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F I N A N C I A L , I N C.
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
’182018 A N N UA L R E P O R T
2018 ANNUAL REPORT CONTENTS:
Letter to Shareholders
Form 10-K
Stock Performance Graph
Corporate Information
James Casebere, Landscape with Houses
(Dutchess County, NY) #1, 2010
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
F I N A N C I A L , I N C.
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 fun-
damentals. 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.
2018 A N N UA L R E P ORT—PAGE ON E
DE A R F E L L OW M FA SH A R E HOL DE R S:
Last year, we celebrated our 20th anniversary as a public company by ringing the closing bell at the New York Stock Exchange
on April 17, 2018. MFA also achieved another milestone during 2018, as we successfully executed on our strategy and
acquired over $5.7 billion of new assets, growing our investment portfolio by $2.2 billion or 22%. Our efforts that began in
early 2017 to forge relationships with loan originators by serving as a reliable capital partner paid off in 2018, as we sourced
over $2 billion of newly originated performing loans. During our 20-year history as a listed company, through many interest
rate cycles and various economic environments, we have generated a cumulative total return for our shareholders of 675%,
or 10.4%, on an annualized basis. Over the last ten years, our annualized total stock return has been 14.5%.
It is worth noting that we deliver these returns to our stockholders
with significantly less risk than most of our peers due to our low
leverage (2.6 times debt to equity as of year-end 2018), relatively low
interest rate sensitivity as measured by net duration (0.96 at year-end
2018) and reduced sensitivity to prepayments. Our asset selection
process is heavily centered around residential mortgage credit, where
we continue to build on our eleven-year history of credit expertise.
We invest in multiple asset classes across the residential mortgage
spectrum, and despite the complexity embedded in these invest-
ments, we are proud to be recognized as an industry leader in trans-
parency and disclosure. As we have continued to expand our asset
classes and our business has become more intricate, we have invested
in additional resources including people and technology. In particu-
lar, our asset management team has grown to support our credit sen-
sitive loan portfolio, and we have seen these efforts pay off in the
form of better and faster resolutions of non-performing loans, which
has boosted both our realized and expected returns. Nevertheless,
despite our increased investment in resources, MFA’s operating
expenses remain among the lowest in our peer group at 1.35% of
stockholders’ equity for 2018. Finally, our internal management
structure both reduces operating costs and tightly aligns our interests
with those of our shareholders.
The fourth quarter, and in particular the last two months of 2018, was
a challenging period for holders of financial assets. The Dow Jones
Industrial Average experienced daily swings of 500 points or more for
much of the last two weeks of the year (including a 650 point drop on
Christmas Eve). Bonds rallied significantly between early November
and year end, with yields on two, five and ten year U.S. Treasuries fall-
ing by 50 to 60 basis points. Credit spreads also experienced volatility
during this period, with high yield spreads widening by 180 basis
points. Levered investors in both Agency mortgages and mortgage
credit experienced significant value declines as spreads on these assets
widened, with corresponding book value reductions commensurate
with the amount of leverage deployed. While not immune to these
movements, MFA fared better than most of our peers with a modest
book value decline of 4.2% during the fourth quarter, due largely to
our asset mix and low leverage. Furthermore, while wider credit
spreads negatively impacted pricing on our mortgage credit assets, this
spread widening was very much a technical phenomenon rather than
the result of deteriorating credit or diminution of projected cash flows.
Despite this turmoil in the fourth quarter, MFA produced a positive
economic return for the year of 3.2%, while most of our peers had
negative economic returns for 2018.
MFA recognized in 2017 that in order to compete effectively in sourc-
ing recently originated loans, we would need to formulate a new strat-
egy. Acquiring these investments is a distinctly different process than
the traditional method of submitting bids to dealers or sellers of loans
from time to time. MFA was an early mover in establishing strategic
relationships with originators, entering flow agreements and, in cer-
tain cases, making minority equity or preferred stock investments in
these origination partners. While forging these alliances and negotiat-
ing the related necessary agreements are time-consuming, we recog-
nized the value realizable through these endeavors over the long term.
The deep relationships we have built provide our origination partners
with a reliable capital colleague that they need to grow their businesses
while at the same time furnishing MFA with a dependable and recur-
ring source of future investments. Our vision and willingness to
engage in these considerable efforts has begun to meaningfully con-
tribute to our financial results. We are excited about the growth pros-
pects both for our origination partners and our own balance sheet.
2019 AND BEYOND
With significant liquidity, a short duration portfolio and a low level
of leverage, MFA has considerable capacity to take advantage of mar-
ket opportunities to continue to augment our portfolio, and asset
growth will drive future earnings. Recent economic developments
and pronouncements from the Federal Reserve have suggested that
its interest rate posture has decidedly shifted to a more dovish tone. A
stable interest rate environment tends to support our mortgage
investment asset values, and reduced expectations of future interest
rate increases bode well for our future borrowing costs as this head-
wind abates. Recent press sometimes suggesting a “housing slump” is
in reality a reference to reduced trading volume, which is primarily
due to high home prices and insufficient new supply to satisfy house-
hold formation. These are good omens for MFA’s substantial residential
mortgage credit investments, as fewer housing starts bolster the
demand for (and value of) existing homes that underly our mortgage
investments. We believe we are well positioned to continue to take
advantage of investment opportunities within the residential mort-
gage 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 30 and pages 77 to 78 of MFA’s Annual Report on Form 10-K, which is a part hereof.
2018 A N N UA L R E P ORT—PAGE T WO
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, 2018
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)
13-3974868
(I.R.S. Employer Identification No.)
