalents
Restricted cash
Other assets
Total Assets
Liabilities:
Repurchase agreements and other advances
Obligation to return securities obtained as collateral, at fair value
Other liabilities
Total Liabilities
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)
Common stock, $.01 par value; 886,950 shares authorized; 397,831 and 371,854 shares issued
and outstanding, respectively
Additional paid-in capital, in excess of par
Accumulated deficit
Accumulated other comprehensive income
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
3,533,966
664,403
492,080
908,516
1,325,115
5,684,836
404,850
226,780
590,540
814,682
504,062
449,757
13,307
238,847
$ 10,954,734
510,767
260,112
58,463
194,495
$ 12,484,022
$
$
$
6,614,701
504,062
574,335
7,693,098
$
$
8,687,268
510,767
252,085
9,450,120
80
$
80
3,978
3,227,304
(578,950)
609,224
3,261,636
$
$ 10,954,734
3,719
3,029,062
(572,641)
573,682
3,033,902
$
$ 12,484,022
(1) Includes approximately $174.4 million of Non-Agency MBS transferred to consolidated variable interest entities (“VIEs”) at December 31, 2016. Such assets
can be used only to settle the obligations of each respective VIE.
(2) Includes approximately $183.2 million of Residential whole loans, at carrying value and $289.3 million of Residential whole loans, at fair value transferred to
consolidated VIEs at December 31, 2017. 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.
84
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
For the Year Ended December 31,
2017
2016
2015
Interest Income:
Agency MBS
Non-Agency MBS
CRT securities
MSR related assets
Residential whole loans held at carrying value
Cash and cash equivalent investments
Interest Income
Interest Expense:
Repurchase agreements and other advances
Other interest expense
Interest Expense
Net Interest Income
Other-Than-Temporary Impairments:
Total other-than-temporary impairment losses
Portion of loss (reclassed from)/recognized in other comprehensive income
Net Impairment Losses Recognized in Earnings
Other Income, net:
Net gain on residential whole loans held at fair value
Net gain on sales of MBS and U.S. Treasury securities
Other, net
Other Income, net
Operating and Other Expense:
Compensation and benefits
Other general and administrative expense
Loan servicing and other related operating expenses
Operating and Other Expense
Net Income
Less Preferred Stock Dividends
Net Income Available to Common Stock and Participating Securities
Earnings per Common Share - Basic and Diluted
$
65,355
$
83,069
$
271,112
31,715
24,830
36,187
4,249
332,821
14,770
2,100
23,916
774
105,835
363,570
6,572
—
16,036
130
$
$
$
$
$
$
$
$
$
$
$
$
$
433,448
$
457,450
$
492,143
186,347
10,794
197,141
236,307
$
$
$
184,986
8,369
193,355
264,095
$
$
$
(63) $
(969)
(1,032) $
(1,255) $
770
(485) $
90,019
$
62,605
$
39,577
29,423
35,837
10,600
159,019
$
109,042
$
31,673
$
29,281
$
17,960
22,268
71,901
322,393
15,000
307,393
0.79
$
$
$
$
16,331
14,372
59,984
312,668
15,000
297,668
0.80
$
$
$
$
166,918
10,030
176,948
315,195
(525)
(180)
(705)
19,575
34,900
(3,310)
51,165
26,293
15,752
10,384
52,429
313,226
15,000
298,226
0.80
The accompanying notes are an integral part of the consolidated financial statements.
85
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(In Thousands)
Net income
Other Comprehensive Income/(Loss):
Unrealized loss on Agency MBS, net
Unrealized gain/(loss) on Non-Agency MBS, net
Reclassification adjustment for MBS sales included in net income
Reclassification adjustment for other-than-temporary impairments included
in net income
Derivative hedging instrument fair value changes, net
Cumulative effect adjustment on adoption of revised accounting standard for
repurchase agreement financing
Other Comprehensive Income/(Loss)
Comprehensive income before preferred stock dividends
Dividends declared on preferred stock
Comprehensive Income Available to Common Stock and Participating Securities
For the Year Ended December 31,
2017
2016
2015
$
322,393
$
312,668
$
313,226
(39,158)
79,142
(38,707)
(1,032)
35,297
—
35,542
357,935
(15,000)
342,935
$
$
(9,322)
81,882
(36,922)
(485)
22,678
—
57,831
370,499
(15,000)
355,499
$
$
(51,332)
(143,558)
(37,207)
(705)
(10,337)
4,537
(238,602)
74,624
(15,000)
59,624
$
$
The accompanying notes are an integral part of the consolidated financial statements.
86
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the Year Ended December 31, 2017
Preferred Stock
7.50% Series B
Cumulative
Redeemable -
Liquidation Preference
$25.00 per Share
Common Stock
Shares
Amount
Shares
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Income
Total
(In Thousands,
Except Per Share Amounts)
Balance at December 31, 2016
8,000
$
Net income
Issuance of common stock, net of
expenses (1)
Repurchase of shares of common stock (1)
Equity based compensation expense
Accrued dividends attributable to stock-
based awards
Dividends declared on common stock
Dividends declared on preferred stock
Dividends attributable to dividend
equivalents
Change in unrealized gains on MBS, net
Derivative hedging instrument fair value
changes, net
—
—
—
—
—
—
—
—
—
—
Balance at December 31, 2017
8,000
$
80
—
—
—
—
—
—
—
—
—
—
80
371,854
$ 3,719
$ 3,029,062
$
(572,641) $
573,682
$ 3,033,902
—
—
—
322,393
26,722
(745)
—
—
—
—
—
—
—
259
196,549
—
—
—
—
—
—
—
—
(5,995)
7,872
(184)
—
—
—
—
—
—
—
—
—
(312,810)
(15,000)
(892)
—
—
—
—
—
—
—
—
—
—
245
322,393
196,808
(5,995)
7,872
(184)
(312,810)
(15,000)
(892)
245
35,297
35,297
397,831
$ 3,978
$ 3,227,304
$
(578,950) $
609,224
$ 3,261,636
For the Year Ended December 31, 2016
Preferred Stock
7.50% Series B
Cumulative
Redeemable -
Liquidation Preference
$25.00 per Share
Common Stock
Shares
Amount
Shares
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Income
Total
(In Thousands,
Except Per Share Amounts)
Balance at December 31, 2015
8,000
$
Net income
Issuance of common stock, net of
expenses (1)
Repurchase of shares of common stock (1)
Equity based compensation expense
Accrued dividends attributable to stock-
based awards
Dividends declared on common stock
Dividends declared on preferred stock
Dividends attributable to dividend
equivalents
Change in unrealized gains on MBS, net
Derivative hedging instruments fair value
changes, net
—
—
—
—
—
—
—
—
—
—
Balance at December 31, 2016
8,000
$
80
—
—
—
—
—
—
—
—
—
—
80
370,584
$ 3,706
$ 3,019,956
$
(572,332) $
515,851
$ 2,967,261
—
1,758
(488)
—
—
—
—
—
—
—
—
13
—
—
—
—
—
—
—
—
—
312,668
4,647
(3,551)
8,695
(685)
—
—
—
—
—
—
—
—
—
(297,046)
(15,000)
(931)
—
—
—
—
—
—
—
—
—
—
35,153
312,668
4,660
(3,551)
8,695
(685)
(297,046)
(15,000)
(931)
35,153
22,678
22,678
371,854
$ 3,719
$ 3,029,062
$
(572,641) $
573,682
$ 3,033,902
87
For the Year Ended December 31, 2015
Preferred Stock
7.50% Series B
Cumulative
Redeemable -
Liquidation Preference
$25.00 per Share
Common Stock
Shares
Amount
Shares
Amount
Additional
Paid-in
Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Income
Total
(In Thousands,
Except Per Share Amounts)
Balance at December 31, 2014
8,000
$
80
370,084
$ 3,701
$ 3,013,634
$
(568,596) $
754,453
$ 3,203,272
Cumulative effect adjustment on adoption
of revised accounting standard for
repurchase agreement financing
Net income
Issuance of common stock, net of
expenses (1)
Repurchase of shares of common stock (1)
Equity based compensation expense
Accrued dividends attributable to stock-
based awards
Dividends declared on common stock
Dividends declared on preferred stock
Dividends attributable to dividend
equivalents
Change in unrealized losses on MBS, net
Derivative hedging instruments fair value
changes, net
—
—
—
—
—
—
—
—
—
—
—
Balance at December 31, 2015
8,000
$
—
—
—
—
—
—
—
—
—
—
—
80
—
—
809
(309)
—
—
—
—
—
—
—
—
—
5
—
—
—
—
—
—
—
—
—
—
(4,537)
313,226
1,216
(2,273)
7,829
(450)
—
—
—
—
—
—
—
—
—
(296,384)
(15,000)
(1,041)
—
—
4,537
—
—
—
—
—
—
—
—
—
313,226
1,221
(2,273)
7,829
(450)
(296,384)
(15,000)
(1,041)
(232,802)
(232,802)
(10,337)
(10,337)
370,584
$ 3,706
$ 3,019,956
$
(572,332) $
515,851
$ 2,967,261
(1) For the year ended December 31, 2017, includes approximately $6.0 million (744,588 shares) surrendered for tax purposes related to equity-based compensation
awards. For the year ended December 31, 2016, includes approximately $3.6 million (487,559 shares) surrendered for tax purposes related to equity-based
compensation awards. For the year ended December 31, 2015, includes approximately $2.3 million (309,206 shares) surrendered for tax purposes related to
equity-based compensation awards.
The accompanying notes are an integral part of the consolidated financial statements.
88
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
Cash Flows From Operating Activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sales of MBS and U.S. Treasury securities
Gain on sales of real estate owned
Gain on liquidation of residential whole loans
Other-than-temporary impairment charges
Accretion of purchase discounts on MBS and CRT securities, residential whole loans and MSR related
assets
Amortization of purchase premiums on MBS and CRT securities
Depreciation and amortization on real estate, fixed assets and other assets
Equity-based compensation expense
Unrealized gain on residential whole loans at fair value
Increase in other assets and other
(Decrease)/increase in other liabilities
Net cash provided by operating activities
Cash Flows From Investing Activities:
Principal payments on MBS, CRT securities and MSR related assets
Proceeds from sales of MBS and U.S. Treasury securities
For the Year Ended December 31,
2017
2016
2015
$
322,393
$
312,668
$
313,226
(39,577)
(4,475)
(11,868)
1,032
(86,318)
30,330
1,519
8,033
(33,617)
(5,569)
(5,813)
(35,837)
(3,229)
—
485
(84,615)
36,725
964
9,162
(31,254)
(23,122)
(6,943)
(34,900)
(76)
—
705
(95,377)
41,624
860
7,832
(6,532)
(5,407)
56,170
$
176,070
$
175,004
$
278,125
$
3,996,489
$
3,339,597
$
2,916,807
243,081
85,594
70,747
Purchases of MBS, CRT securities, MSR related assets, and U.S. Treasury Securities
(1,583,130)
(1,995,013)
(1,810,303)
Purchases of residential whole loans and capitalized advances
(1,065,981)
(677,003)
(617,017)
Principal payments on residential whole loans
Proceeds from sales of real estate owned
Purchases of real estate owned and capital improvements
Redemption of Federal Home Loan Bank stock
Purchases of Federal Home Loan Bank stock
Additions to leasehold improvements, furniture and fixtures
Net cash provided by investing activities
Cash Flows From Financing Activities:
Principal payments on repurchase agreements and other advances
Proceeds from borrowings under repurchase agreements and other advances
Proceeds from issuance of securitized debt
Principal payments on securitized debt
Payments made for securitization related costs
Payments made for margin calls and settlements on repurchase agreements and interest rate swap
agreements (“Swaps”)
Proceeds from reverse margin calls and settlements on repurchase agreements and Swaps
Proceeds from issuances of common stock
Dividends paid on preferred stock
Dividends paid on common stock and dividend equivalents
Net cash used in financing activities
Net increase/(decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
160,469
75,671
(19,801)
10,422
—
(872)
103,997
34,200
(2,825)
51,400
(1,805)
(708)
51,427
4,049
—
—
(60,017)
(1,560)
$
1,816,348
$
937,434
$
554,133
(72,563,218)
(82,408,484)
(92,012,931)
70,490,091
81,706,806
91,614,851
382,847
(16,562)
(2,646)
—
—
(22,057)
(88,347)
—
—
(46,022)
(177,363)
(267,200)
79,517
196,808
(15,000)
(308,588)
192,000
4,660
(15,000)
(297,895)
215,100
1,218
(15,000)
(297,379)
$ (1,802,773) $ (1,017,333) $
(849,688)
$
$
$
189,645
260,112
449,757
$
$
$
95,105
165,007
260,112
$
$
$
(17,430)
182,437
165,007
89
Supplemental Disclosure of Cash Flow Information
Interest Paid
$
198,159
$
194,626
$
172,919
Non-cash Investing and Financing Activities:
MBS and CRT securities recorded upon adoption of revised accounting standard for repurchase agreement
financing
Repurchase agreements recorded upon adoption of revised accounting standard for repurchase agreement
financing
Net increase in securities obtained as collateral/obligation to return securities obtained as collateral
Transfer from residential whole loans to real estate owned
Dividends and dividend equivalents declared and unpaid
$
$
$
$
$
— $
— $
1,917,813
— $
— $
1,519,593
134,100
136,734
79,771
$
$
$
5,385
91,896
74,657
$
$
$
32,670
30,104
74,575
The accompanying notes are an integral part of the consolidated financial statements.
90
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
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 Notes 2(p) and 11)
2.
Summary of Significant Accounting Policies
(a) Basis of Presentation and Consolidation
The accompanying consolidated financial statements of the Company have been prepared on the accrual basis of accounting
in accordance with U.S. generally accepted accounting principles (“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 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(p)) 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 MBS resecuritization
transactions completed in prior years as well as transactions related to the acquisition and securitization of residential whole loans.
Certain prior period amounts have been reclassified to conform to the current period presentation.
(b) MBS (including Non-Agency MBS transferred to consolidated VIEs) and CRT 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 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 based on the performance of loans in a reference pool of previously securitized MBS. As
the loans in the underlying reference pool are paid, the principal balance of the CRT securities is paid. As an investor in a CRT
security, the Company may incur a loss if certain defined credit events occur, including, for certain CRT securities, if the loans in
the reference pool experience delinquencies exceeding specified thresholds.
91
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Designation
The Company generally intends to hold its MBS until maturity; however, from time to time, it may sell any of its securities
as part of the overall management of its business. As a result, all of the Company’s MBS are designated as “available-for-
sale” (“AFS”) and, accordingly, are carried at their fair value with unrealized gains and losses excluded from earnings (except
when an OTTI is recognized, as discussed below) and reported in Accumulated other comprehensive income/(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 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
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 MBS and CRT Securities
In determining the fair value of the Company’s MBS and CRT 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)
92
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
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 OTTI 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 and may not be adjusted for subsequent
recoveries in fair value through earnings. However, OTTIs recognized through charges to earnings may be accreted back to the
amortized cost basis of the security on a prospective basis through interest income. The determination as to whether an OTTI
exists and, if so, the amount 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 the 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, as well as reports by credit rating agencies, such as Moody’s
Investors Services, Inc. (“Moody’s”), Standard & Poor’s Corporation (“S&P”) or Fitch, Inc. (collectively with Moody’s and S&P,
“Rating Agencies”), general market assessments, and dialogue with market participants. As a result, significant judgment is used
in the Company’s analysis to determine the expected cash flows for its Non-Agency MBS. In determining the 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 and CRT securities 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 MBS and CRT securities pledged as collateral against repurchase agreements, Federal Home Loan Bank
advances 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.
(c) 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)
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
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MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
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 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 Loan
The Company has entered into a loan agreement with an entity that originates loans and owns the related MSRs. Under the
terms of loan agreement, the Company has committed to lend $130.0 million of which approximately $111.2 million was drawn
at December 31, 2017. The loan is secured by certain U.S. Government, Agency and private-label MSRs, as well as other
unencumbered assets owned by the borrower. The term loan is 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 will be recorded as Other
Income on the Company’s consolidated statements of operations. The Company evaluates the recoverability of the loan on a
quarterly basis by considering various factors, including the current status of the loan, changes in fair value of the MSRs that secure
the loan and the recent financial performance of the borrower.
(d) Residential Whole Loans (including Residential Whole Loans transferred to consolidated VIEs)
Residential whole loans included in the Company’s consolidated balance sheets are comprised of pools of fixed and adjustable
rate residential mortgage loans acquired through consolidated trusts in secondary market transactions, with the majority at
discounted purchase prices. 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 under “Residential Whole Loans at Carrying Value” is typically utilized by the Company
for loans where the underlying borrower has a delinquency status of less than 60 days at the acquisition date. The accounting
model described below under “Residential Whole Loans 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
The Company has generally 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 the underlying borrowers have previously
experienced payment delinquencies and the amount owed on the mortgage loan 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
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MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
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 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
loans 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 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 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 held
at fair value on the Company’s consolidated statements of operations.
Cash received reflecting coupon payments on residential whole loans held at fair value is not included in Interest Income,
but rather is presented in Net gain on residential whole loans held at fair value 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 Net gain on residential whole loans held at fair value.
(e) Securities Obtained and Pledged as Collateral/Obligation to Return Securities Obtained as Collateral
The Company has obtained securities as collateral under collateralized financing arrangements in connection with its financing
strategy for Non-Agency MBS. Securities obtained as collateral in connection with these transactions are recorded on the
Company’s consolidated balance sheets as an asset along with a liability representing the obligation to return the collateral obtained,
at fair value. While beneficial ownership of securities obtained remains with the counterparty, the Company has the right to transfer
the collateral obtained or to pledge it as part of a subsequent collateralized financing transaction. (See Note 2(l) for Repurchase
Agreements and Reverse Repurchase Agreements)
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MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
(f) Cash and Cash Equivalents
Cash and cash equivalents include cash on deposit with financial institutions and investments in money market funds, all of
which have original maturities of three months or less. Cash and cash equivalents may also include cash pledged as collateral to
the Company by its repurchase agreement and/or Swap counterparties as a result of reverse margin calls (i.e., margin calls made
by the Company). The Company did not hold any cash pledged by its counterparties at December 31, 2017 or 2016. 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 or any other government agency were $354.0 million and $208.9 million at December 31, 2017 and 2016,
respectively. (See Notes 7 and 14)
(g) 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 Swaps counterparties, or may be returned to the Company when the related
collateral requirements are exceeded or at the maturity of the Swap or repurchase agreement. The Company had aggregate restricted
cash held as collateral or otherwise in connection with its Swaps and repurchase agreements of $13.3 million and $58.5 million
at December 31, 2017 and 2016, respectively. (See Notes 5(b), 6, 7 and 14)
(h) Goodwill
At December 31, 2017 and 2016, the Company had goodwill of $7.2 million, which represents the unamortized portion of
the excess of the fair value of its common stock issued over the fair value of net assets acquired in connection with its formation
in 1998. Goodwill is tested for impairment at least annually, or more frequently under certain circumstances, at the entity level.