350 Park Avenue, 20th Floor, New York, New York
(Address of principal executive offices)
10022
(Zip Code)
(212) 207-6400
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
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 every Interactive Data File required to be submitted 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 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, a smaller reporting company, or an emerging
growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of
the Exchange Act.
Large accelerated filer
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 29, 2018, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $3.0 billion based on the closing sales
price of our common stock on such date as reported on the New York Stock Exchange.
On February 14, 2019, the registrant had a total of 450,476,867 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 22, 2019, are incorporated by reference into Part III of this Annual Report on Form 10-K.
MFA FINANCIAL, INC.
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
31
31
31
31
32
35
37
74
83
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 MBS issued prior to 2008, and (ii) RPL/NPL MBS, which refers to MBS
backed primarily by securitized re-performing and non-performing loans and are generally structured such that the coupon
increases from 300 - 400 basis points at 36 - 48 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 which have interest rates that reset annually or more
frequently; CRT securities refer to credit risk transfer securities, that are debt obligations issued by or sponsored 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 residential mortgage assets, an increase of which could result
in a reduction of the yield on certain investments in our portfolio and could require us to reinvest the proceeds received by us as
a result of such prepayments in investments with lower coupons, while a decrease in which could result in an increase in the
interest rate duration of certain investments in our portfolio making their valuation more sensitive to changes in interest rates and
could result in lower forecasted cash flows or, in certain circumstances, other-than-temporary impairment on certain Legacy Non-
Agency MBS purchased at a discount; 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 modifications, foreclosures and liquidations; 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 continue growing 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 residential whole 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; targeted or expected returns on our investments in recently-originated loans, the performance of
which is, similar to our other mortgage loan investments, subject to, among other things, prepayment risk, credit risk and financing
cost associated with such investments; 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 an internally-managed real estate investment trust (or REIT) primarily engaged in the business of investing, on a
leveraged basis, in residential mortgage assets. Our investments include principally the following;
•
•
Residential mortgage securities including Non-Agency MBS, Agency MBS and CRT securities;
Residential whole loans, including purchased performing loans, purchased credit impaired and non-performing loans;
and
• MSR-related assets, which include term notes backed directly or indirectly by MSRs and loans to provide financing to
entities that originate residential mortgage loans and own the related MSRs.
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 a 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
We primarily invest, through our various subsidiaries, in residential mortgage assets. We continue to acquire residential
mortgage securities and such investments comprised more than 50% of our total assets at the end of 2018. In recent years we
have substantially increased investments in residential whole loans, as proceeds received from portfolio run-off from Agency and
Non-Agency MBS and equity capital raised in the market have been deployed primarily in loan investments. Consequently, at
the end of 2018, residential whole loan investments comprised approximately 38% of our assets and more than 50% of our allocated
net equity. During 2019, we expect to continue to seek investment opportunities primarily in residential whole loans and selectively
in residential mortgage securities and MSR-related assets as market opportunities arise. We expect that we will moderately increase
leverage to support further asset growth in 2019, both through use of repurchase agreement financing and securitization.
Residential Whole Loans
During 2018, we continued to grow our residential whole loan portfolio, which we acquired through interests in certain trusts
established to acquire the loans, that are consolidated on our balance sheet for financial reporting purposes. In particular during
2018, growth in our residential whole loan portfolio was primarily through acquisitions or commitments to acquire purchased
performing loans. Such loans include: (i) loans to finance (or refinance) one-to four-family residential properties that are not
considered to meet the definition of a “Qualified Mortgage” in accordance with guidelines adopted by the Consumer Financial
Protection Bureau (or Non-QM loans), (ii) short-term business purpose loans collateralized by residential properties made to non-
occupant borrowers who intend to rehabilitate and sell the property for a profit (or Rehabilitation loans or Fix and Flip loans), (iii)
loans to finance (or refinance) non-owner occupied one-to four-family residential properties that are rented to one or more tenants
(or Single-family rental loans), and (iv) previously originated loans secured by residential real estate that is generally owner
occupied (or Seasoned performing loans). The majority of our purchased performing loans are Hybrids or, in the case of
Rehabilitation loans, are expected to have relatively short duration. Consequently, we believe that our purchased performing loans
acquired to date will exhibit relatively lower interest rate sensitivity than conventional fixed rate residential whole loans.
1
In addition, during 2018, we continued to purchase packages of both purchased credit impaired and non-performing residential
whole loans which were acquired in secondary market transactions. Purchased credit impaired loans are typically characterized
by borrowers who have previously experienced payment delinquencies and the amount owed 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
their contractual loan balance to reflect the impaired credit history of the borrower, the loan-to-value ratio (or LTV) of the loan
and the coupon rate. 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 these 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 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 balances of “real estate owned” (or REO) property to increase.
Residential Mortgage Securities
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 purchase 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.
Due to their strong performance over the past several years, and resulting increased demand for these investments, returns available
on Legacy Non-Agency MBS have been lower than for other residential mortgage assets. Consequently, in recent years we have
managed this portfolio through opportunistic sales of certain Legacy Non-Agency MBS based on an assessment of expected future
cash flows and prevailing market pricing.
Our RPL/NPL MBS were purchased primarily at prices around par and represent the senior and mezzanine tranches of the
related securitizations. These securities are structured with significant credit enhancement (typically approximately 40-50% for
the most senior tranches and approximately 25-35% for mezzanine tranches) 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 tranches are paid
off. Prior to purchase, we analyze the deal structure and the credit risk of the underlying loans. 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 supporting 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 generally contain a contractual coupon step-up feature,
where the coupon increases up to 300 - 400 basis points at 36 - 48 months or sooner. We expect that the combination of the priority
cash flow and the step-up feature associated with these investments will result in their exhibiting short average lives and, accordingly,
reduced interest rate sensitivity.
The mortgages collateralizing our Agency MBS portfolio are predominantly Hybrids, 15 and 30 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
2
(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, the fair values of 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 2018, as we have for the past several years, we allowed our Hybrid and 15-year Agency MBS to run off. We
also sold approximately $122 million of lower yielding 15-year Agency MBS during the year. In addition, we purchased 30-year
Agency MBS and concurrently entered into interest rate swap hedges that are intended to reduce associated interest rate sensitivity.
For the past several years, we have also invested in CRT securities. CRT securities are debt obligations issued by or sponsored
by Fannie Mae and Freddie Mac. The payments of principal and interest on the CRT securities are paid on a monthly basis and
are dependent on the performance of loans in either a reference pool or an actual pool of loans. We may incur a principal loss if
the performance of the underlying actual or reference pool loans results either in calculated or actual losses that 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 loan pool. During 2018, we have taken advantage of market
opportunities to rotate out of seasoned higher dollar priced securities, resulting in realized gains, and reinvested the sales proceeds
in newer issue securities at prices close to par.
MSR-Related Assets
Although we do not own or otherwise invest directly in MSRs, we have made investments in term notes backed directly or
indirectly by MSRs and loans to finance entities that originate residential mortgage loans and own the related MSRs. In the case
of term notes backed by MSR-related collateral, we believe the 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 related
special purpose vehicle issuing the note, 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. Credit risk on MSR-related corporate loans is
mitigated as the loans are secured by MSRs and certain other unencumbered assets owned by the borrower.
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. We have also securitized both re-performing and non-performing residential whole loans as part of our
financing strategy. 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 asset back to the borrower at a future date (i.e., the
maturity of the borrowing) at a price that is higher than the original sales 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 assets as collateral to secure the borrowing,
in an amount equal 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 assets or cash as collateral to secure borrowings under our
repurchase financing with such lender, are routinely experienced by us when the value of the assets pledged as collateral declines
as a result of principal amortization and prepayments or due to changes in market interest rates, spreads or other market conditions.
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, 2018, we had
outstanding balances under repurchase agreements with 26 separate lenders.
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In addition to repurchase agreements, 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.
COMPETITION
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, 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
(or 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, 2018, we had 59 full-time and one part-time employee. We believe that our relationship with our employees
is good. None of our employees are 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.
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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 and collateral, which
is driven by numerous factors, including the supply and demand for residential mortgage assets in the marketplace, our ability to
source new investments at appropriate yields, 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, especially in the real estate and mortgage sector,
our competition, 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), market credit spreads, borrowing costs (i.e., our interest expense), delinquencies, defaults and prepayment
speeds on our investments, 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, liquidity, 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 various risks, including but not limited to: interest rate risk,
credit risk, default risk, liquidity risk, financing risk, legal or regulatory 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 those of our historical
investments. For example, in recent years, we have made new investments principally in residential whole loans, RPL/NPL MBS,
CRT securities, MSR-related assets and fixed rate 30-Year Agency MBS. 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), residential whole loans and CRT securities 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, CRT securities and other investment assets of lower credit quality. In general, these investments (which,
as of December 31, 2018 represented 68.4% 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 residential
whole loans, CRT securities, 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 residential whole loans involve credit risks, some of which are different from those of 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 2018, and represented
approximately 37.7% of our total assets as of December 31, 2018. We expect that our investment portfolio in residential whole
loans will continue to increase during 2019. 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. A number
of factors impact a borrower’s ability to repay including, among other things, changes in employment status, changes in interest
rates or the availability of credit, and changes in real estate values. 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.
Our investments are subject to changes in credit spreads and other risks.
Credit spreads, which at times can be very volatile and react to various macro-economic events or conditions, measure the
additional yield demanded on securities by the market based on their perceived credit relative to a specific benchmark. Fixed rate
securities are valued based on a market credit spread over the rate payable on fixed rate U.S. Treasuries of like maturity. Floating
rate securities are generally valued based on a market credit spread over LIBOR. Excessive supply of these securities combined
with reduced demand will generally cause the market to require a higher yield on these securities, resulting in the use of a higher,
or “wider,” spread over the benchmark rate to value such securities. Under such conditions, the value of our MBS portfolio would
tend to decline. Conversely, if the spread used to value such securities were to decrease, or “tighten,” the value of our MBS
portfolio would tend to increase. In addition, MBS valuations are subject to other financial risks, including mortgage basis spread
risk. In periods of market volatility, changes in credit spreads and mortgage basis may result in changes in the value of MBS not
being equally offset by changes in the value of derivative contracts used to manage portfolio valuation risks arising due to changes
in interest rates. Such changes in the market value of our investments may affect our net equity, net income or cash flow directly
through their impact on portfolio unrealized gains or losses, and therefore our ability to realize gains on such investments, or
indirectly through their impact on our ability to borrow and access capital.
A significant portion of our Non-Agency MBS, residential whole loans and CRT securities are secured by properties in a
small number of geographic areas and may be disproportionately affected by economic or housing downturns, our
competition, 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, residential whole loan and CRT securities
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, residential whole loan and CRT securities 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 residential whole loans, CRT securities 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 residential whole loan investments, CRT securities 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, mudslide 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, residential
whole loans or CRT securities. Because certain natural disasters are not typically covered by the standard hazard insurance policies
maintained by borrowers (such as hurricanes, earthquakes or certain flooding), or the proceeds payable for losses covered by any
such policy are not sufficient to make the related repairs, the affected borrowers may have to pay for any repairs themselves.