Through December 31, 2017, the Company had not recognized any impairment against its goodwill. Goodwill is included in
Other assets on the Company’s consolidated balance sheets.
(i) 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))
(j) Depreciation
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.
96
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
(k) MBS Resecuritization, Loan Securitization and Other Debt Issuance Costs
MBS resecuritization and 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.
(l) Repurchase Agreements and Other Advances
Repurchase 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, which is equal in value to a specified percentage of the fair
value of the pledged collateral, while the Company retains beneficial ownership of the pledged collateral. At the maturity of a
repurchase financing, unless the repurchase financing is renewed with the same counterparty, the Company is required to repay
the loan, 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 securities or cash as collateral to secure borrowings under its repurchase
financing with such lender, are routinely experienced by the Company when the value of the MBS pledged as collateral declines
as a result of principal amortization 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 or 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 has 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. Securities obtained and pledged as collateral are recorded as
an asset on the Company’s consolidated balance sheets. Interest income is recorded on the reverse repurchase agreement and
interest expense is recorded on the repurchase agreement on an accrual basis. Both the Company and the counterparty have the
right to make daily margin calls based on changes in the value of the collateral obtained and/or pledged. The Company’s liability
to the counterparty in connection with this financing arrangement is recorded on the Company’s consolidated balance sheets and
disclosed as “Obligation to return securities obtained as collateral, at fair value.” (See Note 2(e))
97
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Federal Home Loan Bank (“FHLB”) Advances
In January 2016, the Federal Housing Finance Agency released its final rule amending its regulation on FHLB membership,
which, among other things, provided termination rules for then current captive insurance members. As a result of such regulation,
the Company’s wholly-owned subsidiary, MFA Insurance, Inc. (“MFA Insurance”) was required to repay all of its outstanding
FHLB advances by February 19, 2017 and its FHLB membership was terminated on such date. FHLB advances were secured
financing transactions and were carried at their contractual amounts. Accrued interest payable on FHLB advances is included in
Other liabilities on the Company’s consolidated balance sheets at December 31, 2016. (See Notes 6, 7 and 14)
(m) Equity-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. (See Note 2(u))
From 2011 through 2013, the Company granted certain restricted stock units (“RSUs”) that vested annually over a one or
three-year period, provided that certain criteria were met, which were based on a formula tied to the Company’s achievement of
average total stockholder return during that three-year period. Starting in 2014, the Company has made annual grants of RSUs
certain of which cliff vest after a three-year period and others of which cliff vest after a three-year period, subject to the achievement
of certain performance criteria based on a formula tied to the Company’s achievement of average total stockholder return during
that three-year period. The features in these awards related to the attainment of total stockholder 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 has awarded dividend equivalents in connection with its equity-based awards. 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 do
not or are not expected to vest and grantees are not required to return payments of dividends or dividend equivalents to the Company.
(See Notes 2(n) and 13)
(n) Earnings per Common Share (“EPS”)
Basic EPS is computed using the two-class method, which includes the weighted-average number of shares of common stock
outstanding during the period and 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
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)
(o) Comprehensive 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.
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MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
(p) U.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 may be conducted through one or more TRS, its income earned by TRS may be 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
deferred tax benefit was recorded by the Company in 2017 or 2016, as a valuation allowance for the full amount of the associated
deferred tax asset was recognized as its recovery is not considered more likely than not.
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 December 31, 2017, 2016 or 2015. The
Company filed its 2016 tax return prior to October 16, 2017. The Company’s tax returns for tax years 2014 through 2016 are open
to examination.
(q) Derivative 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, 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 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.
99
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
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 fair value of the Swap. Changes in the fair value of the Company’s
Swaps designated in hedging transactions are recorded in OCI provided that the hedge remains effective. Changes in fair value
for any ineffective amount of a Swap are recognized in earnings. The Company has not recognized any change in the value of its
existing Swaps designated as hedges through earnings as a result of hedge ineffectiveness.
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.
As of September 30, 2017, all of the Company’s Swaps have been novated to a central clearing house. (See Notes 5(b), 7
and 14)
(r) Fair Value Measurements and the Fair Value Option for Financial Assets and Financial Liabilities
The Company’s presentation of fair value for its financial assets and liabilities is determined within a framework that stipulates
that the fair value of a financial asset or liability is an exchange price in an orderly transaction between market participants to sell
the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the
principal or most advantageous market for the asset or liability. The transaction to sell the asset or transfer the liability is a
hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or
owes the liability. This definition of fair value 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 and CRT securities at time of acquisition. Subsequent changes in the fair value of these
loans and CRT securities are reported in Net gain on residential whole loans held at fair value and Other income, net respectively
on 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(d), 4 and 14)
(s) Variable 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 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) 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 consolidating the VIEs that
were created to facilitate the transactions. In determining the accounting treatment to be applied to these transactions, the Company
concluded that the entities used to facilitate these transactions were 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 a 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.
100
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
(t) Offering Costs Related to Issuance and Redemption of Preferred Stock
Offering costs related to 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.
(u) New Accounting Standards and Interpretations
Accounting Standards Adopted in 2017
Compensation - Stock Compensation - Improvements to Employee Share-Based Payment Accounting
In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-09,
Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). The amendments of this ASU require all income
tax effects of awards to be recognized in the income statement when the awards vest or are settled. ASU 2016-09 also allows an
employer to repurchase more of an employee’s shares than it could prior to adoption of this ASU for tax withholding purposes
without triggering liability accounting and to make a policy election to account for forfeitures as they occur. ASU 2016-09 was
effective for the Company for annual periods, and interim periods within those annual periods, beginning after December 15, 2016.
The Company’s adoption of ASU 2016-09 did not have a significant impact on its financial position or financial statement
disclosures.
Intangibles - Goodwill and Other - Simplifying the Test for Goodwill Impairment
In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other - Simplifying the Test for Goodwill
Impairment (“ASU 2017-04”). The amendments in ASU 2017-04 eliminate the requirement to calculate the implied fair value of
goodwill (Step 2 from today’s goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record
an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value (i.e., measure the charge based
on today’s Step 1). Public business entities should adopt the amendments in ASU 2017-04 for its annual or any interim goodwill
impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill
impairment tests performed on testing dates on or after January 1, 2017. The amendments of this ASU should be applied on a
prospective basis. The Company adopted this ASU on December 31, 2017 and its adoption did not have any impact on its financial
position or financial statement disclosures.
101
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
3. MBS, CRT 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”); (iii) mortgages that have interest rates that reset more frequently (collectively, “ARM-
MBS”); and (iv) 15-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 structured with a contractual coupon step-up feature where the coupon increases up to 300
basis points at 36 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 (including Non-Agency MBS transferred to consolidated VIEs): 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 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 a reference pool of Agency MBS securitized by the issuing entity. As an investor in a CRT security, the Company may
incur a loss if losses on the mortgage loans in the reference pool exceed the credit enhancement on the underlying CRT 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 reference pool. The Company pledges a portion of its CRT securities as collateral against
its borrowings under repurchase agreements. (See Note 7)
102
2016:
(In Thousands)
Agency MBS:
Fannie Mae
Freddie Mac
Ginnie Mae
Total Agency MBS
Non-Agency MBS:
(In Thousands)
Agency MBS:
Fannie Mae
Freddie Mac
Ginnie Mae
Total Agency MBS
Non-Agency MBS:
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following tables present certain information about the Company’s MBS and CRT securities at December 31, 2017 and
December 31, 2017
Principal/
Current
Face
Purchase
Premiums
Accretable
Purchase
Discounts
Discount
Designated
as Credit
Reserve and
OTTI (1)
Amortized
Cost (2)
Fair Value
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Net
Unrealized
Gain/
(Loss)
$
2,170,974
$
82,271
$
(40)
$
— $
2,253,205
$
2,246,600
$
21,736
$
(28,341)
$
(6,605)
561,346
6,142
21,683
112
2,738,462
104,066
Expected to Recover Par (3)(4)
1,128,808
Expected to Recover Less than
Par (3)
Total Non-Agency MBS (5)
Total MBS
CRT securities (6)
2,589,935
3,718,743
6,457,205
602,799
50
—
50
104,116
8,887
—
—
(40)
(22,737)
(192,588)
(215,325)
(215,365)
(3,550)
—
—
—
—
584,920
6,254
571,748
6,333
1,624
79
(14,796)
(13,172)
—
79
2,844,379
2,824,681
23,439
(43,137)
(19,698)
1,106,121
1,132,205
26,518
(434)
26,084
(593,227)
1,804,120
(593,227)
2,910,241
(593,227)
5,754,620
2,401,761
3,533,966
6,358,647
—
608,136
664,403
597,660
624,178
647,617
56,290
(19)
(453)
(43,590)
(23)
597,641
623,725
604,027
56,267
Total MBS and CRT securities
$
7,060,004
$
113,003
$
(218,915)
$
(593,227)
$
6,362,756
$
7,023,050
$
703,907
$
(43,613)
$
660,294
December 31, 2016
Principal/
Current
Face
Purchase
Premiums
Accretable
Purchase
Discounts
Discount
Designated
as Credit
Reserve and
OTTI (1)
Amortized
Cost (2)
Fair Value
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Net
Unrealized
Gain/
(Loss)
$
2,879,807
$
108,310
$
(51)
$
— $
2,988,066
$
3,014,464
$
45,706
$
(19,308)
$
26,398
693,945
7,550
26,736
136
3,581,302
135,182
Expected to Recover Par (3)(4)
2,706,418
Expected to Recover Less than
Par (3)
Total Non-Agency MBS (5)
Total MBS
CRT securities (6)
3,359,200
6,065,618
9,646,920
384,993
57
—
57
135,239
3,312
—
—
(51)
(24,273)
(253,918)
(278,191)
(278,242)
(5,557)
—
—
—
—
723,285
7,686
716,209
7,824
4,809
138
(11,885)
(7,076)
—
138
3,719,037
3,738,497
50,653
(31,193)
19,460
2,682,202
2,706,311
26,477
(2,368)
24,109
(694,241)
2,411,041
(694,241)
5,093,243
(694,241)
8,812,280
2,978,525
5,684,836
9,423,333
—
382,748
404,850
570,318
596,795
647,448
22,105
(2,834)
(5,202)
(36,395)
(3)
567,484
591,593
611,053
22,102
Total MBS and CRT securities
$ 10,031,913
$
138,551
$
(283,799)
$
(694,241)
$
9,195,028
$
9,828,183
$
669,553
$
(36,398)
$
633,155
(1) Discount designated as Credit Reserve and amounts related to OTTI are generally not expected to be accreted into interest income. Amounts
disclosed at December 31, 2017 reflect Credit Reserve of $579 million and OTTI of $14.2 million. Amounts disclosed at December 31, 2016
reflect Credit Reserve of $675.6 million and OTTI of $18.6 million.
(2) Includes principal payments receivable of $1.9 million and $2.6 million at December 31, 2017 and 2016, respectively, which are not included
in the Principal/Current Face.
(3) Based on management’s current estimates of future principal cash flows expected to be received.
(4) Includes RPL/NPL MBS, which at December 31, 2017 had a $922.0 million Principal/Current face, $920.1 million amortized cost and $923.1
million fair value. At December 31, 2016, RPL/NPL MBS had a $2.5 billion Principal/Current face, $2.5 billion amortized cost and $2.5
billion fair value.
(5) At December 31, 2017 and 2016, the Company expected to recover approximately 84% and 89%, respectively, of the then-current face amount
of Non-Agency MBS.
(6) Amounts disclosed at December 31, 2017 includes CRT securities with a fair value of $480.8 million for which the fair value option has been
elected. Such securities had gross unrealized gains of approximately $40.5 million and gross unrealized losses of approximately $23,000 at
December 31, 2017. Amounts disclosed at December 31, 2016 includes CRT securities with a fair value of $271.2 million for which the fair
value option has been elected. Such securities had gross unrealized gains of approximately $12.7 million and gross unrealized losses of
approximately $3,000 at December 31, 2016.
103
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Unrealized Losses on MBS and CRT Securities
The following table presents information about the Company’s MBS and CRT securities that were in an unrealized loss
position at December 31, 2017:
(Dollars in Thousands)
Agency MBS:
Fannie Mae
Freddie Mac
Ginnie Mae
Total Agency MBS
Non-Agency MBS:
Expected to Recover Par (1)
Expected to Recover Less than Par (1)
Total Non-Agency MBS
Total MBS
CRT securities (2)
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
$ 385,839
$
3,128
104
$ 871,828
$
25,213
63,924
233
449,996
64,394
6,237
70,631
520,627
16,266
472
—
3,600
195
19
214
3,814
23
23
1
407,885
14,324
—
—
128
1,279,713
39,537
2
4
6
12,531
—
12,531
239
—
239
134
1,292,244
39,776
4
—
—
200
105
—
305
9
—
9
314
—
$ 1,257,667
$
28,341
471,809
14,796
233
—
1,729,709
43,137
76,925
6,237
83,162
434
19
453
1,812,871
43,590
16,266
23
Total MBS and CRT securities
$ 536,893
$
3,837
138
$ 1,292,244
$
39,776
314
$ 1,829,137
$
43,613
(1) Based on management’s current estimates of future principal cash flows expected to be received.
(2) Amounts disclosed at December 31, 2017 includes CRT securities with a fair value of $16.3 million for which the fair value option has
been elected. Such securities have unrealized losses of $23,000 at December 31, 2017.
At December 31, 2017, 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 $43.1 million at December 31, 2017. 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 December 31, 2017 any unrealized losses on its Agency MBS were temporary.
Gross unrealized losses on the Company’s Non-Agency MBS were $453,000 at December 31, 2017. 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
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 recognized credit-related OTTI losses through earnings related to its Non-Agency MBS of $1.0 million,
$485,000, and $705,000 during the years ended December 31, 2017, 2016, and 2015, respectively.
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
104
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
loans, year of origination, LTVs, geographic concentrations, as well as Rating Agency reports, general market assessments, 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 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 the composition of OTTI charges recorded by the Company for the years ended December 31,
2017, 2016 and 2015:
(In Thousands)
Total OTTI losses
OTTI recognized in/(reclassified from) OCI
OTTI recognized in earnings
For the Year Ended December 31,
2017
2016
2015
$
$
(63) $
(969)
(1,032) $
(1,255) $
770
(485) $
(525)
(180)
(705)
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 for the years ended December 31, 2017, 2016 and 2015.
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.
(In Thousands)
Credit loss component of OTTI at beginning of period
Additions for credit related OTTI not previously recognized
Subsequent additional credit related OTTI recorded
Credit loss component of OTTI at end of period
For the Year Ended December 31,
2017
2016
2015
$
$
37,305
$
36,820
$
36,115
63
969
314
171
461
244
38,337
$
37,305
$
36,820
105
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Purchase Discounts on Non-Agency MBS
The following table presents the changes in the components of the Company’s purchase discount on its Non-Agency MBS
between purchase discount designated as Credit Reserve and OTTI and accretable purchase discount for the years ended
December 31, 2017 and 2016:
(In Thousands)
For the Year Ended December 31,
2017
2016
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
$
(694,241) $
(278,191) $
(787,541) $
Impact of RMBS Issuer settlement (2)
Accretion of discount
Realized credit losses
Purchases
Sales
Net impairment losses recognized in earnings
Transfers/release of credit reserve
Balance at end of period
$
—
—
49,291
(29,810)
31,730
(1,032)
50,835
(593,227) $
—
77,513
—
18,386
17,802
—
(50,835)
(215,325) $
—
—
64,217
(25,999)
17,863
(485)
37,704
(694,241) $
(312,182)
(59,900)
80,548
—
13,094
37,953
—
(37,704)
(278,191)
(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 $61.8 million and $7.0 million of cash proceeds (a one-time payment) received by the Company during
the year ended December 31, 2016 in connection with the settlements of litigation related to certain Countrywide and Citigroup sponsored
residential mortgage backed securitization trusts, respectively.
Sales of MBS
During 2017, the Company sold certain Non-Agency MBS for $104.0 million, realizing gross gains of $39.9 million. During
2016, the Company sold certain Non-Agency MBS for $85.6 million, realizing gross gains of $35.8 million. During 2015, the
Company sold certain Non-Agency MBS for $70.7 million realizing gross gains of $34.9 million. The Company has no continuing
involvement with any of the sold MBS.
MSR Related Assets
(a) Term Notes Backed by MSR Related Collateral
At December 31, 2017 and December 31, 2016, the Company had $381.8 million and $141.0 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 December 31, 2017, these term notes had an amortized cost of $381.0 million, gross unrealized gains of $804,000, a
weighted average yield of 5.80% and a weighted average term to maturity of 3.4 years. At December 31, 2016, the term notes
had an amortized cost of $141.0 million, no gross unrealized gains, a weighted average yield of 5.50% and a weighted average
term to maturity of 4.6 years.
106
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
(b) Corporate Loan
The Company has entered into a loan agreement with an entity that originates loans and owns the related MSRs. The loan
is secured by certain U.S. Government, Agency and private-label MSRs, as well as other unencumbered assets owned by the
borrower. Under the terms of the loan agreement, the Company has committed to lend $130.0 million of which approximately
$111.2 million was drawn at December 31, 2017. At December 31, 2017, the coupon paid by the borrower on the drawn amount
is 8.07%, the remaining term associated with the loan is 2.5 years and the remaining commitment period on any undrawn amount
is six months. During the remaining commitment period of six months, the Company receives a commitment fee of 1.5%. For
the year ended December 31, 2017, the Company recognized interest income of $7.9 million including discount accretion and
commitment fee income of $296,000.
Impact of AFS Securities on AOCI
The following table presents the impact of the Company’s AFS securities on its AOCI for the years ended December 31,
2017, 2016, and 2015:
(In Thousands)
AOCI from AFS securities:
Unrealized gain on AFS securities at beginning of period
$
Unrealized loss on Agency MBS, net
Unrealized gain/(loss) on Non-Agency MBS, net
Cumulative effect adjustment on adoption of revised accounting standard
for repurchase agreement financing (1)
Reclassification adjustment for MBS sales included in net income
Reclassification adjustment for OTTI included in net income
Change in AOCI from AFS securities
Balance at end of period
For the Year Ended December 31,
2017
2016
2015
$
620,403
(39,158)
79,142
$
585,250
(9,322)
81,882
—
(38,707)
(1,032)
245
—
(36,922)
(485)
35,153
$
620,648
$
620,403
$
813,515
(51,332)
(143,558)
4,537
(37,207)
(705)
(228,265)
585,250
(1) Cumulative effect adjustment on adoption of accounting guidance that was effective for the Company as of January 1, 2015 which prospectively
eliminated the use of linked transactions accounting for certain assets that were purchased from and financed by the same counterparty.
107
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Interest Income on MBS, CRT Securities and MSR Related Assets
The following table presents components of interest income on the Company’s MBS, CRT securities and MSR related assets
for the years ended December 31, 2017, 2016 and 2015:
(In Thousands)
Agency MBS
Coupon interest
Effective yield adjustment (1)
Interest income
Legacy Non-Agency MBS
Coupon interest
Effective yield adjustment (2)
Interest income
RPL/NPL MBS
Coupon interest
Effective yield adjustment (1)
Interest income
CRT securities
Coupon interest
Effective yield adjustment (2)
Interest income
MSR related assets
Coupon interest
Effective yield adjustment (1)
Interest income
For the Year Ended December 31,
2017
2016
2015
96,678
(31,323)
65,355
127,645
76,005
203,650
65,957
1,505
67,462
27,706
4,009
31,715
24,534
296
24,830
$
$
$
$
$
$
$
$
$
$
119,966
(36,897)
83,069
154,057
78,443
232,500
98,213
2,108
100,321
13,023
1,747
14,770
2,090
10
2,100
$
$
$
$
$
$
$
$
$
$
147,066
(41,231)
105,835
183,349
91,003
274,352
87,429
1,789
89,218
5,844
728
6,572
—
—
—
$
$
$
$
$
$
$
$
$
$
(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.
4.
Residential Whole Loans
Included on the Company’s consolidated balance sheets as of December 31, 2017 and 2016 are approximately $2.2 billion
and $1.4 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 consolidated for financial reporting purposes.
Residential Whole Loans at Carrying Value
Residential whole loans, at carrying value totaled approximately $908.5 million and $590.5 million at December 31, 2017
and 2016, respectively. The carrying value reflects the original investment amount, plus accretion of interest income, less principal
and interest cash flows received. The carrying value is reduced by any allowance for loan losses established subsequent to
acquisition. The Company had approximately 4,800 and 3,200 Residential whole loans held at carrying value at December 31,
2017 and 2016, respectively.
108
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
As of December 31, 2017 and 2016, the Company had established an allowance for loan losses of approximately $330,000
and $1.0 million, respectively, on its residential whole loan pools held at carrying value. For the years ended December 31, 2017
and 2016, a net reversal of provision for loan losses of approximately $660,000 and $175,000 was recorded, which is included in
Operating and Other expense on the Company’s consolidated statements of operations. For the year ended December 31, 2015,
a net provision for loan losses of approximately $1.0 million was recorded.
The following table presents the activity in the Company’s allowance for loan losses on its residential whole loan pools at
carrying value for the years ended December 31, 2017, 2016 and 2015:
(In Thousands)
Balance at the beginning of period
(Reversal of provisions)/provisions for loan losses
Balance at the end of period
For the Year Ended December 31,
2017
2016
2015
$
$
990
(660)
330
$
$
1,165
(175)
990
$
$
137
1,028
1,165
The following table presents information regarding estimates of the contractually required payments, the cash flows expected
to be collected, and the estimated fair value of the purchase credit impaired residential whole loans held at carrying value acquired
by the Company for the years ended December 31, 2017 and 2016:
(In Thousands)
Contractually required principal and interest
Contractual cash flows not expected to be collected (non-accretable yield)
Expected cash flows to be collected
Interest component of expected cash flows (accretable yield)
Fair value at the date of acquisition
For the Year Ended December 31,
2017
2016
$
$
534,112
(129,547)
404,565
(137,378)
267,187
$
$
662,747
(117,694)
545,053
(181,534)
363,519
The following table presents accretable yield activity for the Company’s purchase credit impaired residential whole loans
held at carrying value for the years ended December 31, 2017 and 2016:
(In Thousands)
Balance at beginning of period
Additions
Accretion
Liquidations and other
Reclassifications from non-accretable difference, net
Balance at end of period
For the Year Ended December 31,
2017
2016
$
$
334,379
137,378
(35,657)
(16,356)
2,128
421,872
$
$
175,271
181,534
(23,916)
—
1,490
334,379
Accretable yield for residential whole loans is the excess of loan cash flows expected to be collected over the purchase price.
The cash flows expected to be collected represent the Company’s estimate of the amount and timing of undiscounted principal
and interest cash flows. Additions include accretable yield estimates for purchases made during the period and reclassification to
accretable yield from non-accretable yield. Accretable yield is reduced by accretion during the period. The reclassifications
between accretable and non-accretable yield and the accretion of interest income are based on changes in estimates regarding loan
performance and the value of the underlying real estate securing the loans. In future periods, as the Company updates estimates
of cash flows expected to be collected from the loans and the underlying collateral, the accretable yield may change. Therefore,
the amount of accretable income recorded during the year ended December 31, 2017 is not necessarily indicative of future results.
109
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
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 time of acquisition. Subsequent changes in fair value are reported in current period earnings and
presented in Net gain on residential whole loans held at fair value on the Company’s consolidated statements of operations.
The following table presents information regarding the Company’s residential whole loans held at fair value at December 31,
2017 and 2016:
(Dollars in Thousands)
Outstanding principal balance
Aggregate fair value
Number of loans
December 31, 2017
December 31, 2016
$
$
1,562,373
1,325,115
6,514
$
$
966,174
814,682
3,812
During the years ended December 31, 2017, 2016 and 2015, the Company recorded net gains on residential whole loans held
at fair value of $90.0 million, $62.6 million and $19.6 million, respectively.
The following table presents the components of Net gain on residential whole loans held at fair value for the years ended
December 31, 2017, 2016 and 2015:
(In Thousands)
Coupon payments and other income received
Net unrealized gains
Net gain on payoff/liquidation of loans
Net gain on transfers to REO
Total
5. Other Assets
For the Year Ended December 31,
2017
2016
2015
41,373
$
23,017
$
33,617
4,958
10,071
31,254
5,413
2,921
9,304
6,539
1,879
1,853
90,019
$
62,605
$
19,575
$
$
The following table presents the components of the Company’s Other assets at December 31, 2017 and 2016:
(In Thousands)
REO
Interest receivable
Swaps, at fair value
Goodwill
Prepaid and other assets
Total Other Assets
December 31, 2017
December 31, 2016
$
$
152,356
$
27,415
679
7,189
51,208
238,847
$
80,503
27,795
233
7,189
78,775
194,495
110
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
(a) Real Estate Owned
At December 31, 2017, the Company had 709 REO properties with an aggregate carrying value of $152.4 million. At
December 31, 2016, the Company had 447 REO properties with an aggregate carrying value of $80.5 million.
During the years ended December 31, 2017 and 2016, the Company reclassified 698 and 517 mortgage loans to REO at an
aggregate estimated fair value less estimated selling costs of $136.7 million and $91.9 million, respectively at the time of transfer.
Such transfers occur when the Company takes possession of the property by foreclosing on the borrower or completes a “deed-
in-lieu of foreclosure” transaction. From time to time, the Company also acquires REO in connection with transactions to acquire
residential whole loans.
At December 31, 2017, $140.4 million of residential real estate property was held by the Company that was acquired either
through a completed foreclosure proceeding or from completion of a deed-in-lieu of foreclosure or similar legal agreement. In
addition, formal foreclosure proceedings were in process with respect to $33.5 million of residential whole loans at carrying value
and $689.6 million of residential whole loans at fair value at December 31, 2017.
During the year ended December 31, 2017, the Company sold 517 REO properties for consideration of $78.4 million, realizing
net gains of approximately $4.5 million. During the year ended December 31, 2016, the Company sold 256 REO properties for
consideration of $37.9 million, realizing net gains of approximately $3.2 million. During the year ended December 31, 2015, the
Company sold 63 REO properties for consideration of $6.5 million, realizing net gains of approximately $76,000. These amounts
are included in Other, net on the Company’s consolidated statements of operations. In addition, following an updated assessment
of liquidation amounts expected to be realized that was performed on all REO held at the end of each quarter during the years
ended December 31, 2017 and 2016, an aggregate downward adjustment of approximately $11.0 million and $7.5 million was
recorded to reflect certain REO properties at the lower of cost or estimated fair value as of December 31, 2017 and 2016, respectively.
The following table presents the activity in the Company’s REO for the years ended December 31, 2017 and 2016:
(In Thousands)
Balance at beginning of period
Adjustments to record at lower of cost or fair value
Transfer from residential whole loans (1)
Purchases and capital improvements
Disposals
Balance at end of period
For the Year Ended December 31,
2017
2016
$
$
80,503
(11,018)
136,734
19,801
(73,664)
152,356
$
$
28,026
(7,527)
91,896
2,825
(34,717)
80,503
(1) Includes net gain recorded on transfer of approximately $10.2 million and $2.9 million, respectively, for the years ended December 31, 2017
and 2016.
111
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
(b) Derivative Instruments
The Company’s derivative instruments are currently comprised of Swaps, which are designated as cash flow hedges against
the interest rate risk associated with its borrowings. The following table presents the fair value of the Company’s derivative
instruments and their balance sheet location at December 31, 2017 and 2016:
December 31,
2017
2016
Derivative Instrument
Designation
Balance Sheet
Location
Notional
Amount
Fair Value
Notional
Amount
Fair Value
(In Thousands)
Non-cleared legacy Swaps (1)
Cleared Swaps (2)
Cleared Swaps (2)
Hedging
Hedging
Hedging
Assets
Assets
$
$
— $
$
750,000
— $
$
679
350,000
$
— $
Liabilities
$ 1,800,000
$
— $ 2,550,000
$
233
—
(46,954)
(1) Non-cleared legacy Swaps include Swaps executed and settled bilaterally with counterparties without the use of an organized exchange or central clearing
house. The Company’s final non-cleared legacy Swaps expired during the three months ended June 30, 2017.
(2) Cleared Swaps include Swaps executed bilaterally with a counterparty in the over-the-counter market but then novated to a central clearing house, whereby
the central clearing house becomes the counterparty to both of the original counterparties. As of December 31, 2017, all of the Company’s Swaps have been
novated to and are cleared by a central clearing house are subject to initial margin requirements. Beginning in January 2017, variation margin payments on
the Company’s cleared swaps 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 fair value of the
Swap.
Swaps
The following table presents the assets pledged as collateral against the Company’s Swap contracts at December 31, 2017
and 2016:
(In Thousands)
Agency MBS, at fair value
Restricted cash
Total assets pledged against Swaps
December 31,
2017
2016
$
$
21,756
6,405
28,161
$
$
32,468
53,849
86,317
The Company’s derivative hedging instruments, or a portion thereof, could become ineffective in the future if the associated
repurchase agreements that such derivatives hedge fail to exist or fail to have terms that match those of the derivatives that hedge
such borrowings. At December 31, 2017, all of the Company’s derivatives were deemed effective for hedging purposes and no
derivatives were terminated during the years ended December 31, 2017 and 2016.
The Company’s Swaps designated as hedging transactions have the effect of modifying the repricing characteristics of the
Company’s repurchase agreements and cash flows for such liabilities. To date, no cost has been incurred at the inception of a
Swap (except for certain transaction fees related to entering into Swaps cleared though a central clearing house), pursuant to which
the Company agrees to pay a fixed rate of interest and receive a variable interest rate, generally based on one-month or three-
month London Interbank Offered Rate (“LIBOR”), on the notional amount of the Swap. The Company did not recognize any
change in the value of its existing Swaps designated as hedges through earnings as a result of hedge ineffectiveness during any of
the three years ended December 31, 2017.
112
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
At December 31, 2017, the Company had Swaps designated in hedging relationships with an aggregate notional amount of
$2.6 billion and extended 27 months on average with a maximum term of approximately 68 months.
The following table presents certain information with respect to the Company’s Swap activity during the year ended
December 31, 2017:
(Dollars in Thousands)
New Swaps:
Aggregate notional amount
Weighted average fixed-pay rate
Initial maturity date
Number of new Swaps
Swaps amortized/expired:
Aggregate notional amount
Weighted average fixed-pay rate
December 31, 2017
$
$
—
—%
N/A
—
350,000
0.58%
The following table presents information about the Company’s Swaps at December 31, 2017 and 2016:
Maturity (1)
(Dollars in Thousands)
Within 30 days
Over 30 days to 3 months
Over 3 months to 6 months
Over 6 months to 12 months
Over 12 months to 24 months
Over 24 months to 36 months
Over 36 months to 48 months
Over 48 months to 60 months
$
Notional
Amount
—
—
50,000
500,000
200,000
1,500,000
200,000
—
Over 60 months to 72 months (3)
100,000
Over 72 months to 84 months (3)
—
December 31, 2017
December 31, 2016
Weighted
Average
Fixed-Pay
Interest Rate
Weighted
Average
Variable
Interest Rate (2)
Notional
Amount
Weighted
Average
Fixed-Pay
Interest Rate
Weighted
Average
Variable
Interest Rate (2)
—%
—% $
—
—%
—%
—
1.45
1.50
1.71
2.22
2.20
—
2.75
—
—
1.56
1.46
1.54
1.51
1.53
—
1.50
—
50,000
300,000
—
550,000
200,000
1,500,000
200,000
—
100,000
0.67
0.57
—
1.49
1.71
2.22
2.20
—
2.75
0.64
0.66
—
0.71
0.76
0.74
0.75
—
0.74
Total Swaps
$ 2,550,000
2.04%
1.50% $ 2,900,000
1.87%
0.72%
(1) Each maturity category reflects contractual amortization and/or maturity of notional amounts.
(2) Reflects the benchmark variable rate due from the counterparty at the date presented, which rate adjusts monthly or quarterly based on one-
month or three-month LIBOR, respectively.
(3) Reflects one Swap with a maturity date of July 2023.
113
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following table presents the net impact of the Company’s derivative hedging instruments on its interest expense and the
weighted average interest rate paid and received for such Swaps for the years ended December 31, 2017, 2016 and 2015:
(Dollars in Thousands)
Interest expense attributable to Swaps
Weighted average Swap rate paid
Weighted average Swap rate received
Impact of Derivative Hedging Instruments on AOCI
For the Year Ended December 31,
2017
2016
2015
$
24,524
$
40,898
$
53,759
1.98%
1.07%
1.82%
0.48%
1.86%
0.19%
The following table presents the impact of the Company’s derivative hedging instruments on its AOCI for the years ended
December 31, 2017, 2016 and 2015:
(In Thousands)
AOCI from derivative hedging instruments:
Balance at beginning of period
Net gain/(loss) on Swaps
Balance at end of period
6.
Repurchase Agreements and Other Advances
Repurchase Agreements
For the Year Ended December 31,
2017
2016
2015
$
$
(46,721) $
35,297
(11,424) $
(69,399) $
22,678
(46,721) $
(59,062)
(10,337)
(69,399)
The Company’s repurchase agreements are accounted for as secured borrowings and bear interest that is generally LIBOR-
based. (See Notes 2(l) and 7) At December 31, 2017, the Company’s borrowings under repurchase agreements had a weighted
average remaining term-to-interest rate reset of 16 days and an effective repricing period of 11 months, including the impact of
related Swaps. At December 31, 2016, the Company’s borrowings under repurchase agreements had a weighted average remaining
term-to-interest rate reset of 19 days and an effective repricing period of 12 months, including the impact of related Swaps.
114
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following table presents information with respect to the Company’s borrowings under repurchase agreements and
associated assets pledged as collateral at December 31, 2017 and 2016:
(Dollars in Thousands)
December 31, 2017
December 31, 2016
Repurchase agreement borrowings secured by Agency MBS
Fair value of Agency MBS pledged as collateral under repurchase agreements
Weighted average haircut on Agency MBS (1)
Repurchase agreement borrowings secured by Legacy Non-Agency MBS
Fair value of Legacy Non-Agency MBS pledged as collateral under repurchase
agreements (2)
Weighted average haircut on Legacy Non-Agency MBS (1)
Repurchase agreement borrowings secured by RPL/NPL MBS
Fair value of RPL/NPL MBS pledged as collateral under repurchase agreements
Weighted average haircut on RPL/NPL MBS (1)
Repurchase agreements secured by U.S. Treasuries
Fair value of U.S. Treasuries pledged as collateral under repurchase agreements
Weighted average haircut on U.S. Treasuries (1)
Repurchase agreements secured by CRT securities
Fair value of CRT securities pledged as collateral under repurchase agreements
Weighted average haircut on CRT securities (1)
Repurchase agreements secured by MSR related assets
Fair value of MSR related assets pledged as collateral under repurchase agreements
Weighted average haircut on MSR related assets (1)
Repurchase agreements secured by residential whole loans (3)
Fair value of residential whole loans pledged as collateral under repurchase agreements
$
$
$
$
$
$
$
$
$
$
$
$
$
$
2,501,340
2,705,754
4.65%
1,256,033
1,652,983
21.87%
567,140
726,540
22.05%
470,334
472,095
1.47%
459,058
595,900
22.16%
317,255
482,158
33.19%
1,043,747
1,474,704
$
$
$
$
$
$
$
$
$
$
$
$
$
$
3,095,020
3,280,689
4.67%
1,690,937
2,317,708
24.01%
1,943,572
2,433,711
20.98%
504,572
510,767
1.60%
271,205
357,488
23.22%
135,112
226,780
41.40%
832,060
1,175,088
Weighted average haircut on residential whole loans (1)
26.10%
25.03%
(1) Haircut represents the percentage amount by which the collateral value is contractually required to exceed the loan amount.
(2) Includes $172.4 million of Legacy Non-Agency MBS acquired from consolidated VIEs that are eliminated from the Company’s consolidated
balance sheets at December 31, 2016.
(3) Excludes $206,000 and $210,000 of unamortized debt issuance costs at December 31, 2017 and 2016, respectively.