Under these circumstances, borrowers may decide not to repair the damaged property or may stop paying the mortgage, either of
which could cause defaults and credit loss severities to increase.
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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.
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 certain mortgage loans, sellers may make 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 U.S. generally
accepted accounting principles (or 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 and 2018. There can be
no assurance that such volatility in periodic financial results will not continue during 2019 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 residential mortgage securities that are accounted for as available-for-sale (or AFS) may
require us to recognize an “other-than-temporary impairment” (or OTTI) against such assets under GAAP. 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 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
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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, if recovered, 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.
The 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, models may be used to evaluate, depending on the asset class, house price appreciation
and depreciation by county or region, prepayment speeds and frequency, cost and timing of foreclosures, as well as other factors.
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 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 buy certain assets at prices that are
too high, sell certain assets at prices that are too low or 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 generally 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 results of operations, financial condition and business could be materially adversely affected if our fair value
determinations of these assets are materially higher than could actually be realized in the market.
Our investments in residential whole loans are difficult to value and are dependent upon the borrower’s ability to service
or refinance their debt. The inability of the borrower 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
the risk factor captioned “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 help a borrower 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 the refinancing of NPLs and RPLs potentially more difficult and
less profitable for us.
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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 Federal Reserve, the U.S. Treasury Department, the Federal Housing Administration (or
the FHA), the Consumer Financial Protection Bureau (or CFPB), and other agencies have in the past implemented, and may in
the future implement, a number of federal programs designed to assist homeowners and help them avoid residential mortgage loan
foreclosures, reduce or forgive certain mortgage payments, or otherwise mitigate losses for homeowners. In addition, Fannie Mae
and Freddie Mac implemented their Flex Modification foreclosure prevention program, developed at the direction of the Federal
Housing Finance Agency (or 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 respect to our Non-Agency MBS and residential whole loan investments, 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 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.
Tax reform legislation may adversely affect our business.
Recent tax reform legislation adopted at the end of 2017 includes changes that could have an adverse impact on the U.S.
residential housing market and potentially reduce the market value of our investments. Among other items, there is a temporary
reduction of the deductibility of interest on mortgage debt, a cap on 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.
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),
for loans that we purchase together with the related servicing rights, 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 the risk factor captioned “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.
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
9
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 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
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.
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.
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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
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 changes in 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
risk factor captioned “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, pay expenses or to make improvements before a property can be sold, and we cannot assure that we will have cash available
to make these payments. As a result, our ownership of REOs could materially and adversely affect our liquidity and results of
operations.
Our investments in MSR-related assets expose us to additional risks.
As of December 31, 2018, we had approximately $611.8 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. Furthermore, the value of MSRs is highly sensitive to changes in prepayment rates. Decreasing market interest
rates are generally associated with increases in prepayment rates as borrowers are able to refinance their loans at lower costs.
Prepayments result in the partial or complete loss of the cash flows from the related MSR. If these or other MSR-related risks
come to fruition, the value of our MSR-related assets could decline significantly.
Prepayment and Reinvestment Risk
Prepayment rates on the mortgage loans underlying certain of our residential mortgage assets may materially adversely
affect our profitability or result in liquidity shortfalls that could require us to sell assets in unfavorable market conditions.
In general, the mortgages collateralizing certain of our residential mortgage assets may be prepaid at any time without
penalty. Prepayments result when borrowers satisfy (i.e., pay off) the mortgage upon selling or refinancing their mortgaged
property. When we acquire assets collateralized by residential mortgage loans, 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 asset. If
we purchase an asset at a premium to par value, and borrowers then prepay the underlying mortgage loans at a faster rate than we
expected, the increased prepayments would result in a yield lower than expected on such assets because we would be required to
amortize the related premium on an accelerated basis. Conversely, if we purchase residential mortgage assets at a discount to par
value, and borrowers then prepay the underlying mortgage loans at a slower rate than we expected, the decreased prepayments
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would result in a lower yield than expected on the asset and/or may result in a decline in the fair value of the asset, which would
result in losses if the asset is accounted for a fair value or OTTI for an AFS security 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 certain of our assets (in particular our longer
duration 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.
With respect to certain residential mortgage assets, we have, at times, purchased assets 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 assets. In accordance with GAAP, we amortize premiums over the life of the related asset. If the underlying mortgage loans
securing these assets 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.
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 assets purchased
at a premium which are prepaid, the rate at which prepayments are made on our certain assets purchased at a discount, 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-
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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
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, 2018, we had amounts outstanding under repurchase agreements with 26 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 the uncertainty surrounding 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 assets 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 short-term repurchase agreements to finance our generally longer-term 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 assets 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
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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.
•
•
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, 2018, we had greater than 5% stockholders’ equity at risk to the following repurchase agreement
counterparties: Goldman Sachs (approximately 9.4%), RBC (approximately 7.4%), Wells Fargo (approximately 5.5%)
and Barclay's Bank (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 investments 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:
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•
•
•
•
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, our borrowing costs generally will increase at a faster
pace than our interest earnings on the leveraged 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 certain of our loans and the loans collateralizing our MBS may materially adversely affect our
profitability if short-term interest rates increase. The coupons earned on adjustable rate and hybrid loans as well as
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 assets; however, the level of adjustment to the interest rates earned on our ARM-MBS and certain of our loans is
typically limited by contract (or in certain cases by state or federal law). The interim and lifetime interest rate caps on
certain of our loans and the loans 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 certain of our loans and the loans 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 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 related 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. In addition, a flatter yield curve would generally reduce the net spread we could earn on new
investments. 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 inter-bank lending rate reporting practices, the method pursuant to which LIBOR is determined or the
establishment of alternative reference rates may adversely affect our profitability.