The following table presents repricing information about the Company’s borrowings under repurchase agreements, which
does not reflect the impact of associated derivative hedging instruments, at December 31, 2017 and 2016:
Time Until Interest Rate Reset
(Dollars in Thousands)
Within 30 days
Over 30 days to 3 months
Over 3 months to 12 months
Total repurchase agreements
Less debt issuance costs
Total repurchase agreements less debt
issuance costs
December 31, 2017
December 31, 2016
Balance
Weighted
Average
Interest Rate
Balance
Weighted
Average
Interest Rate
$
6,161,008
2.39% $
7,284,062
453,899
—
2.76
—
1,188,416
—
$
6,614,907
2.42% $
8,472,478
206
210
$
6,614,701
$
8,472,268
1.77%
1.91
—
1.79%
115
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following table presents contractual maturity information about the Company’s borrowings under repurchase agreements,
all of which are accounted for as secured borrowings, at December 31, 2017 and does not reflect the impact of derivative contracts
that hedge such repurchase agreements:
December 31, 2017
Contractual Maturity
(Dollars in Thousands)
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
U.S. Treasuries
CRT securities
MSR relates assets
Residential whole loans
Total (1)
Overnight
Within 30 Days
Over 30 Days
to 3 Months
Over 3 Months
to 12 Months
Over 12
months
Total
$
— $ 2,501,340
$
— $
— $
—
—
—
—
—
—
797,265
482,860
470,334
434,722
317,255
359,730
69,833
—
24,336
—
99,038
14,447
—
—
—
—
113,415
930,332
$
— $ 5,003,776
$
567,314
$ 1,043,817
$
— $ 2,501,340
—
1,256,033
—
—
—
—
567,140
470,334
459,058
317,255
—
1,043,747
— $ 6,614,907
Weighted Average Interest Rate
—%
2.09%
2.95%
3.69%
—%
2.42%
Gross amount of recognized liabilities for repurchase agreements in Note 8
Amounts related to repurchase agreements not included in offsetting disclosure in Note 8
$ 6,614,907
$
—
(1) Excludes $206,000 of unamortized debt issuance costs at December 31, 2017.
116
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The Company had repurchase agreements with 31 counterparties at both December 31, 2017 and 2016, respectively. The
following table presents information with respect to each counterparty under repurchase agreements for which the Company had
greater than 5% of stockholders’ equity at risk in the aggregate at December 31, 2017:
Counterparty
(Dollars in Thousands)
Goldman Sachs (3)
Wells Fargo (4)
RBC (5)
Credit Suisse (6)
UBS (7)
December 31, 2017
Counterparty
Rating (1)
Amount at
Risk (2)
BBB+/A3/A $
AA-/Aa2/AA-
AA-/A1/AA
BBB+/Aa2/A-
A+/A1/A+
239,473
189,015
186,652
171,449
167,390
Weighted
Average Months
to Maturity for
Repurchase
Agreements
Percent of
Stockholders’
Equity
5
5
1
2
5
7.3%
5.8
5.7
5.3
5.1
(1) As rated at December 31, 2017 by S&P, Moody’s and Fitch, Inc., respectively. The counterparty rating presented is the lowest published for
these entities.
(2) The amount at risk reflects the difference between (a) the amount loaned to the Company through repurchase agreements, including interest
payable, and (b) the cash and the fair value of the securities pledged by the Company as collateral, including accrued interest receivable on
such securities.
(3) Includes $186.4 million at risk with Goldman Sachs Lending Partners and $53.0 million at risk with Goldman Sachs Bank USA.
(4) Includes $178.8 million at risk with Wells Fargo Bank, NA and $10.2 million at risk with Wells Fargo Securities LLC.
(5) Includes $166.8 million at risk with RBC Barbados, $15.1 million at risk with Royal of Canada and $4.8 million at risk with RBC Capital
Markets LLC. Counterparty ratings are not published for RBC Barbados and RBS Capital Market LLC.
(6) Includes $139.5 million at risk with Credit Suisse AG, Cayman Islands and $31.9 million at risk with Credit Suisse. Counterparty ratings
are not published for Credit Suisse AG, Cayman Islands.
(7) Includes Non-Agency MBS pledged as collateral with contemporaneous repurchase and reverse repurchase agreements.
FHLB Advances
In January 2016, the Federal Housing Finance Agency released its final rule amending its regulation on FHLB membership,
which, among other things, provided termination rules for then current captive insurance members. As a result of such regulation,
MFA Insurance was required to repay all of its outstanding FHLB advances by February 19, 2017 and its FHLB membership was
terminated on such date. At December 31, 2016, MFA Insurance had $215.0 million in outstanding long-term secured FHLB
advances with a weighted average borrowing rate of 0.78%. Interest payable on outstanding FHLB advances at December 31,
2016 totaled approximately $42,000 and was included in Other liabilities on the Company’s consolidated balance sheets.
7.
Collateral Positions
The Company pledges securities or cash as collateral to its counterparties pursuant to its borrowings under repurchase
agreements and for initial margin payments on centrally cleared Swaps. In addition, the Company receives securities or cash as
collateral pursuant to financing provided under reverse repurchase agreements. The Company exchanges collateral with its
counterparties based on changes in the fair value, notional amount and term of the associated repurchase agreements and Swap
contracts, as applicable. In connection with these margining practices, either the Company or its counterparty may be required
to pledge cash or securities as collateral. When the Company’s pledged collateral exceeds the required margin, the Company
may initiate a reverse margin call, at which time the counterparty may either return the excess collateral, or provide collateral to
the Company in the form of cash or equivalent securities.
117
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following table summarizes the fair value of the Company’s collateral positions, which includes collateral pledged and
collateral held, with respect to its borrowings under repurchase agreements, reverse repurchase agreements, derivative hedging
instruments and FHLB advances at December 31, 2017 and 2016:
(In Thousands)
Derivative Hedging Instruments:
Agency MBS
Cash (1)
Repurchase Agreement Borrowings:
Agency MBS
Legacy Non-Agency MBS (2)(3)
RPL/NPL MBS
U.S. Treasury securities
CRT securities
MSR related assets
Residential whole loans
Cash (1)
FHLB Advances:
Agency MBS
Reverse Repurchase Agreements:
U.S. Treasury securities
December 31, 2017
December 31, 2016
Assets Pledged
Collateral Held
Assets Pledged
Collateral Held
$
21,756
$
— $
32,468
$
6,405
28,161
2,705,754
1,652,983
726,540
472,095
595,900
482,158
1,474,704
6,902
8,117,036
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
53,849
86,317
3,280,689
2,317,708
2,433,711
510,767
357,488
226,780
1,175,088
4,614
10,306,845
227,244
227,244
504,062
504,062
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
510,767
510,767
510,767
Total
$
8,145,197
$
504,062
$ 10,620,406
$
(1) Cash pledged as collateral is reported as “Restricted cash” on the Company’s consolidated balance sheets.
(2) Includes $172.4 million of Legacy Non-Agency MBS acquired in connection with resecuritization transactions from consolidated VIEs that
are eliminated from the Company’s consolidated balance sheets at December 31, 2016.
(3) In addition, at December 31, 2017 and 2016, $688.1 million and $688.2 million of Legacy Non-Agency MBS, respectively, are pledged as
collateral in connection with contemporaneous repurchase and reverse repurchase agreements entered into with a single counterparty.
118
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following table presents detailed information about the Company’s assets pledged as collateral pursuant to its borrowings
under repurchase agreements and other advances, and derivative hedging instruments at December 31, 2017:
December 31, 2017
Assets Pledged Under Repurchase
Agreements
Assets Pledged Against Derivative
Hedging Instruments
Fair Value
Amortized
Cost
Accrued
Interest on
Pledged
Assets
Fair Value/
Carrying
Value
Amortized
Cost
Accrued
Interest on
Pledged
Assets
$ 2,705,754
$ 2,724,736
$
7,069
$
21,756
$
22,476
$
(In Thousands)
Agency MBS
Legacy Non-Agency MBS (1)
1,652,983
1,268,702
6,132
RPL/NPL MBS
U.S. Treasuries
CRT securities
MSR related assets
726,540
472,095
595,900
482,158
723,719
542,642
481,354
Residential whole loans (2)
1,474,704
1,444,915
6,902
6,902
571
—
467
1,120
4,168
—
—
—
—
—
—
—
—
—
—
—
—
—
6,405
6,405
$ 8,117,036
$ 7,192,970
$
19,527
$
28,161
$
28,881
$
Cash (3)
Total
Total Fair
Value of
Assets
Pledged and
Accrued
Interest
$ 2,734,627
1,659,115
727,111
472,095
596,367
483,278
1,478,872
13,307
$ 8,164,772
48
—
—
—
—
—
—
—
48
(1) In addition, at December 31, 2017, $688.1 million of Legacy Non-Agency MBS are pledged as collateral in connection with contemporaneous
repurchase and reverse repurchase agreements entered into with a single counterparty.
(2) Includes residential whole loans held at carrying value with an aggregate fair value of $478.5 million and aggregate amortized cost of $448.7
million and residential whole loans held at fair value with an aggregate fair value and amortized cost of $996.2 million.
(3) Cash pledged as collateral is reported as “Restricted cash” on the Company’s consolidated balance sheets.
119
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
8. Offsetting Assets and Liabilities
The following tables present information about certain assets and liabilities that are subject to master netting arrangements
(or similar agreements) and may potentially be offset on the Company’s consolidated balance sheets at December 31, 2017 and
2016:
Offsetting of Financial Assets and Derivative Assets
(In Thousands)
December 31, 2017
Swaps, at fair value
Total
December 31, 2016
Swaps, at fair value
Total
Gross Amounts
of Recognized
Assets
Gross Amounts
Offset in the
Consolidated
Balance Sheets
Net Amounts of
Assets
Presented in
the
Consolidated
Balance Sheets
Gross Amounts Not Offset in
the Consolidated Balance Sheets
Financial
Instruments
Cash
Collateral
Received
Net Amount
$
$
$
$
679
679
233
233
$
$
$
$
— $
— $
— $
— $
679
679
233
233
$
$
$
$
(679) $
(679) $
(233) $
(233) $
— $
— $
— $
— $
—
—
—
—
Offsetting of Financial Liabilities and Derivative Liabilities
(In Thousands)
December 31, 2017
Swaps, at fair value (2)
Repurchase agreements and
other advances (3)(4)
Total
December 31, 2016
Swaps, at fair value (2)
Repurchase agreements and
other advances (3)(4)
Total
Gross
Amounts of
Recognized
Liabilities
Gross Amounts
Offset in the
Consolidated
Balance Sheets
Net Amounts of
Liabilities
Presented in
the
Consolidated
Balance Sheets
Gross Amounts Not Offset in the
Consolidated Balance Sheets
Financial
Instruments (1)
Cash
Collateral
Pledged (1)
Net Amount
$
— $
— $
— $
— $
— $
6,614,907
$ 6,614,907
$
—
6,614,907
— $ 6,614,907
(6,608,005)
$ (6,608,005) $
(6,902)
(6,902) $
$
46,954
$
— $
46,954
$
— $
(46,954) $
8,687,478
$ 8,734,432
$
—
8,687,478
— $ 8,734,432
(8,682,864)
$ (8,682,864) $
(4,614)
(51,568) $
—
—
—
—
—
—
(1) Amounts disclosed in the Financial Instruments column of the table above represent collateral pledged that is available to be offset against
liability balances associated with repurchase agreements and other advances, and derivative transactions. Amounts disclosed in the Cash
Collateral Pledged column of the table above represent amounts pledged as collateral against derivative transactions and repurchase
agreements, and exclude excess collateral of $6.4 million and $6.9 million at December 31, 2017 and 2016, respectively.
(2) The fair value of securities pledged against the Company’s Swaps was $21.8 million and $32.5 million at December 31, 2017 and 2016,
respectively. Beginning in January 2017, variation margin payments on the Company’s cleared Swaps 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 fair value of the Swap.
(3) The fair value of financial instruments pledged against the Company’s repurchase agreements and other advances was $8.1 billion and $10.5
billion at December 31, 2017 and 2016, respectively.
(4) Excludes $206,000 and $210,000 of unamortized debt issuance costs at December 31, 2017 and 2016, respectively.
120
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Nature of Setoff Rights
In the Company’s consolidated balance sheets, all balances associated with the repurchase agreement and Swap transactions
that are not centrally cleared are presented on a gross basis.
Certain of the Company’s repurchase agreement and derivative transactions are governed by underlying agreements that
generally provide for a right of setoff in the event of default or in the event of a bankruptcy of either party to the transaction. For
one repurchase agreement counterparty, the underlying agreements provide for an unconditional right of setoff.
9. Other Liabilities
The following table presents the components of the Company’s Other liabilities at December 31, 2017 and 2016:
(In Thousands)
Securitized debt (1)
Senior Notes
Dividends and dividend equivalents payable
Accrued interest payable
Swaps, at fair value (2)
Accrued expenses and other liabilities
Total Other Liabilities
December 31, 2017
December 31, 2016
$
$
363,944
$
96,773
79,771
12,263
—
21,584
—
96,733
74,657
14,129
46,954
19,612
574,335
$
252,085
(1) Securitized debt represents third-party liabilities of consolidated VIEs and excludes liabilities of the VIEs acquired by the Company that are
eliminated in consolidation. The third-party beneficial interest holders in the VIEs have no recourse to the general credit of the Company.
(See Notes 10 and 15 for further discussion.)
(2) Beginning in January 2017, variation margin payments on the Company’s cleared Swaps 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 fair value of the Swap.
Senior Notes
On April 11, 2012, the Company issued $100.0 million in aggregate principal amount of its Senior Notes in an underwritten
public offering. The total net proceeds to the Company from the offering of the Senior Notes were approximately $96.6 million,
after deducting offering expenses and the underwriting discount. The Senior Notes bear interest at a fixed rate of 8.00% per year,
paid quarterly in arrears on January 15, April 15, July 15 and October 15 of each year and will mature on April 15, 2042. The
Senior Notes have an effective interest rate, including the impact of amortization to interest expense of debt issuance costs, of
8.31%. The Company may redeem the Senior Notes, in whole or in part, at any time on or after April 15, 2017, at a redemption
price equal to 100% of the principal amount redeemed plus accrued and unpaid interest to, but not excluding, the redemption date.
The Senior Notes are the Company’s senior unsecured obligations and are subordinate to all of the Company’s secured
indebtedness, which includes the Company’s repurchase agreements, obligation to return securities obtained as collateral, and
other financing arrangements, to the extent of the value of the collateral securing such indebtedness.
121
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
10. Commitments and Contingencies
(a) Lease Commitments
The Company pays monthly rent pursuant to two operating leases. The lease term for the Company’s headquarters in New
York, New York extends through June 30, 2020. The lease provides for aggregate cash payments ranging over time of approximately
$2.6 million per year, paid on a monthly basis, exclusive of escalation charges. In addition, as part of this lease agreement, the
Company has provided the landlord a $785,000 irrevocable standby letter of credit fully collateralized by cash. The letter of credit
may be drawn upon by the landlord in the event that the Company defaults under certain terms of the lease. In addition, the
Company has a lease through December 31, 2021 for its off-site back-up facility located in Rockville Centre, New York, which
provides for, among other things, lease payments totaling $32,000, annually.
The Company recognized lease expense of $2.7 million, $2.5 million and $2.6 million for the years ended December 31,
2017, 2016 and 2015, respectively, which is included in Other general and administrative expense within the consolidated statements
of operations. At December 31, 2017, the contractual minimum rental payments (exclusive of possible rent escalation charges
and normal recurring charges for maintenance, insurance and taxes) were as follows:
Year Ended December 31,
Minimum Rental Payments
(In Thousands)
2018
2019
2020
2021
2022
Total
$
$
2,553
2,553
1,082
32
—
6,220
(b) Corporate Loan
The Company has entered into a loan agreement with an entity that originates loans and owns the related MSRs. The loan
is secured by certain U.S. Government, Agency and private-label MSRs, as well as other unencumbered assets owned by the
borrower. Under the terms of the loan agreement, the Company has committed to lend $130.0 million of which approximately
$111.2 million was drawn at December 31, 2017.
(c) Representations and Warranties in Connection with Loan Securitization Transactions
In connection with the loan securitization transactions entered into by the Company in 2017 (See Note 15 for further
discussion), the Company has the obligation under certain circumstances to repurchase assets previously transferred to securitization
vehicles upon breach of certain representations and warranties. As of December 31, 2017, the Company had no reserve established
for repurchases of loans and was not aware of any material unsettled repurchase claims that would require the establishment of
such a reserve.
11. Stockholders’ Equity
(a) Preferred Stock
On April 15, 2013, the Company completed the issuance of 8.0 million shares of its 7.50% Series B Cumulative Redeemable
Preferred Stock (“Series B Preferred Stock”) with a par value of $0.01 per share, and a liquidation preference of $25.00 per share
plus accrued and unpaid dividends, in an underwritten public offering. The Company’s Series B Preferred Stock is entitled to
receive a dividend at a rate of 7.50% per year on the $25.00 liquidation preference before the Company’s common stock is paid
any dividends and is senior to the Company’s common stock with respect to distributions upon liquidation, dissolution or winding
up. Dividends on the Series B Preferred Stock are payable quarterly in arrears on or about March 31, June 30, September 30 and
December 31 of each year. The Series B Preferred Stock is redeemable at $25.00 per share plus accrued and unpaid dividends
(whether or not authorized or declared) exclusively at the Company’s option commencing on April 15, 2018 (subject to the
Company’s right, under limited circumstances, to redeem the Series B Preferred Stock prior to that date in order to preserve its
122
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
qualification as a REIT) and upon certain specified change in control transactions in which the Company’s common stock and the
acquiring or surviving entity common securities would not be listed on the New York Stock Exchange (the “NYSE”), the NYSE
American LLC or NASDAQ, or any successor exchange.
The Series B Preferred Stock generally does not have any voting rights, subject to an exception in the event the Company
fails to pay dividends on such stock for six or more quarterly periods (whether or not consecutive). Under such circumstances,
the Series B Preferred Stock will be entitled to vote to elect two additional directors to the Company’s Board of Directors (the
“Board”), until all unpaid dividends have been paid or declared and set apart for payment. In addition, certain material and adverse
changes to the terms of the Series B Preferred Stock cannot be made without the affirmative vote of holders of at least 66 2/3%
of the outstanding shares of Series B Preferred Stock.