As discussed above, the interest rates on certain of our investments, our repurchase transactions and our interest rate swaps
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
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elsewhere are conducting criminal and civil investigations into whether the banks that contribute information to the British Bankers’
Association (or 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
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, that we 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 repurchase 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.
The use of non-recourse long-term financing structures expose us to risks, which could result in losses to us.
We use securitization financing for certain of our residential whole loan investments. In such structures, our financing sources
typically have only a claim against the assets included in a securitization rather than a general claim against us as an entity. Prior
to any such financing, we generally seek to finance our investments with relatively short-term repurchase agreements until a
sufficient portfolio of assets is accumulated. As a result, we are subject to the risk that we would not be able to acquire, during
the period that any short-term repurchase agreements are available, sufficient eligible assets or securities to maximize the efficiency
of a securitization. We also bear the risk that we would not be able to obtain new short-term repurchase agreements or would not
be able to renew any short-term repurchase agreements after they expire should we need more time to seek and acquire sufficient
eligible assets or securities for a securitization. In addition, conditions in the capital markets may make the issuance of any such
securitization less attractive to us even when we do have sufficient eligible assets or securities. While we would generally intend
to retain a portion of the interests issued under such securitizations and, therefore, still have exposure to any investments included
in such securitizations, our inability to enter into such securitizations may increase our overall exposure to risks associated with
direct ownership of such investments, including the risk of default. If we are unable to obtain and renew short-term repurchase
agreements or to consummate securitizations to finance the selected investments on a long-term basis, we may be required to seek
other forms of potentially less attractive financing or to liquidate assets at an inopportune time or price.
These financing arrangements require us to make certain representations and warranties regarding the assets that collateralize
the borrowings. Although we perform due diligence on the assets that we acquire, certain representations and warranties that we
make in respect of such assets may ultimately be determined to be inaccurate. Such representations and warranties may include,
but are not limited to, issues such as the validity of the lien; the absence of delinquent taxes or other liens; the loans’ compliance
with all local, state and federal laws and the delivery of all documents required to perfect title to the lien. In the event of a breach
of a representation or warranty, we may be required to repurchase affected loans, make indemnification payments to certain
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indemnified parties or address any claims associated with such breach. Further, we may have limited or no recourse against the
seller from whom we purchased the loans. Such recourse may be limited due to a variety of factors, including the absence of a
representation or warranty from the seller corresponding to the representation provided by us or the contractual expiration thereof.
A breach of a representation or warranty could adversely affect our results of operations and liquidity.
Certain of our financing arrangements are rated by one or more rating agencies and we may sponsor financing facilities in
the future that are rated by credit agencies. The related agency or rating agencies may suspend rating notes at any time. Rating
agency delays may result in our inability to obtain timely ratings on new notes, which could adversely impact the availability of
borrowings or the interest rates, advance rates or other financing terms and adversely affect our results of operations and liquidity.
Further, if we are unable to secure ratings from other agencies, limited investor demand for unrated notes could result in further
adverse changes to our liquidity and profitability.
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.
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
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 and servicing 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), CFPB, Federal Deposit Insurance Corporation (or FDIC), Federal Reserve, and the SEC may have a
significant effect on the financial markets, and may affect the availability or terms of financing, derivatives or MBS, each of which
could have a material adverse effect on our business.
In addition, the U.S. Government, the 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
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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.
The Federal Reserve announced in November 2008 a program of large-scale purchases of Agency MBS in an attempt to
lower longer-term interest rates and contribute to an overall easing of adverse financial conditions. Subject to specified investment
guidelines, the portfolios of Agency MBS purchased through the programs established by the U.S. Treasury and the Federal Reserve
may be held to maturity and, based on mortgage market conditions, adjustments may be made to these portfolios. This flexibility
may adversely affect the pricing and availability of Agency MBS during the remaining term of these portfolios.
The final Basel FRTB Ruling, which raised capital charges for bank holders of ABS, CMBS and Non-Agency MBS beginning
in 2019, could adversely impact available trading liquidity and access to financing.
In January 2006, the Basel Committee on Banking Supervision released a finalized framework for calculating minimum
capital requirements for market risk, which takes effect in January 2019. In the final proposal, capital requirements would overall
be meaningfully higher than current requirements. However, each country’s specific regulator may codify the rules differently.
Under the framework, capital charges on a bond are calculated based on three components: default, market and residual risk.
Implementation of the final proposal could impose meaningfully higher capital charges on dealers compared with current
requirements, and could reduce liquidity in the securitized products market, negatively impacting the value of certain of our assets.
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.
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
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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) to 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.
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.
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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 hedged instrument;
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
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
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both the CFTC and the SEC. These additional fees, costs, margin requirements, documentation requirements, and regulations
could adversely affect our business and results of operations.
Clearing facilities or exchanges upon which 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
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, 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.
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Our failure to maintain our qualification as a REIT would cause our stock to be delisted from the NYSE.
The New York Stock Exchange (or NYSE) requires, as a condition to the listing of our shares, that we maintain our REIT
status. Consequently, if we fail to maintain our REIT status, our shares would promptly be delisted from the NYSE, which would
decrease the trading activity of such shares. This could make it difficult to sell shares and would likely cause the market volume
of the shares trading to decline.