The following table presents cash dividends declared by the Company on its Series B Preferred Stock from January 1, 2015
through December 31, 2017:
Year
2017
Declaration Date
Record Date
Payment Date
Dividend Per Share
November 17, 2017
December 1, 2017
December 29, 2017
August 10, 2017
September 1, 2017
September 29, 2017
May 16, 2017
June 2, 2017
February 17, 2017
March 6, 2017
June 30, 2017
March 31, 2017
$0.46875
0.46875
0.46875
0.46875
$0.46875
0.46875
0.46875
0.46875
$0.46875
0.46875
0.46875
0.46875
2016
November 22, 2016
December 6, 2016
December 30, 2016
August 12, 2016
September 2, 2016
September 30, 2016
May 18, 2016
June 3, 2016
June 30, 2016
February 12, 2016
February 29, 2016
March 31, 2016
2015
November 19, 2015
December 3, 2015
December 31, 2015
August 24, 2015
September 9, 2015
September 30, 2015
May 18, 2015
June 2, 2015
June 30, 2015
February 13, 2015
February 27, 2015
March 31, 2015
123
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
(b) Dividends on Common Stock
The following table presents cash dividends declared by the Company on its common stock from January 1, 2015 through
December 31, 2017:
Year
2017
Declaration Date
Record Date
Payment Date
Dividend Per Share
December 13, 2017
December 28, 2017
January 31, 2018
$0.20
(1)
September 14, 2017
September 28, 2017
October 31, 2017
June 12, 2017
March 8, 2017
June 29, 2017
March 29, 2017
July 28, 2017
April 28, 2017
2016
December 14, 2016
December 28, 2016
January 31, 2017
September 15, 2016
September 28, 2016
October 31, 2016
June 14, 2016
March 11, 2016
June 28, 2016
March 28, 2016
July 29, 2016
April 29, 2016
2015
December 9, 2015
December 28, 2015
January 29, 2016
September 17, 2015
September 29, 2015
October 30, 2015
June 15, 2015
March 13, 2015
June 29, 2015
March 27, 2015
July 31, 2015
April 30, 2015
0.20
0.20
0.20
$0.20
0.20
0.20
0.20
$0.20
0.20
0.20
0.20
(1) At December 31, 2017, the Company had accrued dividends and dividend equivalents payable of $79.8 million related to the common stock
dividend declared on December 13, 2017.
In general, the Company’s common stock dividends have been characterized as ordinary income to its stockholders for income
tax purposes. However, a portion of the Company’s common stock dividends may, from time to time, be characterized as capital
gains or return of capital. For the years ended December 31, 2017, 2016 and 2015 a portion of the Company’s common stock
dividends were deemed to be capitalized gains.
(c) Public Offering of Common Stock
The table below presents information with respect to shares of the Company’s common stock issued through public offerings
during the year ended December 31, 2017. The Company did not issue any common stock through public offerings during the
years ended December 31, 2016 and 2015.
Share Issue Date
Shares Issued
Gross Proceeds
Per Share
Gross Proceeds (1)
(In Thousands, Except Per Share Amounts)
May 10, 2017
23,000
$
7.85
$
180,550 (1)
(1) The Company incurred approximately $2.3 million of underwriting discounts and related expenses in connection with this equity offering.
(d) Discount Waiver, Direct Stock Purchase and Dividend Reinvestment Plan (“DRSPP”)
On September 16, 2016, the Company filed a shelf registration statement on Form S-3 with the SEC under the Securities Act
of 1933, as amended (the “1933 Act”), for the purpose of registering additional common stock for sale through its DRSPP. Pursuant
to Rule 462(e) of the 1933 Act, this shelf registration statement became effective automatically upon filing with the SEC and,
when combined with the unused portion of the Company’s previous DRSPP shelf registration statements, registered an aggregate
of 15 million shares of common stock. The Company’s DRSPP is designed to provide existing stockholders and new investors
with a convenient and economical way to purchase shares of common stock through the automatic reinvestment of dividends and/
or optional cash investments. At December 31, 2017, 12.0 million shares of common stock remained available for issuance pursuant
to the DRSPP shelf registration statement.
124
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
During the years ended December 31, 2017, 2016 and 2015, the Company issued 2,293,192, 653,793 and 162,373 shares of
common stock through the DRSPP, raising net proceeds of approximately $18.5 million, $4.7 million and $1.2 million, respectively.
From the inception of the DRSPP in September 2003 through December 31, 2017, the Company issued 33,675,977 shares pursuant
to the DRSPP, raising net proceeds of $281.4 million.
(e) Stock Repurchase Program
As previously disclosed, in August 2005, the Company’s Board authorized a stock repurchase program (the “Repurchase
Program”) to repurchase up to 4.0 million shares of its outstanding common stock. The Board reaffirmed such authorization in
May 2010. In December 2013, the Board increased the number of shares authorized under the Repurchase Program to an aggregate
of 10.0 million. Such authorization does not have an expiration date and, at present, there is no intention to modify or otherwise
rescind such authorization. Subject to applicable securities laws, repurchases of common stock under the Repurchase Program
are made at times and in amounts as the Company deems appropriate, (including, in our discretion, through the use of one or more
plans adopted under Rule 10b5-1 promulgated under the Securities Exchange Act of 1934, as amended (the “1934 Act”)) using
available cash resources. Shares of common stock repurchased by the Company under the Repurchase Program are cancelled and,
until reissued by the Company, are deemed to be authorized but unissued shares of the Company’s common stock. The Repurchase
Program may be suspended or discontinued by the Company at any time and without prior notice. The Company did not repurchase
any shares of its common stock during the three years ended December 31, 2017. At December 31, 2017, 6,616,355 shares remained
authorized for repurchase under the Repurchase Program.
(f) Accumulated Other Comprehensive Income/(Loss)
The following table presents changes in the balances of each component of the Company’s AOCI for the years ended
December 31, 2017, 2016 and 2015:
For the Year Ended December 31,
Net
Unrealized
Gain/
(Loss) on
AFS
Securities
2017
Net
Unrealized
Gain/
(Loss)
on Swaps
Net
Unrealized
Gain/
(Loss) on
AFS
Securities
2016
Net
Unrealized
Gain/
(Loss)
on Swaps
Total
AOCI
Net
Unrealized
Gain/
(Loss) on
AFS
Securities
2015
Net
Unrealized
Gain/
(Loss)
on Swaps
Total
AOCI
Total
AOCI
(In Thousands)
Balance at beginning of period
$ 620,403
$ (46,721) $573,682
$ 585,250
$ (69,399) $515,851
$ 813,515
$ (59,062) $754,453
OCI before reclassifications
39,984
35,297
75,281
72,560
22,678
95,238
(194,890)
(10,337)
(205,227)
Amounts reclassified from
AOCI (1)
Cumulative effect adjustment
on adoption of revised
accounting standard for
repurchase agreement
financing
(39,739)
— (39,739)
(37,407)
— (37,407)
(37,912)
— (37,912)
—
—
—
—
—
—
4,537
—
4,537
Net OCI during period (2)
245
35,297
35,542
35,153
22,678
57,831
(228,265)
(10,337)
(238,602)
Balance at end of period
$ 620,648
$ (11,424) $609,224
$ 620,403
$ (46,721) $573,682
$ 585,250
$ (69,399) $515,851
(1) See separate table below for details about these reclassifications.
(2) For further information regarding changes in OCI, see the Company’s consolidated statements of comprehensive income/(loss).
125
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following table presents information about the significant amounts reclassified out of the Company’s AOCI for the years
ended December 31, 2017, 2016, and 2015:
Details about AOCI Components
Amounts Reclassified from AOCI
Affected Line Item in the Statement
Where Net Income is Presented
For the Year Ended December 31,
2017
2016
2015
(In Thousands)
AFS Securities:
Realized gain on sale of securities
OTTI recognized in earnings
Total AFS Securities
Total reclassifications for period
$
$
$
(38,707) $
(36,922) $
(37,207)
(1,032)
(39,739) $
(39,739) $
(485)
(37,407) $
(37,407) $
(705)
(37,912)
(37,912)
Net gain on sales of MBS and
U.S. Treasury securities
Net impairment losses
recognized in earnings
On securities for which OTTI had been recognized in prior periods, the Company did not have any unrealized losses recorded
in AOCI at December 31, 2017 and had $1.7 million unrealized losses recorded in AOCI at December 31, 2016.
12. EPS Calculation
The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted EPS for the
years ended December 31, 2017, 2016 and 2015:
(In Thousands, Except Per Share Amounts)
Numerator:
Net income
Dividends declared on preferred stock
Dividends, dividend equivalents and undistributed earnings allocated to
participating securities
Net income available to common stockholders - basic and diluted
Denominator:
Weighted average common shares for basic and diluted earnings per share (1)
Basic and diluted earnings per share
For the Year Ended December 31,
2017
2016
2015
322,393
(15,000)
(1,708)
305,685
$
$
312,668
(15,000)
(1,628)
296,040
$
$
313,226
(15,000)
(1,539)
296,687
388,357
371,122
372,114
0.79
$
0.80
$
0.80
$
$
$
(1) At December 31, 2017, the Company had approximately 2.2 million equity instruments outstanding that were not included in the calculation
of diluted EPS for the year ended December 31, 2017, as their inclusion would have been anti-dilutive. These equity instruments reflect
RSUs (based on current estimate of expected share settlement amount) with a weighted average grant date fair value of $6.43. These equity
instruments may have a dilutive impact on future EPS.
13. Equity Compensation, Employment Agreements and Other Benefit Plans
(a) Equity Compensation Plan
In accordance with the terms of the Company’s Equity Compensation Plan (the “Equity Plan”), which was adopted by the
Company’s stockholders on May 21, 2015 (and which amended and restated the Company’s 2010 Equity Compensation Plan),
directors, officers and employees of the Company and any of its subsidiaries and other persons expected to provide significant
services for the Company and any of its subsidiaries are eligible to receive grants of stock options (“Options”), restricted stock,
RSUs, dividend equivalent rights and other stock-based awards under the Equity Plan.
126
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Subject to certain exceptions, stock-based awards relating to a maximum of 12.0 million shares of common stock may be
granted under the Equity Plan; forfeitures and/or awards that expire unexercised do not count towards this limit. At December 31,
2017, approximately 6.7 million shares of common stock remained available for grant in connection with stock-based awards
under the Equity Plan. A participant may generally not receive stock-based awards in excess of 1.5 million shares of common
stock in any one year and no award may be granted to any person who, assuming exercise of all Options and payment of all awards
held by such person, would own or be deemed to own more than 9.8% of the outstanding shares of the Company’s common stock.
Unless previously terminated by the Board, awards may be granted under the Equity Plan until May 20, 2025.
Restricted Stock Units
Under the terms of the Equity Plan, RSUs are instruments that provide the holder with the right to receive, subject to the
satisfaction of conditions set by the Compensation Committee of the Board (the “Compensation Committee”) at the time of grant,
a payment of a specified value, which may be a share of the Company’s common stock, the fair market value of a share of the
Company’s common stock, or such fair market value to the extent in excess of an established base value, on the applicable settlement
date. Although the Equity Plan permits the Company to issue RSUs that can settle in cash, all of the Company’s outstanding RSUs
as of December 31, 2017 are designated to be settled in shares of the Company’s common stock. All RSUs outstanding at
December 31, 2017 may be entitled to receive dividend equivalent payments depending on the terms and conditions of the award
either in cash at the time dividends are paid by the Company, or for certain performance-based RSU awards, as a grant of stock
at the time such awards are settled. At December 31, 2017 and 2016, the Company had unrecognized compensation expense of
$4.1 million and $3.6 million, respectively, related to RSUs. The unrecognized compensation expense at December 31, 2017 is
expected to be recognized over a weighted average period of 1.8 years.
127
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following table presents information with respect to the Company’s RSUs during the years ended December 31, 2017,
2016 and 2015:
For the Year Ended December 31, 2017
RSUs With
Service
Condition
Weighted
Average
Grant Date
Fair Value
RSUs With
Market and
Service
Conditions
Weighted
Average
Grant Date
Fair Value
Total
RSUs
Total
Weighted
Average
Grant Date
Fair Value
Outstanding at beginning of year:
1,194,299
$
Granted (1)
Settled
Cancelled/forfeited
447,695
(616,966)
—
Outstanding at end of year
1,025,028
RSUs vested but not settled at
end of year
RSUs unvested at end of year
586,419
438,609
$
$
$
7.38
7.96
7.32
—
7.67
7.98
7.25
863,800
$
451,250
(293,800)
—
1,021,250
275,000
746,250
$
$
$
5.45
6.48
5.83
—
5.80
5.73
5.82
2,058,099
$
898,945
(910,766)
—
2,046,278
861,419
1,184,859
$
$
$
6.57
7.22
6.84
—
6.73
7.26
6.35
For the Year Ended December 31, 2016
RSUs With
Service
Condition
Weighted
Average
Grant Date
Fair Value
RSUs With
Market and
Service
Conditions
Weighted
Average
Grant Date
Fair Value
Total
RSUs
Total
Weighted
Average
Grant Date
Fair Value
Outstanding at beginning of year:
1,138,930
$
Granted (2)
Settled
Cancelled/forfeited
420,695
(360,326)
(5,000)
Outstanding at end of year
1,194,299
RSUs vested but not settled at
end of year
RSUs unvested at end of year
617,518
576,781
$
$
$
7.71
6.81
7.75
7.32
7.38
7.45
7.30
736,800
$
307,500
(175,500)
(5,000)
863,800
293,800
570,000
$
$
$
5.66
4.81
5.21
5.27
5.45
5.83
5.25
1,875,730
$
728,195
(535,826)
(10,000)
2,058,099
911,318
1,146,781
$
$
$
6.90
5.96
6.92
6.29
6.57
6.93
6.28
Outstanding at beginning of year:
Granted (3)
Settled
Cancelled/forfeited
RSUs With
Service
Condition
769,174
390,804
(17,298)
(3,750)
Outstanding at end of year
1,138,930
RSUs vested but not settled at
end of year
RSUs unvested at end of year
554,023
584,907
For the Year Ended December 31, 2015
Weighted
Average
Grant Date
Fair Value
RSUs With
Market and
Service
Conditions
Weighted
Average
Grant Date
Fair Value
Total
RSUs
Total
Weighted
Average
Grant Date
Fair Value
$
$
$
$
7.55
7.96
6.60
7.97
7.71
7.83
7.59
449,300
291,250
—
(3,750)
736,800
175,500
561,300
$
$
$
$
5.61
5.73
—
5.73
5.66
5.21
5.80
1,218,474
$
682,054
(17,298)
(7,500)
1,875,730
729,523
1,146,207
$
$
$
6.84
7.01
6.60
6.85
6.90
7.20
6.71
(1) The weighted average grant date fair value of these awards require the Company to estimate certain valuation inputs. In determining the
fair value for 758,750 of these awards granted in 2017, the Company applied: (i) a weighted average volatility estimate of approximately
15%, which was determined considering historic volatility in the price of the Company’s and its peer group companies’ common stock over
the three-year period prior to the grant date and the implied volatility of certain exchange-traded options on the Company’s and peer group
companies’ common stock at the grant date; and (ii) a weighted average risk-free rate of 1.46% based on the continuously compounded
128
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
constant maturity treasury rate corresponding to a maturity commensurate with the expected vesting term of the awards. The weighted
average grant date fair value for the remaining 140,195 awards with a service condition only was estimated based on the closing price of
the Company’s common stock at the grant date of $8.31. There are no post vesting conditions on these awards.
(2) The weighted average grant date fair value of these awards require the Company to estimate certain valuation inputs. In determining the
fair value for 615,000 of these awards granted in 2016, the Company applied: (i) a weighted average volatility estimate of approximately
17%, which was determined considering historic volatility in the price of Company’s common stock over the three-year period prior to the
grant date and the implied volatility of certain exchange-traded options on the Company’s common stock at the grant date; (ii) a weighted
average risk-free rate of 1.20% based on the continuously compounded constant maturity treasury rate corresponding to a maturity
commensurate with the expected vesting term of the awards; and (iii) an estimated annual dividend yield of 11%. The weighted average
grant date fair value for the remaining 113,195 awards with a service condition only was estimated based on the closing price of the Company’s
common stock at the grant date of $7.20. There are no post vesting conditions on these awards.
(3) The weighted average grant date fair value of these awards require the Company to estimate certain valuation inputs. In determining the
fair value for 582,500 of these awards granted in 2015, the Company applied: (i) a weighted average volatility estimate of approximately
18%, which was determined considering historic volatility in the price of Company’s common stock over the three-year period prior to the
grant date and the implied volatility of certain exchange-traded options on the Company’s common stock at the grant date; (ii) a weighted
average risk-free rate of 0.90% based on the continuously compounded constant maturity treasury rate corresponding to a maturity
commensurate with the expected vesting term of the awards; and (iii) an estimated annual dividend yield of 9%. The weighted average grant
date fair value for the remaining 99,554 awards with a service condition only was estimated based on the closing price of the Company’s
common stock at the grant date ranging from $7.93 to $7.97. There are no post vesting conditions on these awards.
Restricted Stock
At December 31, 2017, the Company did not have any unvested shares of restricted common stock outstanding. At
December 31, 2016, the Company had unrecognized compensation expense of approximately $203,000 and had accrued dividends
payable of approximately $55,000 related to unvested shares of restricted stock, respectively. The total fair value of restricted
shares vested during the years ended December 31, 2017, 2016 and 2015 was approximately $2.0 million, $4.3 million and $4.3
million, respectively.
The following table presents information with respect to the Company’s restricted stock for the years ended December 31,
2017, 2016 and 2015:
For the Year Ended December 31,
2017
2016
2015
Shares of
Restricted
Stock
Weighted
Average
Grant Date
Fair Value (1)
Shares of
Restricted
Stock
Weighted
Average
Grant Date
Fair Value (1)
Shares of
Restricted
Stock
Weighted
Average
Grant Date
Fair Value (1)
Outstanding at beginning of year:
28,968
$
Granted
Vested (2)
Cancelled/forfeited
Outstanding at end of year
214,859
(243,827)
—
— $
7.12
8.06
7.95
—
—
110,920
$
487,216
(567,851)
(1,317)
28,968
$
7.41
7.66
7.64
7.12
7.12
243,948
$
497,007
(629,212)
(823)
110,920
$
7.48
6.83
6.98
7.74
7.41
(1) The grant date fair value of restricted stock awards is based on the closing market price of the Company’s common stock at the grant date.
(2) All restrictions associated with restricted stock are removed on vesting.
Dividend Equivalents
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 Equity Plan, and they are paid in cash or other consideration at such times and
in accordance with such rules, as the Compensation Committee of the Board shall determine in its discretion. Payments made on
the Company’s outstanding dividend equivalent rights that have been granted as a separate instrument are charged to Stockholders’
Equity when common stock dividends are declared to the extent that such equivalents are expected to vest. The Company did not
make any payments in respect of such instruments during the year ended December 31, 2017 and made payments of approximately
$5,000 and $16,000 during the years ended December 31, 2016 and 2015, respectively.
129
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following table presents information about the Company’s dividend equivalents rights awarded as separate instruments
at and for each of the years ended December 31, 2016 and 2015. No such awards were granted during 2017:
Outstanding at beginning of year:
Granted
Cancelled, forfeited or expired
Outstanding at end of year
For the Year Ended December 31,
2016
2015
Number of Dividend Equivalent Rights
8,215
—
(8,215)
—
24,402
—
(16,187)
8,215
The weighted average grant date fair value of the dividend equivalent rights in the above table is $2.77. The determination
of the weighted average grant date fair value of these awards required the Company to estimate certain valuation inputs. In
determining the fair value for these awards granted in 2011, the Company applied: (i) a weighted average volatility estimate of
approximately 31%, which was determined considering historic volatility in the price of Company’s common stock over the six-
year period prior to the grant date and the implied volatility of certain exchange-traded options on the Company’s common stock
at the grant date; (ii) a weighted average risk-free rate of 2.23% based on the continuously compounded constant maturity treasury
rate corresponding to a maturity commensurate with the expected vesting term of the awards; and (iii) an estimated annual dividend
yield of 13%.
Options
The Company did not grant any stock options during the three years ended December 31, 2017. At December 31, 2017, the
Company had no Options outstanding.
Expense Recognized for Equity-Based Compensation Instruments
The following table presents the Company’s expenses related to its equity-based compensation instruments for the years
ended December 31, 2017, 2016 and 2015:
(In Thousands)
RSUs (1)
Restricted shares of common stock
Dividend equivalent rights
Total
For the Year Ended December 31,
2017
2016
2015
$
$
6,098
$
4,792
$
1,935
—
4,326
44
8,033
$
9,162
$
3,377
4,373
82
7,832
(1) Equity-based compensation for the year ended December 31, 2017 includes a one-time expense of approximately $900,000 for the accelerated
vesting of certain time-based equity awards arising from the death of the Company’s former Chief Executive Officer.
(b) Employment Agreements
At December 31, 2017, the Company had employment agreements with three of its officers, with varying terms that provide
for, among other things, base salary, bonus and change-in-control payments upon the occurrence of certain triggering events.
(c) Deferred Compensation Plans
The Company administers deferred compensation plans for its senior officers and non-employee directors (collectively, the
“Deferred Plans”), pursuant to which participants may elect to defer up to 100% of certain cash compensation. The Deferred Plans
are designed to align participants’ interests with those of the Company’s stockholders.
130
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Amounts deferred under the Deferred Plans are considered to be converted into “stock units” of the Company. Stock units
do not represent stock of the Company, but rather are a liability of the Company that changes in value as would equivalent shares
of the Company’s common stock. Deferred compensation liabilities are settled in cash at the termination of the deferral period,
based on the value of the stock units at that time. The Deferred Plans are non-qualified plans under the Employee Retirement
Income Security Act of 1974 and, as such, are not funded. Prior to the time that the deferred accounts are settled, participants are
unsecured creditors of the Company.
The Company’s liability for stock units in the Deferred Plans is based on the market price of the Company’s common stock
at the measurement date. The following table presents the Company’s expenses related to its Deferred Plans for its non-employee
directors and senior officers for the years ended December 31, 2017, 2016 and 2015:
(In Thousands)
Non-employee directors
Total
For the Year Ended December 31,
2017
2016
2015
$
$
171
171
$
$
231
231
$
$
(59)
(59)
The Company did not distribute cash to the participants of the Deferred Plans during the year ended December 31, 2017.
The Company distributed cash of $122,000 and $109,000 to the participants of the Deferred Plans during the years ended
December 31, 2016 and 2015, respectively. The following table presents the aggregate amount of income deferred by participants
of the Deferred Plans through December 31, 2017 and 2016 that had not been distributed and the Company’s associated liability
for such deferrals at December 31, 2017 and 2016:
(In Thousands)
Non-employee directors
Total
December 31, 2017
December 31, 2016
Undistributed
Income
Deferred (1)
$
$
1,688
1,688
Liability Under
Deferred Plans
2,056
$
2,056
$
$
$
Undistributed
Income
Deferred (1)
1,066
1,066
Liability Under
Deferred Plans
1,263
$
1,263
$
(1) Represents the cumulative amounts that were deferred by participants through December 31, 2017 and 2016, which had not been distributed
through such respective date.
(d) Savings Plan
The Company sponsors a tax-qualified employee savings plan (the “Savings Plan”) in accordance with Section 401(k) of the
Code. Subject to certain restrictions, all of the Company’s employees are eligible to make tax deferred contributions to the Savings
Plan subject to limitations under applicable law. Participant’s accounts are self-directed and the Company bears the costs of
administering the Savings Plan. The Company matches 100% of the first 3% of eligible compensation deferred by employees and
50% of the next 2%, subject to a maximum as provided by the Code. The Company has elected to operate the Savings Plan under
the applicable safe harbor provisions of the Code, whereby among other things, the Company must make contributions for all
participating employees and all matches contributed by the Company immediately vest 100%. For the years ended December 31,
2017, 2016 and 2015, the Company recognized expenses for matching contributions of $363,000, $359,000 and $309,000,
respectively.
131
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
14. Fair Value of Financial Instruments
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant
to the fair value measurement. The three levels of valuation hierarchy are defined as follows:
Level 1 — Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 — Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and
inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 — Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The following describes the valuation methodologies used for the Company’s financial instruments measured at fair value on
a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.
Securities Obtained and Pledged as Collateral/Obligation to Return Securities Obtained as Collateral
The fair value of U.S. Treasury securities obtained as collateral and the associated obligation to return securities obtained as
collateral are based upon prices obtained from a third-party pricing service, which are indicative of market activity. Securities
obtained as collateral are classified as Level 1 in the fair value hierarchy.
MBS and CRT Securities
The Company determines the fair value of its Agency MBS, based upon prices obtained from third-party pricing services,
which are indicative of market activity and repurchase agreement counterparties.
For Agency MBS, the valuation methodology of the Company’s third-party pricing services incorporate commonly used
market pricing methods, trading activity observed in the marketplace and other data inputs. The methodology also considers the
underlying characteristics of each security, which are also observable inputs, including: collateral vintage, coupon, maturity date,
loan age, reset date, collateral type, periodic and life cap, geography, and prepayment speeds. Management analyzes pricing data
received from third-party pricing services and compares it to other indications of fair value including data received from repurchase
agreement counterparties and its own observations of trading activity observed in the marketplace.
In determining the fair value of its Non-Agency MBS and CRT securities, management considers a number of observable
market data points, including prices obtained from pricing services and brokers as well as dialogue with market participants. In
valuing Non-Agency MBS, the Company understands that pricing services use observable inputs that include, in addition to trading
activity observed in the marketplace, loan delinquency data, credit enhancement levels and vintage, which are taken into account
to assign pricing factors such as spread and prepayment assumptions. For tranches of Legacy Non-Agency MBS that are cross-
collateralized, performance of all collateral groups involved in the tranche are considered. The Company collects and considers
current market intelligence on all major markets, including benchmark security evaluations and bid-lists from various sources, when
available.
The Company’s Legacy Non-Agency MBS, RPL/NPL MBS and CRT securities are valued using various market data points
as described above, which management considers directly or indirectly observable parameters. Accordingly, these securities are
classified as Level 2 in the fair value hierarchy.
132
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Term Notes Backed by MSR Related Collateral
The Company’s valuation process for term notes backed by MSR related collateral 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 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. At December 31, 2017, the indicative implied yields used in the valuation of these securities ranged from 5.8% to 6.6%.
The weighted average indicative yield to maturity was 6.12%. 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, who 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. As this process includes significant unobservable inputs, these securities are classified as Level 3
in the fair value hierarchy.
Residential Whole Loans, at Fair Value
The Company determines the fair value of its residential whole loans held at fair value after considering valuations obtained
from a third-party who specializes in providing valuations of residential mortgage loans trading activity observed in the marketplace.
The Company’s residential whole loans held at fair value are classified as Level 3 in the fair value hierarchy.
Swaps
As of December 31, 2017, all of the Company’s Swaps are cleared by a central clearing house. Valuations provided by the
clearing house are used for purposes of determining the fair value of the Company’s Swaps. Such valuations obtained are tested
with internally developed models that apply readily observable market parameters. As the Company’s Swaps are subject to the
clearing house’s margin requirements, no credit valuation adjustment was considered necessary in determining the fair value of
such instruments. Beginning in January 2017, variation margin payments on the Company’s cleared Swaps 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 fair value of the Swap.
Swaps are classified as Level 2 in the fair value hierarchy.
Changes to the valuation methodologies used with respect to the Company’s financial instruments are reviewed by management
to ensure any such changes result in appropriate exit price valuations. The Company will refine its valuation methodologies as
markets and products develop and pricing methodologies evolve. The methods described above may produce fair value estimates
that may not be indicative of net realizable value or reflective of future fair values. Furthermore, while the Company believes its
valuation methods are appropriate and consistent with those used by market participants, the use of different methodologies, or
assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the
reporting date. The Company uses inputs that are current as of the measurement date, which may include periods of market
dislocation, during which price transparency may be reduced. The Company reviews the classification of its financial instruments
within the fair value hierarchy on a quarterly basis, and management may conclude that its financial instruments should be reclassified
to a different level in the future.
133
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following tables present the Company’s financial instruments carried at fair value on a recurring basis as of
December 31, 2017 and 2016, on the consolidated balance sheets by the valuation hierarchy, as previously described:
Fair Value at December 31, 2017
(In Thousands)
Assets:
Agency MBS
Non-Agency MBS
CRT securities
Term notes backed by MSR related collateral
Residential whole loans, at fair value
Securities obtained and pledged as collateral
Swaps
Total assets carried at fair value
Liabilities:
Swaps
Obligation to return securities obtained as collateral
Total liabilities carried at fair value
Level 1
Level 2
Level 3
Total
$
— $
2,824,681
$
— $
2,824,681
—
—
—
—
504,062
—
3,533,966
664,403
—
—
—
679
—
—
381,804
1,325,115
—
—
3,533,966
664,403
381,804
1,325,115
504,062
679
504,062
$
7,023,729
$
1,706,919
$
9,234,710
— $
504,062
504,062
$
— $
—
— $
— $
—
— $
—
504,062
504,062
$
$
$
Fair Value at December 31, 2016
(In Thousands)
Assets:
Agency MBS
Non-Agency MBS, including MBS transferred to
consolidated VIEs
CRT securities
Term notes backed by MSR related collateral
Residential whole loans, at fair value
Securities obtained and pledged as collateral
Swaps
Total assets carried at fair value
Liabilities:
Swaps
Obligation to return securities obtained as collateral
Total liabilities carried at fair value
Level 1
Level 2
Level 3
Total
$
— $
3,738,497
$
— $
3,738,497
—
—
—
—
510,767
—
5,684,836
404,850
140,980
—
—
233
$
$
$
510,767
$
9,969,396
— $
46,954
510,767
—
510,767
$
46,954
$
$
$
—
—
—
814,682
—
—
5,684,836
404,850
140,980
814,682
510,767
233
814,682
$ 11,294,845
— $
—
— $
46,954
510,767
557,721
134
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis
The following table presents additional information for the years ended December 31, 2017 and 2016 about the Company’s
Residential whole loans, at fair value, which are classified as Level 3 and measured at fair value on a recurring basis:
(In Thousands)
Balance at beginning of period
Purchases and capitalized advances
Changes in fair value recorded in Net gain on residential whole
loans held at fair value
Collection of principal, net of liquidation gains/losses
Repurchases
Transfers to REO
Balance at end of period
Residential Whole Loans, at Fair Value
For the Year Ended December 31,
2017
2016
$
814,682
$
683,735
33,617
(87,072)
(2,716)
(117,131)
1,325,115
$
$
623,276
316,407
31,254
(66,694)
(2,909)
(86,652)
814,682
The following table presents additional information for the years ended December 31, 2017 and 2016 about the Company’s
investments in term notes backed by MSR related collateral held at fair value, which are classified as Level 3 and measured at fair
value on a recurring basis:
(In Thousands)
Balance at beginning of period
Purchases
Collection of principal
Changes in unrealized gain/losses
Transfers from Level 2 to Level 3 (1)
Balance at end of period
Term Notes Backed by MSR Related Collateral
Year Ended December 31,
2017 (1)
2016
$
$
— $
381,000
(140,980)
804
140,980
381,804
—
—
—
—
—
—
(1) Investments in term notes backed by MSR related collateral were transferred from Level 2 to Level 3 during the year ended December 31,
2017 as there has been very limited secondary market trading in these securities since issuance. Transfers between levels are deemed to take
place on the first day of the reporting period in which the transfer has taken place.
The Company did not transfer any assets or liabilities from one level to another during the year ended December 31, 2016.
135
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Fair Value Methodology for Level 3 Financial Instruments
Residential Whole Loans, at Fair Value
The following tables present a summary of quantitative information about the significant unobservable inputs used in the fair
value measurement of the Company’s residential whole loans held at fair value for which it has utilized Level 3 inputs to determine
fair value as of December 31, 2017 and 2016:
(Dollars in Thousands)
Fair Value (1)
Valuation Technique
Unobservable Input
Weighted
Average (2)
Range
December 31, 2017
Residential whole loans, at
fair value
$
358,871 Discounted cash flow
Discount rate
Prepayment rate
Default rate
Loss severity
$
592,940 Liquidation model
Discount rate
Annual change in home
prices
Liquidation timeline (in
years)
5.5%
4.1%
2.9%
13.8%
8.0%
2.5%
1.6
4.5-13.0%
1.15-15.1%
0.0-6.5%
0.0-100.0%
6.1-50.0%
(8.0)-8.8%
0.1-4.5
Total
$
951,811
Current value of
underlying properties (3)
$
772
$0-$9,900
(Dollars in Thousands)
Fair Value (1)
Valuation Technique
Unobservable Input
Weighted
Average (2)
Range
December 31, 2016
Residential whole loans, at
fair value
$
253,287 Discounted cash flow
Discount rate
Prepayment rate
Default rate
Loss severity
$
516,014 Liquidation model
Discount rate
Annual change in home
prices
Liquidation timeline (in
years)
6.6%
7.6%
2.9%
13.0%
7.7%
1.7%
1.6
5.0-7.7%
0.0-12.0%
0.0-9.7%
0.0-77.5%
6.8-26.9%
(9.2)-7.7%
0.1-4.4
Total
$
769,301
Current value of
underlying properties (3)
$
634
$5-$4,900
(1) Excludes approximately $373.3 million and $45.4 million of loans for which management considers the purchase price continues to reflect
the fair value of such loans at December 31, 2017 and 2016, respectively.
(2) Amounts are weighted based on the fair value of the underlying loan.
(3) The simple average value of the properties underlying residential whole loans held at fair value valued via a liquidation model was approximately
$336,000 and $320,000 as of December 31, 2017 and 2016, respectively.
136
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
The following table presents the difference between the fair value and the aggregate unpaid principal balance of the Company’s
residential whole loans for which the fair value option was elected at December 31, 2017 and 2016:
Residential Whole Loans
December 31, 2017
December 31, 2016
(In Thousands)
Residential whole loans, at fair value
Total loans
Loans 90 days or more past due
Fair Value
Unpaid
Principal
Balance
Difference
Fair Value
Unpaid
Principal
Balance
Difference
$ 1,325,115
$ 1,562,373
$ 840,572
$ 1,027,818
$ (237,258) $ 814,682
$ (187,246) $ 570,025
$ 966,174
$ (151,492)
$ 695,282
$ (125,257)
The following table presents the carrying values and estimated fair values of the Company’s financial instruments at
December 31, 2017 and 2016:
(In Thousands)
Financial Assets:
Agency MBS
Non-Agency MBS, including MBS transferred to
consolidated VIEs
CRT securities
MSR related assets
Residential whole loans, at carrying value
Residential whole loans, at fair value
Securities obtained and pledged as collateral
Cash and cash equivalents
Restricted cash
Swaps
Financial Liabilities (1):
Repurchase agreements
FHLB advances
Obligation to return securities obtained as collateral
Securitized debt
Senior Notes
Swaps
December 31, 2017
December 31, 2016
Carrying
Value
Estimated
Fair Value
Carrying
Value
Estimated
Fair Value
$
2,824,681
$
2,824,681
$
3,738,497
$
3,738,497
3,533,966
3,533,966
5,684,836
5,684,836
664,403
492,080
908,516
664,403
493,026
988,688
1,325,115
1,325,115
504,062
449,757
13,307
679
504,062
449,757
13,307
679
404,850
226,780
590,540
814,682
510,767
260,112
58,463
233
404,850
226,780
621,548
814,682
510,767
260,112
58,463
233
6,614,701
6,623,255
8,472,268
8,472,078
—
504,062
363,944
96,773
—
—
504,062
366,109
103,729
—
215,000
510,767
—
96,733
46,954
215,000
510,767
—
101,111
46,954
(1) Carrying value of securitized debt, Senior Notes and certain repurchase agreements is net of associated debt issuance costs.
In addition to the methodologies used to determine the fair value of the Company’s financial assets and liabilities reported at
fair value on a recurring basis, discussed on pages 132-137, the following methods and assumptions were used by the Company in
arriving at the fair value of the Company’s other financial instruments presented in the above table that are not reported at fair value
on a recurring basis:
Residential Whole Loans at Carrying Value: The Company determines the fair value of its residential whole loans held at
carrying 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. The Company’s residential whole loans held at carrying value
are classified as Level 3 in the fair value hierarchy.
137
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Cash and Cash Equivalents and Restricted Cash: Cash and cash equivalents and restricted cash are comprised of cash held
in overnight money market investments and demand deposit accounts. At December 31, 2017 and 2016, the Company’s money
market funds were invested in securities issued by the U.S. Government, or its agencies, instrumentalities, and sponsored entities,
and repurchase agreements involving the securities described above. Given the overnight term and assessed credit risk, the
Company’s investments in money market funds are determined to have a fair value equal to their carrying value.
Corporate Loan: The Company determines the fair value of this loan after considering recent past and expected future loan
performance, recent financial performance of the borrower and estimates of the current value of the underlying collateral, which
includes certain MSRs and other assets of the borrower that are pledged to secure the borrowing. The Company’s investment in
this term loan is classified as Level 3 in the fair value hierarchy.
Repurchase Agreements: The fair value of repurchase agreements reflects the present value of the contractual cash flows
discounted at market interest rates at the valuation date for repurchase agreements with a term equivalent to the remaining term to
interest rate repricing, which may be at maturity. Such interest rates are estimated based on LIBOR rates observed in the market.
The Company’s repurchase agreements are classified as Level 2 in the fair value hierarchy.
FHLB Advances: As previously discussed, the Company did not have any FHLB advances as of December 31, 2017. FHLB
advances at December 31, 2016 reflected collateralized borrowings at variable market interest rates that reset on a monthly basis.