If we were delisted as a result of losing our REIT status and desired to relist our shares on the NYSE, we would have to
reapply to the NYSE to be listed as a domestic corporation. As the NYSE’s listing standards for REITs are less onerous than its
standards for domestic corporations, it would be more difficult for us to become a listed company under these heightened standards.
We might not be able to satisfy the NYSE’s listing standards for a domestic corporation. As a result, if we were delisted from the
NYSE, we might not be able to relist as a domestic corporation, in which case our shares could not trade on the NYSE.
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,
distribute amounts that would otherwise be invested in future acquisitions or make a taxable distribution of our stock to make
distributions sufficient to maintain our qualification as a REIT or avoid corporate income 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-
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.
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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
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.
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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.
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.
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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 business. Any income from a properly
designated hedging transaction we enter into to manage the 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, which we are
required to include in our taxable income either over time or as principle payments are received, as applicable. 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 (or possibly sooner if such income is included in our financial
statements) and will be taxed based on the assumption that all future projected payments due on such debt instruments will be
made. 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.
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The interest apportionment rules may affect our ability to comply with the REIT asset and gross income tests.
Most of the purchased credit impaired and non-performing loans that we have acquired were acquired by us at a discount
from their outstanding principal amount, because our pricing was generally based on the value of the underlying real estate that
secures those mortgage loans. Treasury Regulation Section 1.856-5(c) (the “interest apportionment regulation”) provides that if
a mortgage is secured by both real property and other property, a REIT is required to apportion its annual interest income to the
real property security based on a fraction, the numerator of which is the value of the real property securing the loan, determined
when the REIT commits to acquire the loan, and the denominator of which is the highest “principal amount” of the loan during
the year. If a mortgage is secured by both real property and personal property and the value of the personal property does not
exceed 15% of the aggregate value of the property securing the mortgage, the mortgage is treated as secured solely by real property
for this purpose. Revenue Procedure 2014-51 interprets the “principal amount” of the loan to be the face amount of the loan,
despite the Code requiring taxpayers to treat any market discount, that is the difference between the purchase price of the loan
and its face amount, for all purposes (other than certain withholding and information reporting purposes) as interest rather than
principal.
The interest apportionment regulation applies only if the debt in question is secured both by real property and personal
property. We believe that all of the mortgage loans that we acquire at a discount under the circumstances contemplated by Revenue
Procedure 2014-51 are secured only by real property, and no other property value is taken into account in our underwriting and
pricing. Accordingly, we believe that the interest apportionment regulation does not apply to our portfolio.
Nevertheless, if the IRS were to assert successfully that our mortgage loans were secured by property other than real estate,
that the interest apportionment regulation applied for purposes of our REIT testing, and that the position taken in Revenue Procedure
2014-51 should be applied to our portfolio, then depending upon the value of the real property securing our loans and their face
amount, and the sources of our gross income generally, we might not be able to meet the REIT 75% gross income test, and possibly
the asset tests applicable to REITs. If we did not meet these tests, we could potentially either lose our REIT status or be required
to pay a tax penalty to the IRS. With respect to the REIT 75% asset test, Revenue Procedure 2014-51 provides a safe harbor under
which the IRS will not challenge a REIT’s treatment of a loan as being a real estate asset in an amount equal to the lesser of (1)
the greater of (a) the current value of the real property securing the loan or (b) the fair market value of the real property securing
the loan determined as of the date the REIT committed to acquire the loan or (2) the fair market value of the loan on the date of
the relevant quarterly REIT asset testing date. This safe harbor, if it applied to us, would help us comply with the REIT asset tests
following the acquisition of distressed debt if the value of the real property securing the loan were to subsequently decline. If we
did not meet one or more of the REIT asset tests, then we could potentially either lose our REIT status or be required to pay a tax
penalty to the IRS.
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 before January 1, 2026, 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 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.
We may in the future choose to make distributions in our own stock, in which case you could be required to pay income
taxes in excess of any cash distributions you receive.
We may in the future make taxable distributions that are payable in cash and shares of our common stock at the election of
each stockholder. Taxable stockholders receiving such distributions will be required to include the full amount of the distribution
as ordinary income to the extent of our current and accumulated earnings and profits for federal income tax purposes. As a result,
stockholders may be required to pay income taxes with respect to such distributions in excess of the cash distributions received.
If a U.S. stockholder sells the stock that it receives as a distribution in order to pay this tax, the sale proceeds may be less than the
amount included in income with respect to the distribution, depending on the market price of our stock at the time of the sale.
Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such
distributions, including in respect of all or a portion of such distribution that is payable in stock. In addition, if a significant number
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of our stockholders determine to sell shares of our common stock in order to pay taxes owed on distributions, it may put downward
pressure on the market price of our common stock.
The IRS has issued guidance authorizing elective cash/stock dividends to be made by public REITs where there is a minimum
(of at least 20%) amount of cash that must be paid as part of the dividend, provided that certain requirements are met. It is unclear
whether and to what extent we would be able to or choose to pay taxable distributions in cash and stock. In addition, no assurance
can be given that the IRS will not impose additional requirements in the future with respect to taxable cash/stock distributions,
including on a retroactive basis, or assert that the requirements for such taxable cash/stock distributions have not been met.
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 Tax Cuts and Jobs Act (or 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
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
27
•
“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
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, such as through equity awards
to our employees, 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.
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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 other 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 as well as the servicers of our loans.
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
and servicers) 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.
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.
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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 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.
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Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Office Leases
We currently pay monthly rent pursuant to two office leases. In November 2018, we amended the lease for our corporate
headquarters in New York, New York, under the same terms and conditions, to extend the expiration date for the lease by up to
one year, through June 30, 2021. For the year ended December 31, 2018, we recorded an expense of approximately $2.7 million
in connection with lease rental for our current corporate headquarters. 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.
In addition, in November 2018, we executed a lease agreement on new office space in New York, New York. We plan to
relocate our corporate headquarters to this new space upon the substantial completion of the building. The changes and growth
our Company has experienced over the past several years has resulted in an increase in our space requirements in the ten year
period since our previous office lease was entered into. Accordingly, our new lease is for approximately 50% more space than
our current corporate headquarters. The lease term specified in the agreement is fifteen years with an option to renew for an
additional five years. Our current estimate of annual lease rental expense under the new lease, excluding escalation charges which
at this point are unknown, is approximately $4.6 million. We currently expect to relocate to the space in the fourth fiscal quarter
of 2020, but this timing as well as when we are required to begin making payments and recognize rental and other expenses under
the new lease, is dependent on when the building is actually available for use.
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.
31
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”, and our preferred stock is also
listed on the NYSE, under the symbol “MFA/PB.”
Holders
As of February 14, 2019, we had 536 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, 2018. We have historically
declared cash dividends on our common stock on a quarterly basis. During 2018 and 2017, we declared total cash dividends to
holders of our common stock of $339.2 million ($0.80 per share) and $312.8 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, 2018, 2017 and 2016 the portions of our common stock dividends that were deemed to be capital gains
were $0.1290, $0.0831 and $0.0361 per share of common stock, respectively. (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.
We declared and paid the following dividends on our common stock during the years 2018 and 2017:
Year
2018
Declaration Date
December 12, 2018
September 13, 2018
June 7, 2018
March 7, 2018
Record Date
Payment Date
Dividend per
Share
December 28, 2018
October 1, 2018
June 29, 2018
March 29, 2018
January 31, 2019
October 31, 2018
$
0.20 (1)
0.20
July 31, 2018
April 30, 2018
2017
December 13, 2017
December 28, 2017
January 31, 2018
$
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
0.20
0.20
0.20
0.20
0.20
0.20
(1) At December 31, 2018, we had accrued dividends and dividend equivalents payable of $90.2 million related to the common stock dividend
declared on December 12, 2018.
We have not established a minimum payout level for our common stock. 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. (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.)
32
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,
2018 and 2017.
We engaged in no share repurchase activity during the fourth quarter of 2018 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, 2018:
Repurchase Program (2)
Employee Transactions (3)
November 1-30, 2018:
Repurchase Program (2)
Employee Transactions (3)
December 1-31, 2018:
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
— $
—
—
—
—
213,483
$
— $
$
213,483
—
—
—
—
—
6.72
—
6.72
—
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, 2018, 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.
33
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 2018 and 2017, we
issued 379,903 and 2,293,192 shares of common stock through the DRSPP generating net proceeds of approximately $2.8 million
and $18.5 million, respectively.
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, 2018:
Award (1)
RSUs
Total
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
2,357,696
2,357,696
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)
5,238,509 (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, 2018, 998,946 RSUs were vested, 497,500
RSUs were subject to time based vesting and 861,250 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, 2018.
34
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)
2018
2017
2016
2015
2014
At or/For the Year Ended December 31,
Operating Data:
Interest income
Interest expense
Net gain on residential whole loans measured at fair
value through earnings
Net realized gain on sales of residential mortgage
securities (1)
Unrealized net gains and net interest income from
Linked Transactions
Other (loss)/income, net (2)
Operating and other expense
Net income
Preferred stock dividends
Net income available to common stock and
participating securities
Earnings per share — basic and diluted
Dividends declared per share of common stock
Dividends declared per share of preferred stock
Balance Sheet Data:
$
455,675
$
433,448
$
457,450
$
492,143
$
463,817
(232,186)
(197,141)
(193,355)
(176,948)
(159,808)
137,619
90,045
62,605
19,575
116
61,307
39,577
35,837
34,900
37,497
—
(40,951)
(79,663)
—
28,365
(71,901)
$
301,801
$
322,393
15,000
15,000
$
$
$
$
286,801
0.68
0.80
1.875
$
$
$
$
307,393
0.79
0.80
1.875
$
$
$
$
$
—
10,115
(59,984)
312,668
15,000
297,668
0.80
0.80
1.875
$
$
$
$
$
—
(4,015)
(52,429)
17,092
80
(45,290)
313,226
$
313,504
15,000
15,000
298,226
0.80
0.80
1.875
$
$
$
$
298,504
0.81
0.80
1.875
MBS, CRT securities and MSR-related assets
$ 7,121,140
$ 7,515,130
$ 10,054,963
$ 11,356,643
$10,762,622
Residential whole loans, at carrying value
Residential whole loans, at fair value
Cash and cash equivalents
Linked Transactions
Total assets
3,016,715
1,665,978
51,965
—
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
12,420,327
10,954,734
12,484,022
13,162,551
12,354,242
Repurchase agreements and other advances
7,879,087
6,614,701
8,687,268
9,387,622
8,267,388
Securitized debt (3)
Swaps (in a liability position) (4)
Total liabilities
Preferred stock, liquidation preference
Total stockholders’ equity
Other Data:
Average total assets
Average total stockholders’ equity
Return on average total assets (5)
Return on average total stockholders’ equity (6)
Total average stockholders’ equity to total average
assets (7)
Dividend payout ratio (8)
Book value per share of common stock (9)
$
684,420
363,944
—
—
—
46,954
21,868
70,526
110,072
62,198
9,004,226
7,693,098
9,450,120
10,195,290
9,150,970
200,000
200,000
3,416,101
3,261,636
200,000
3,033,902
200,000
200,000
2,967,261
3,203,272
$ 11,186,845
$ 11,619,174
$ 12,836,580
$ 13,669,055
$12,542,584
$ 3,346,980
$ 3,203,814
$ 2,965,570
$ 3,129,461
$ 3,230,932
2.56%
9.02%
2.65%
10.06%
2.32%
10.54%
2.18%
10.01%
2.38%
9.70%
29.92%
27.57%
23.10%
22.89%
25.76%
1.18
7.15
$
1.01
7.70
$
1.00
7.62
$
1.00
7.47
$
0.99
8.12
35
(1) 2018: We sold Agency MBS for $122.0 million, realizing losses of $6.8 million, sold CRT securities for $299.9 million, realizing gains of
$31.4 million, sold Non-Agency MBS for $117.1 million, realizing gains of $36.7 million. 2017: We sold Non-Agency MBS for $104.0
million, realizing gains of $39.9 million and sold U.S. Treasury securities for $139.1 million, realizing losses of approximately $309,000.