Accordingly, the carrying amount of FHLB advances were considered to approximate fair value. The Company’s FHLB advances
at December 31, 2016 were classified as Level 2 in the fair value hierarchy.
Securitized Debt: In determining the fair value of securitized debt, management considers a number of observable market
data points, including prices obtained from pricing services and brokers as well as dialogue with market participants. Accordingly,
the Company’s securitized debt is classified as Level 2 in the fair value hierarchy.
Senior Notes: The fair value of the Senior Notes is determined using the end of day market price quoted on the NYSE at the
reporting date. The Company’s Senior Notes are classified as Level 1 in the fair value hierarchy.
The Company holds REO at the lower of the current carrying amount or fair value less estimated selling costs. At December 31,
2017 and 2016, the Company’s REO had an aggregate carrying value of $152.4 million and $80.5 million, and an aggregate estimated
fair value of $175.8 million and $91.1 million, respectively. The Company classifies fair value measurements of REO as Level 3
in the fair value hierarchy.
15. Use of Special Purpose Entities and Variable Interest Entities
A Special Purpose Entity (“SPE”) is an entity designed to fulfill a specific limited need of the company that organized it.
SPEs are often used to facilitate transactions that involve securitizing financial assets or resecuritizing previously securitized
financial assets. The objective of such transactions may include obtaining non-recourse financing, obtaining liquidity or refinancing
the underlying financial assets on improved terms. Securitization involves transferring assets to a SPE to convert all or a portion
of those assets into cash before they would have been realized in the normal course of business, through the SPE’s issuance of
debt or equity instruments. Investors in an SPE usually have recourse only to the assets in the SPE and, depending on the overall
structure of the transaction, may benefit from various forms of credit enhancement such as over-collateralization in the form of
excess assets in the SPE, priority with respect to receipt of cash flows relative to holders of other debt or equity instruments issued
by the SPE, or a line of credit or other form of liquidity agreement that is designed with the objective of ensuring that investors
receive principal and/or interest cash flow on the investment in accordance with the terms of their investment agreement.
The Company has entered into several financing transactions that resulted in the Company consolidating as VIEs the SPEs
that were created to facilitate the transactions. See Note 2(s) for a discussion of the accounting policies applied to the consolidation
of VIEs and transfers of financial assets in connection with securitization and resecuritization transactions.
The Company has engaged in loan securitizations and MBS resecuritization transactions primarily for the purpose of obtaining
improved overall financing terms as well as non-recourse financing on a portion of its residential whole loan and Non-Agency
MBS portfolios. Notwithstanding the Company’s participation in these transactions, the risks facing the Company are largely
unchanged as the Company remains economically exposed to the first loss position on the underlying assets transferred to the
VIEs.
138
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Loan Securitization Transactions
During the year ended December 31, 2017, the Company completed two loan securitization transactions. As a part of the
transactions, the Company sold residential whole loans with an aggregate unpaid principal balance of $620.9 million (including
$193.3 million of loans at carrying value and $296.5 million of loans at fair value) to two entities which the Company consolidates
as VIEs. In connection with the transactions, third-party investors purchased $382.8 million face amount of senior and mezzanine
bonds (“Senior Bonds”) with a weighted average fixed coupon of 3.12%. As a result of the transactions, the Company acquired
$127.0 million face amount of rated and non-rated certificates issued by the securitization vehicle, and received $382.8 million in
cash, excluding expenses, accrued interest, and underwriting fees.
The following table summarizes the key details of the loan securitization transactions the Company has been involved in to
date:
(Dollars in Thousands)
December 2017
June 2017
Name of Trust (Consolidated as a VIE)
MFA 2017-NPL1, LLC
MFA 2017-RPL 1
Aggregate unpaid principal balance of residential whole loans sold
Face amount of Senior Bonds issued by the VIE and purchased by third-
party investors
Outstanding amount of Senior Bonds at December 31, 2017
Weighted average fixed rate for Senior Bonds issued
Face amount of Senior Support Certificates received by the Company (2)
Cash received
$
$
$
$
$
401,076
235,000
233,683
3.35% (1)
55,000
235,000
$
$
$
$
$
219,848
147,847
132,602
2.753%
72,001
147,845
(1) The Senior Bond sold in connection with this securitization transaction contains a contractual coupon step-up feature whereby the coupon
increases by 300 basis points at 36 months from issuance if the bond is not redeemed before such date.
(2) Provides credit support to the Senior Bonds sold to third-party investors in the securitization transactions.
As of December 31, 2017, as a result of the transactions described above, securitized loans with a carrying value of
approximately $183.2 million are included in “Residential whole loans, at carrying value,” securitized loans with a fair value of
approximately $289.3 million are included in “Residential whole loans, at fair value,” and REO with a carrying value of
approximately $5.5 million is included in “Other assets” on the Company’s consolidated balance sheets. As of December 31,
2017, the aggregate carrying value of Senior Bonds issued by consolidated VIEs was $363.9 million. These Senior Bonds are
disclosed as “Securitized debt” and are included in Other liabilities on the Company’s consolidated balance sheets. The holders
of the securitized debt have no recourse to the general credit of the Company, but the Company does have the obligation, under
certain circumstances to repurchase assets from the VIE upon the breach of certain representations and warranties in relation to
the residential whole loans sold to the VIE. In the absence of such a breach, the Company has no obligation to provide any other
explicit or implicit support to any VIE.
Resecuritization Transactions
During the first quarter of 2017, the Company entered into a transaction to exchange the remaining beneficial interests issued
by the WFMLT 2012-RR1 (the “Trust”) and held by the Company for the underlying securities that had previously been transferred
to and held by the Trust. Following the completion of this transaction, the remaining beneficial interests were cancelled and the
Trust was terminated.
For financial reporting purposes, the exchange transaction and termination of this financing structure did not result in any
gain or loss to the Company as this resecuritization was accounted for as a financing transaction. However, for purposes of
determining REIT taxable income, this resecuritization transaction was originally accounted for as a sale of the underlying securities
to the Trust and acquisition of beneficial interests issued by the Trust. Because the fair value of the underlying securities received
exceeded the Company’s tax basis in the remaining beneficial interests at the exchange date, the unwind of this resecuritization
structure resulted in the Company recognizing taxable income currently estimated to be approximately $53.3 million or $0.13 per
common share. In addition, the underlying securities originally transferred as part of this resecuritization are reported as Non-
139
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
Agency MBS in the Company’s consolidated balance sheets at December 31, 2017 and interest income from the underlying
securities from the date of exchange transaction through December 31, 2017 is reported as Interest income from Non-Agency
MBS in the Company’s consolidated statements of operations.
As of December 31, 2017 the Company did not have any Non-Agency MBS that were resecuritized as described above. At
December 31, 2016, the aggregate fair value of the Non-Agency MBS that were resecuritized as described above was $174.4
million. These assets were included in the Company’s consolidated balance sheets and disclosed as “Non-Agency MBS transferred
to consolidated VIEs, at fair value.”
The Company concluded that the entities created to facilitate these MBS resecuritization and loan securitization transactions
are VIEs. The Company then completed an analysis of whether each VIE created to facilitate the securitization and resecuritization
transactions should be consolidated by the Company, based on consideration of its involvement in each VIE, including the design
and purpose of the SPE, and whether its involvement reflected a controlling financial interest that resulted in the Company being
deemed the primary beneficiary of each VIE. In determining whether the Company would be considered the primary beneficiary,
the following factors were assessed:
• Whether the Company has both the power to direct the activities that most significantly impact the economic performance
of the VIE; and
• Whether the Company has a right to receive benefits or absorb losses of the entity that could be potentially significant to
the VIE.
Based on its evaluation of the factors discussed above, including its involvement in the purpose and design of the entity, the
Company determined that it was required to consolidate each VIE created to facilitate these loan securitization and MBS
resecuritization transactions.
Prior to the completion of the Company’s first MBS resecuritization transaction in October 2010, the Company had not
transferred assets to VIEs or QSPEs and other than acquiring MBS issued by such entities, had no other involvement with VIEs
or QSPEs.
Residential Whole Loans (including Residential Whole Loans transferred to consolidated VIEs)
Included on the Company’s consolidated balance sheets as of December 31, 2017 and 2016 are a total of $2.2 billion and
$1.4 billion of residential whole loans, of which approximately $908.5 million and $590.5 million are reported at carrying value
and $1.3 billion and $814.7 million are reported at fair value, respectively. The inclusion of these assets arises from the Company’s
interest in certain trusts established to acquire the loans and entities established in connection with its loan securitization transactions.
The Company has assessed that these entities are required to be consolidated. During 2017, 2016 and 2015, the Company recognized
interest income from residential whole loans reported at carrying value of approximately $36.2 million, $23.9 million and $16.0
million, respectively. These amounts are included in Interest Income on the Company’s consolidated statements of operations. In
addition, the Company recognized net gains on residential whole loans held at fair value during 2017, 2016 and 2015 of
approximately $90.0 million, $62.6 million and $19.6 million, respectively. These amounts are included in Other Income, net on
the Company’s consolidated statements of operations. (See Note 4)
140
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017
16. Summary of Quarterly Results of Operations (Unaudited)
(In Thousands, Except per Share Amounts)
March 31
June 30
September 30
December 31
2017 Quarter Ended
Interest income
Interest expense
Net interest income
Net impairment losses recognized in earnings
Net gain on residential whole loans held at fair value
Net gain on sales of MBS and U.S. Treasury securities
Other income
Operating and other expense
Net income
Preferred stock dividends
Net income available to common stock and participating
securities
Earnings per Common Share - Basic and Diluted
(In Thousands, Except per Share Amounts)
Interest income
Interest expense
Net interest income
Net impairment losses recognized in earnings
Net gain on residential whole loans held at fair value
Net gain on sales of MBS and U.S. Treasury securities
Other income
Operating and other expense
Net income
Preferred stock dividends
$
$
$
$
$
117,257
(50,349)
66,908
(414)
13,773
9,708
4,512
(16,427)
78,060
(3,750)
$
110,157
(49,022)
61,135
(618)
16,208
5,889
14,847
(17,526)
79,935
(3,750)
$
105,133
(49,275)
55,858
—
18,679
14,933
(4,515)
(21,150)
63,805
(3,750)
100,901
(48,495)
52,406
—
41,359
9,047
14,579
(16,798)
100,593
(3,750)
74,310
0.20
$
$
76,185
0.20
$
$
60,055
0.15
$
$
96,843
0.24
March 31
June 30
September 30
December 31
2016 Quarter Ended
$
117,418
(47,600)
69,818
$
114,507
(47,720)
66,787
—
12,348
9,745
618
(14,459)
78,070
(3,750)
—
15,742
9,241
2,047
(14,867)
78,950
(3,750)
$
$
$
112,716
(48,167)
64,549
(485)
19,639
7,083
7,179
(14,954)
83,011
(3,750)
112,809
(49,868)
62,941
—
14,876
9,768
756
(15,704)
72,637
(3,750)
Net income available to common stock and participating
securities
Earnings per Common Share - Basic and Diluted
$
$
74,320
0.20
$
$
75,200
0.20
$
$
79,261
0.21
$
$
68,887
0.18
141
Schedule IV - Mortgage Loans on Real Estate
December 31, 2017
Asset Type
(Dollars in Thousands)
Residential Whole Loans, at Carrying Value
Original loan balance $0 - $149,999
Original loan balance $150,000 - $299,999
Original loan balance $300,000 - $449,999
Original loan balance greater than $449,999
Residential Whole Loans, at Fair Value
Original loan balance $0 - $149,999
Original loan balance $150,000 - $299,999
Original loan balance $300,000 - $449,999
Number
Interest
Rate
Maturity
Date Range
Balance
Sheet
Reported
Amount
Principal
Amount of
Loans Subject
to Delinquent
Principal or
Interest
1,779
1,669
876
468
4,792
2,349
2,154
1,273
0.00% - 13.08% 9/15/2015-11/1/2057
$
124,818
$
1.00% - 11.00%
5/1/2016-11/1/2064
2.00% - 10.00%
3/1/2018-5/1/2062
1.88% - 9.50%
9/1/2018-12/1/2057
269,846
255,520
258,332
$
908,516
$
0.00% - 14.99%
7/2/2007-11/1/2057
$
169,575
$
0.00% - 12.38% 7/1/2008-10/25/2057
1.50% - 11.00%
7/1/2013-12/1/2057
346,425
373,112
436,003
$ 1,325,115
$ 2,233,631
$
$
17,107
33,693
26,974
20,300
98,074
118,572
262,686
271,908
374,652
1,027,818
1,125,892
Original loan balance greater than $449,999
738
1.00% - 10.88%
9/1/2013-11/1/2057
6,514
11,306
Reconciliation of Balance Sheet Reported Amounts of Mortgage Loans on Real Estate
The following table summarizes the changes in the carrying amounts of residential whole loans during the year ended
December 31, 2017:
(In Thousands)
Beginning Balance
Additions during period:
Purchases and capitalized advances
Discount accretion
Deductions during period:
Cash collections for principal and liquidations
Changes in fair value recorded in Net gain on residential whole
loans held at fair value
Provision for loan loss
Repurchases
Transfer to REO
Ending Balance
$
142
For the Year Ended December 31, 2017
Residential Whole Loans, at
Carrying Value
Residential Whole Loans, at
Fair Value
$
590,540
$
814,682
385,093
5,477
(63,521)
N/A
660
—
(9,733)
908,516
$
683,735
N/A
(87,072)
33,617
N/A
(2,716)
(117,131)
1,325,115
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures
Management, under the direction of its Chief Executive Officer and Chief Financial Officer, is responsible for maintaining
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the 1934 Act) that are designed to ensure
that information required to be disclosed in reports filed or submitted under the 1934 Act is recorded, processed, summarized and
reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated
to management, including the Company’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding
required disclosures.
In connection with the preparation of this Annual Report on Form 10-K, management reviewed and evaluated the Company’s
disclosure controls and procedures. The evaluation was performed under the direction of the Company’s Chief Executive Officer
and Chief Financial Officer to determine the effectiveness, as of December 31, 2017, of the design and operation of the Company’s
disclosure controls and procedures. Based on that review and evaluation, the Chief Executive Officer and the Chief Financial
Officer have concluded that the Company’s current disclosure controls and procedures, as designed and implemented, were effective
as of December 31, 2017. Notwithstanding the foregoing, a control system, no matter how well designed, implemented and
operated can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose
material information otherwise required to be set forth in the Company’s periodic reports.
(b) Management’s Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting
for the Company. Internal control over financial reporting is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the
1934 Act as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers
and effected by the Company’s board of directors, management and other personnel to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S.
GAAP, and includes those policies and procedures that:
•
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions
of the assets of the Company;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in
accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations
of management and directors of the Company; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of
the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because
of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of
December 31, 2017. In making this assessment, the Company’s management used criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission in Internal Control-Integrated Framework 2013 (the “2013 COSO Framework”). As
a result of this assessment, management concluded that, as of December 31, 2017, our internal control over financial reporting
was effective in providing reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with GAAP.
The Company’s independent registered public accounting firm, KPMG LLP, has issued an attestation report on the
effectiveness of the Company’s internal control over financial reporting. This report appears on page 145 of this Annual Report
on Form 10-K.
143
(c) Changes in Internal Control Over Financial Reporting
There have been no changes in the Company’s internal control over financial reporting that occurred during the fourth quarter
of 2017 that materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.
144
Report of Independent Registered Public Accounting Firm
To the stockholders and board of directors
MFA Financial, Inc.:
Opinion on Internal Control Over Financial Reporting
We have audited MFA Financial, Inc. and subsidiaries’ (the “Company”) internal control over financial reporting as of
December 31, 2017, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee
of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control -
Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States)
(“PCAOB”), the consolidated balance sheets of the Company as of December 31, 2017 and 2016, the related consolidated
statements of operations, comprehensive income/(loss), changes in stockholders’ equity, and cash flows for each of the years in
the three-year period ended December 31, 2017, and the related notes and Schedule IV - Mortgage Loans on Real Estate
(collectively, the consolidated financial statements), and our report dated February 15, 2018 expressed an unqualified opinion
on those consolidated financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report
on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control
over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be
independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and
regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all
material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the
company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ KPMG LLP
New York, New York
February 15, 2018
145
Item 9B. Other Information.
None.
Item 10. Directors, Executive Officers and Corporate Governance.
PART III
We expect to file with the SEC, in April 2018 (and, in any event, not later than 120 days after the close of our last fiscal
year), a definitive proxy statement (the “Proxy Statement”), pursuant to SEC Regulation 14A in connection with our Annual
Meeting of Stockholders to be held on or about May 23, 2018. The information to be included in the Proxy Statement regarding
the Company’s directors, executive officers, and certain other matters required by Item 401 of Regulation S-K is incorporated
herein by reference.
The information to be included in the Proxy Statement regarding compliance with Section 16(a) of the 1934 Act required
by Item 405 of Regulation S-K is incorporated herein by reference.
The information to be included in the Proxy Statement regarding the Company’s Code of Business Conduct and Ethics
required by Item 406 of Regulation S-K is incorporated herein by reference.
The information to be included in the Proxy Statement regarding certain matters pertaining to the Company’s corporate
governance required by Item 407(c)(3), (d)(4) and (d)(5) of Regulation S-K is incorporated by reference.
We have adopted a set of Corporate Governance Guidelines, which together with the charters of the three standing committees
of our Board of Directors (Audit, Compensation, and Nominating and Corporate Governance), and our Code of Business Conduct
and Ethics (which constitutes the Company’s code of ethics), provide the framework for the governance of the Company. A
complete copy of our Corporate Governance Guidelines, the charters of each of the Board committees and the Code of Business
Conduct and Ethics (which applies not only to our Chief Executive Officer, Chief Financial Officer and Chief Accounting Officer,
but also to all other employees of the Company) may be found by clicking on the “Company Information” link found at the top
of our homepage at www.mfafinancial.com and then clicking on the “Corporate Governance” link (information from such site is
not incorporated by reference into this Annual Report on Form 10-K). You may also obtain free copies of these materials by
writing to our General Counsel at the Company’s headquarters.
Item 11. Executive Compensation.
The information to be included in the Proxy Statement regarding executive compensation and other compensation related
matters required by Items 402 and 407(e)(4) and (e)(5) of Regulation S-K is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The tables to be included in the Proxy Statement, which will contain information relating to the Company’s equity
compensation and beneficial ownership of the Company required by Items 201(d) and 403 of Regulation S-K, are incorporated
herein by reference.
Item 13. Certain Relationships and Related Transactions and Director Independence.
The information to be included in the Proxy Statement regarding transactions with related persons, promoters and certain
control persons and director independence required by Items 404 and 407(a) of Regulation S-K is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services.
The information to be included in the Proxy Statement concerning principal accounting fees and services and the Audit
Committee’s pre-approval policies and procedures required by Item 14 is incorporated herein by reference.
146
Item 15. Exhibits and Financial Statement Schedules.
(a) Documents filed as part of the report
PART IV
The following documents are filed as part of this Annual Report on Form 10-K:
(1) Financial Statements. The consolidated financial statements of the Company, together with the independent
registered public accounting firm’s report thereon, are set forth on pages 82 through 141 of this Annual Report on Form 10-K and
are incorporated herein by reference.
(b) Exhibits required by Item 601 of Regulation S-K
The information required by this Item is set forth on the Exhibit Index that follows the signature page of this report.
(c) Financial Statement Schedules required by Regulation S-X
Schedule IV - Mortgage Loans on Real Estate as of December 31, 2017.
All other financial statement schedules have been omitted because the required information is not applicable or deemed
not material, or the required information is presented in the consolidated financial statements and/or in the notes to consolidated
financial statements filed in response to Item 8 of this Annual Report on Form 10-K.
147
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
MFA Financial, Inc.
Date: February 15, 2018
By
/s/
Stephen D. Yarad
Stephen D. Yarad
Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates indicated.
148
Date: February 15, 2018
Date: February 15, 2018
Date: February 15, 2018
Date: February 15, 2018
Date: February 15, 2018
Date: February 15, 2018
Date: February 15, 2018
By
By
By
By
By
/s/ Craig L. Knutson
Craig L. Knutson
President, Chief Executive Officer and Director
(Principal Executive Officer)
/s/ Stephen D. Yarad
Stephen D. Yarad
Chief Financial Officer
(Principal Financial Officer)
/s/ Kathleen A. Hanrahan
Kathleen A. Hanrahan
Senior Vice President and
Chief Accounting Officer
(Principal Accounting Officer)
/s/ George H. Krauss
George H. Krauss
Chairman and Director
/s/ Stephen R. Blank
Stephen R. Blank
Director
By
/s/
James A. Brodsky
James A. Brodsky
Director
By
/s/ Richard J. Byrne
Richard J. Byrne
Director
Date: February 15, 2018
By
/s/ Laurie Goodman
Date: February 15, 2018
Date: February 15, 2018
Laurie Goodman
Director
By
By
/s/ Alan L. Gosule
Alan L. Gosule
Director
/s/ Robin Josephs
Robin Josephs
Director
149
EXHIBIT INDEX
The following exhibits are filed as part of this Annual Report on Form 10-K. The exhibit numbers followed by an asterisk
(*) indicate exhibits electronically filed herewith. All other exhibit numbers indicate exhibits previously filed and are hereby
incorporated herein by reference. Exhibits numbered 10.1 through 10.25 are management contracts or compensatory plans or
arrangements.
3.1
Amended and Restated Articles of Incorporation of the Company, dated April 8, 1998 (incorporated herein by
reference to Exhibit 3.1 to the Company’s Form 8-K, dated April 24, 1998 (Commission File No. 1-13991)).
3.2
Articles of Amendment to the Amended and Restated Articles of Incorporation of the Company, dated August 5,
2002 (incorporated herein by reference to Exhibit 3.1 to the Company’s Form 8-K, dated August 13, 2002 (Commission File
No. 1-13991)).
3.3
Articles of Amendment to the Amended and Restated Articles of Incorporation of the Company, dated August 13,
2002 (incorporated herein by reference to Exhibit 3.3 to the Company’s Form 10-Q for the quarter ended September 30, 2002
(Commission File No. 1-13991)).
3.4
Articles of Amendment to the Amended and Restated Articles of Incorporation of the Company, dated
December 29, 2008 (incorporated herein by reference to Exhibit 3.1 to the Company’s Form 8-K, dated December 29, 2008
(Commission File No. 1-13991)).
3.5
Articles of Amendment (Articles Supplementary) to the Amended and Restated Articles of Incorporation of the
Company, dated January 1, 2010 (incorporated herein by reference to Exhibit 3.1 to the Company’s Form 8-K, dated January 5,
2010 (Commission File No. 1-13991)).
3.6
Articles Supplementary of the Company, dated March 8, 2011 (incorporated herein by reference to Exhibit 3.1
to the Company’s Form 8-K, dated March 11, 2011 (Commission File No. 1-13991)).
3.7
Articles of Amendment to the Amended and Restated Articles of Incorporation of the Company, dated May 24,
2011 (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K, dated May 26, 2011 (Commission File No. 1-13991)).
3.8
Articles Supplementary of the Company, dated April 22, 2004, designating the Company’s 8.50% Series A
Cumulative Redeemable Preferred Stock (incorporated herein by reference to Exhibit 3.4 to the Company’s Form 8-A, dated
April 23, 2004 (Commission File No. 1-13991)).
3.9
Articles Supplementary of the Company, dated April 12, 2013, designating the Company’s 7.50% Series B
Cumulative Redeemable Preferred Stock (incorporated herein by reference to Exhibit 3.1 to the Company’s Form 8-K, dated
April 15, 2013 (Commission File No. 1-13991)).
3.10
Amended and Restated Bylaws of the Company (as amended and restated through April 10, 2017) (incorporated
herein by reference to Exhibit 3.1 to the Company’s Form 8-K, dated April 12, 2017 (Commission File No. 1-13991)).
4.1
Specimen of Common Stock Certificate of the Company (incorporated herein by reference to Exhibit 4.1 to
the Company’s Registration Statement on Form S-4, dated February 12, 1998 (Commission File No. 333-46179)).
4.2
Specimen of certificate representing the 7.50% Series B Cumulative Redeemable Preferred Stock (incorporated
herein by reference to Exhibit 4.1 to the Company’s Form 8-K, dated April 15, 2013 (Commission File No. 1-13991)).
4.3
Indenture, dated as of April 11, 2012, between the Company and Wilmington Trust, National Association, as
Trustee (incorporated herein by reference to Exhibit 4.1 to the Company’s Form 8-K, dated April 11, 2012 (Commission File
No. 1-13991)).
4.4
First Supplemental Indenture, dated as of April 11, 2012, between the Company and Wilmington Trust, National
Association, as Trustee (incorporated herein by reference to Exhibit 4.2 to the Company’s Form 8-K, dated April 11, 2012
(Commission File No. 1-13991)).
4.5
Form of 8.00% Senior Notes due 2042 (incorporated herein by reference to Exhibit 4.3 to the Company’s
Form 8-K, dated April 11, 2012 (Commission File No. 1-13991)).
150
10.1
Employment Agreement, entered into as of January 21, 2014, by and between the Company and William S.
Gorin (incorporated herein by reference to Exhibit 10.1 to the Company’s Form 8-K, dated January 24, 2014 (Commission File
No. 1-13991)).
10.2
Employment Agreement, entered into as of November 4, 2016, by and between the Company and William S.
Gorin (incorporated herein by reference to Exhibit 10.1 to the Company’s Form 8-K, dated November 4, 2016 (Commission File
No. 1-13991)).
10.3
Employment Agreement, entered into as of January 21, 2014, by and between the Company and Craig L.
Knutson (incorporated herein by reference to Exhibit 10.2 to the Company’s Form 8-K, dated January 24, 2014 (Commission File
No. 1-13991)).
10.4
Employment Agreement, entered into as of November 4, 2016, by and between the Company and Craig L.
Knutson (incorporated herein by reference to Exhibit 10.2 to the Company’s Form 8-K, dated November 4, 2016 (Commission
File No. 1-13991)).
10.5
Employment Agreement, entered into as of March 1, 2010, by and between the Company and Gudmundur
Kristjansson (incorporated herein by reference to Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the year ended
December 31, 2014 (Commission File No. 1-13991)).
10.6
Amendment No. 1, dated February 9, 2015, to Employment Agreement, entered into as of March 1, 2010, by
and between the Company and Gudmundur Kristjansson (incorporated herein by reference to Exhibit 10.4 to the Company’s
Annual Report on Form 10-K for the year ended December 31, 2014 (Commission File No. 1-13991)).
10.7
Employment Agreement, entered into as of March 1, 2010, by and between the Company and Sunil Yadav
(incorporated herein by reference to Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December
31, 2014 (Commission File No. 1-13991)).
10.8
Amendment No. 1, dated February 9, 2015, to Employment Agreement, entered into as of March 1, 2010, by
and between the Company and Sunil Yadav (incorporated herein by reference to Exhibit 10.6 to the Company’s Annual Report
on Form 10-K for the year ended December 31, 2014 (Commission File No. 1-13991)).
10.9
MFA Financial, Inc. Equity Compensation Plan (incorporated herein by reference to Exhibit 10.1 to the
Company’s Form 8-K dated May 22, 2015 (Commission File No. 1-13991)).
10.10
Senior Officers Deferred Bonus Plan, dated December 10, 2008 (incorporated herein by reference to Exhibit 10.2
to the Company’s Form 8-K, dated December 12, 2008 (Commission File No. 1-13991)).
10.11
Fourth Amended and Restated 2003 Non-Employee Directors Deferred Compensation Plan, as amended and
restated through December 15, 2014 (incorporated herein by reference to Exhibit 10.10 to the Company’s Annual Report on Form
10-K for the year ended December 31, 2015 (Commission File No. 1-13991)).
10.12
Form of Incentive Stock Option Award Agreement relating to the Company’s Amended and Restated 2010
Equity Compensation Plan (incorporated herein by reference to Exhibit 10.10 to the Company’s Form 10-Q for the quarter ended
September 30, 2004 (Commission File No. 1-13991)).
10.13
Form of Non-Qualified Stock Option Award Agreement relating to the Company’s Amended and Restated 2010
Equity Compensation Plan (incorporated herein by reference to Exhibit 10.9 to the Company’s Form 10-Q for the quarter ended
September 30, 2004 (Commission File No. 1-13991)).
10.14
Form of Restricted Stock Award Agreement relating to the Company’s Amended and Restated 2010 Equity
Compensation Plan (incorporated herein by reference to Exhibit 10.11 to the Company’s Form 10-Q for the quarter ended
September 30, 2004 (Commission File No. 1-13991)).
10.15
Form of Phantom Share Award Agreement (Time-Based Vesting) (Gorin and Knutson) relating to the Company’s
Amended and Restated 2010 Equity Compensation Plan (incorporated herein by reference to Exhibit 10.3 to the Company’s
Form 8-K, dated January 24, 2014 (Commission File No. 1-13991)).
151
10.16
Form of Phantom Share Award Agreement (Performance-Based Vesting) (Gorin and Knutson) relating to the
Company’s Amended and Restated 2010 Equity Compensation Plan (incorporated herein by reference to Exhibit 10.4 to the
Company’s Form 8-K, dated January 24, 2014 (Commission File No. 1-13991)).
10.17
Form of Phantom Share Award Agreement (Performance-Based Vesting) (Gorin and Knutson) relating to the
Company’s Equity Compensation Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Form 8-K, dated January
11, 2017 (Commission File No. 1-13991)).
10.18
Form of Phantom Share Award Agreement (Vested Award) relating to the Company’s Amended and Restated
2010 Equity Compensation Plan (incorporated herein by reference to Exhibit 10.5 to the Company’s Form 8-K, dated January 24,
2014 (Commission File No. 1-13991)).
10.19
Form of Phantom Share Award Agreement (Time-Based Vesting) relating to each of the Company’s Equity
Compensation Plan and the Company’s Amended and Restated 2010 Equity Compensation Plan (incorporated herein by reference
to Exhibit 10.7 to the Company’s Form 8-K, dated January 24, 2014 (Commission File No. 1-13991)).
10.20
Form of Phantom Share Award Agreement (Performance-Based Vesting) relating to each of the Company’s
Equity Compensation Plan and the Company’s Amended and Restated 2010 Equity Compensation Plan (incorporated herein by
reference to Exhibit 10.8 to the Company’s Form 8-K, dated January 24, 2014 (Commission File No. 1-13991)).
10.21
Form of Phantom Share Award Agreement (Performance-Based Vesting) relating to the Company’s Equity
Compensation Plan (incorporated herein by reference to Exhibit 10.2 to the Company’s Form 8-K, dated January 11, 2017
(Commission File No. 1-13991)).
10.22
Form of Dividend Equivalent Rights Agreement relating to the Company’s Amended and Restated 2010 Equity
Compensation Plan (incorporated herein by reference to Exhibit 10.6 to the Company’s Form 8-K, dated July 7, 2011 (Commission
File No. 1-13991)).
10.23
Summary Description of Compensation Payable to Non-Employee Directors (incorporated herein by reference
to Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended June 30, 2014 (Commission File No. 1-13991)).
10.24
Modification to Compensation Payable to the Non-Executive Chairman of the Board (incorporated herein by
reference to Exhibit 10.1 to the Company’s Form 10-Q for the quarter ended June 30, 2016 (Commission File No. 1-13991)).
10.25
Modification to Compensation Payable to Non-Employee Directors (incorporated herein by reference to Exhibit
10.1 to the Company’s Form 10-Q for the quarter ended June 30, 2017 (Commission File No. 1-13991)).
12.1* Computation of Ratio of Debt-to-Equity.
21*
Subsidiaries of the Company.
23.1* Consent of KPMG LLP.
31.1* Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2* Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1* Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2* Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**
XBRL Instance Document
101.SCH**
XBRL Taxonomy Extension Schema Document
152
101.CAL**
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF**
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB**
XBRL Taxonomy Extension Label Linkbase Document
101.PRE**
XBRL Taxonomy Extension Presentation Linkbase Document
* Filed herewith.
**These interactive data files are furnished and deemed not filed or part of a registration statement or prospectus for
purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the
Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.
153
STOCK PERFORMANCE GRAPH
The following graph and table provide a comparison of the cumulative total stockholder return on MFA’s common stock,
the S&P 500 Index, the Bloomberg REIT Mortgage Index (or BBG REIT Mortgage Index) and the S&P 500 Financials Index for
the period from December 31, 2012 to December 31, 2017.
In determining the returns, it is assumed that $100 was invested in MFA’s common stock and each of the three other
indices on December 31, 2012, and that all dividends were reinvested.
MFA Financial, Inc.
S&P 500 Index
BBG REIT Mortgage Index
S&P 500 Financials Index
Source: Bloomberg
_________________________
12/31/2012
12/31/2013
12/31/2014
12/31/2015
12/31/2016
12/31/2017
$100.00
$100.00
$100.00
$100.00
$106.19
$132.37
$97.65
$135.59
$132.77
$150.48
$116.63
$156.17
$122.21
$152.55
$105.09
$153.72
$157.75
$170.78
$128.50
$188.69
$180.28
$208.05
$154.54
$230.47
The information in the stock performance graph and table has been obtained from sources believed to be reliable, but
neither its accuracy nor its completeness can be guaranteed. There can be no assurance that MFA’s stock performance will continue
in the future with trends that are the same or similar to those depicted in the graph or the table above. Accordingly, MFA does not
and will not make or endorse any predictions as to future stock performance.
The stock performance graph and table shall not be deemed, under the Securities Act of 1933, as amended, or the Securities
Exchange Act of 1934, as amended, to be (i) “soliciting material” or “filed” or (ii) incorporated by reference by any general
statement into any filing made by MFA with the Securities and Exchange Commission, except to the extent that MFA specifically
incorporates such stock performance graph and table by reference.
DIR EC TOR S A N D OF F ICER S
DIRECTORS
George H. Krauss
Chairman of the Board
Managing Director
The Burlington Capital Group LLC
Craig L. Knutson
Chief Executive Officer and President
MFA Financial, Inc.
EXECUTIVE OFFICERS
Craig L. Knutson
Chief Executive Officer and President
Ronald A. Freydberg
Executive Vice President
Stephen D. Yarad
Chief Financial Officer
Stephen R. Blank
Independent Director
James A. Brodsky
Member
Weiner Brodsky Kider PC
Richard J. Byrne
President
Benefit Street Partners LLC
Kathleen A. Hanrahan
Senior Vice President and
Chief Accounting Officer
Gudmundur Kristjansson
Senior Vice President
Terence B. Meyers
Senior Vice President and
Director of Tax
Laurie Goodman
Co-Director
Housing Finance Policy Center
Urban Institute
Alan L. Gosule
Partner
Clifford Chance US LLP
Robin Josephs
Independent Director
Harold E. Schwartz
Senior Vice President,
General Counsel and Secretary
Bryan Wulfsohn
Senior Vice President
Sunil Yadav
Senior Vice President
S TOCK HOL DER I N FOR M AT ION
Executive Offices
MFA Financial, Inc.
350 Park Avenue, 20th Floor
New York, NY 10022
(212) 207-6400
Registrar and Transfer Agent
Computershare
Regular Mail:
P.O. Box 505000
Louisville, KY 40233
For overnight correspondence:
462 South 4th Street, Suite 1600
Louisville, KY 40202
Toll Free: (866) 249-2610
Foreign Shareowners:
(201) 680-6578
TDD for Hearing Impaired:
(800) 231-5469
Stock Exchange Listing
New York Stock Exchange
(Symbol: MFA)
Independent Registered Public
Accounting Firm
KPMG LLP
345 Park Avenue
New York, NY 10154
Annual Meeting
The 2018 Annual Meeting of Stockholders will be
held on Wednesday, May 23, 2018, at 9:00 a.m.
Eastern Time, at:
The Lotte New York Palace Hotel
455 Madison Avenue
New York, NY 10022
Corporate Governance
Copies of MFA Financial, Inc.’s governance documents,
including its Corporate Governance Guidelines, as
well as the charters of the standing committees of
the Board of Directors and its Code of Business
Conduct and Ethics, are available on the company’s
website at http://www.mfafinancial.com. Written
copies of these materials are available without charge
upon written request to the company’s Secretary at
the address above.
Information Available to Stockholders
Copies of the company’s 2017 Annual Report on
Form 10-K, as filed with the Securities and Exchange
Commission, as well as its proxy statement, press
releases and other documents, are available on the
company’s website at http://www.mfafinancial.com.
Written copies of these materials are available with-
out charge upon written request to the company’s
Secretary at the address above.
Web Addresses:
General: www.computershare.com/investor
Online inquiries: https://www-us.computershare.com/investor/contact
Annual Report Design by Curran & Connors, Inc. / www.curran-connors.com
F I N A N C I A L , I N C.
350 Park Avenue, New York, NY 10022
Telephone: 212.207.6400
Fax: 212.207.6420
www.mfafinancial.com
F I N A N C I A L , I N C.