2016: We sold Non-Agency MBS for $85.6 million, realizing gains of $35.8 million. 2015: We sold Non-Agency MBS for $70.7 million,
realizing gains of $34.9 million. 2014: We sold Non-Agency MBS for $123.9 million, realizing gains of $37.5 million.
(2) Includes OTTI recognized through earnings related to Non-Agency MBS.
(3) 2018 and 2017: Reflects securitized debt from our loan securitization transactions. 2015 and 2014: Reflects securitized debt from our MBS
resecuritization transactions.
(4) 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.
(5) Reflects net income available to common stock and participating securities divided by average total assets.
(6) Reflects net income divided by average total stockholders’ equity.
(7) Reflects total average stockholders’ equity divided by total average assets.
(8) Reflects dividends declared per share of common stock (excluding special dividends) divided by earnings per share.
(9) Reflects total stockholders’ equity less the preferred stock liquidation preference divided by total shares of common stock outstanding.
36
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 an internally-managed REIT primarily engaged in the business of investing, on a leveraged basis, in residential
mortgage assets, including residential mortgage securities, residential whole loans 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, 2018, we had total assets of approximately $12.4 billion, of which $6.5 billion, or 52.4%, represents
investments in residential mortgage securities. At such date, our portfolio includes $2.7 billion of Agency MBS, $3.3 billion of
Non-Agency MBS and $492.8 million of CRT securities. Non-Agency MBS is comprised of $1.9 billion of Legacy Non-Agency
MBS and $1.4 billion of RPL/NPL MBS. These RPL/NPL MBS are backed by securitized re-performing and non-performing
loans and are generally structured with a contractual coupon step-up feature where the coupon increases from 300 - 400 basis
points at 36 - 48 months from issuance or sooner. In addition, at December 31, 2018, we had approximately $4.7 billion in
residential whole loans acquired through interests in certain trusts established to acquire the loans, which represented approximately
37.7% of our total assets. During 2018, our residential whole loan portfolio was our fastest growing asset class, primarily as a
result of acquisitions or commitments to acquire purchased performing loans. Our purchased performing loans, which as of
December 31, 2018 comprised approximately 47% of our residential whole loans, include : (i) loans to finance (or refinance) one-
to four-family residential properties that are not considered to meet the definition of a “Qualified Mortgage” in accordance with
guidelines adopted by the Consumer Financial Protection Bureau (or Non-QM loans), (ii) short-term business purpose loans
collateralized by residential properties made to non-occupant borrowers who intend to rehabilitate and sell the property for a profit
(or Rehabilitation loans or Fix and Flip loans), (iii) loans to finance (or refinance) non-owner occupied one-to four-family residential
properties that are rented to one or more tenants (or Single-family rental loans), and (iv) previously originated loans secured by
residential real estate that is generally owner occupied (or Seasoned performing loans). Our remaining investment-related assets,
which represented approximately 9% of our total assets at December 31, 2018, were primarily comprised of MSR-related assets,
REO and MBS and loan-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. In
recent periods, the impact on our results from market volatility, resulting in changes in market values of certain financial instruments
for which changes in fair value are recorded in net income each period, such as CRT securities, certain residential whole loans,
Agency MBS, and Swaps not designated as hedges, has increased. 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, 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 an asset as a
percentage of the asset 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 residential mortgage assets and, correspondingly, our stockholders’
equity to decline; (iii) coupons on our adjustable rate assets to reset, on a delayed basis, to higher interest rates; (iv) prepayments
on our assets to decline, thereby slowing the amortization of purchase premiums and the accretion of our purchase discounts, and
slowing our ability to redeploy capital to generally higher yielding investments; 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 residential mortgage
assets and, correspondingly, our stockholders’ equity to increase; (iii) coupons on our adjustable rate assets, on a delayed basis,
to lower interest rates; (iv) prepayments on our assets to increase, thereby accelerating the amortization of purchase premiums
and the accretion of our purchase discounts, and accelerating the redeployment of our capital to generally lower yielding
investments; 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.
37
Our investments in residential mortgage assets, particularly investments in residential mortgage loans and Non-Agency MBS,
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. With respect to investments in purchased performing loans, we believe that sound underwriting standards, including
low LTVs at origination, significantly mitigate our risk of loss. Our investment process for credit sensitive assets focuses primarily
on quantifying and pricing credit risk.
The table below presents the composition of our MBS portfolios with respect to repricing characteristics as of December 31,
2018:
Underlying Mortgages
(In Thousands)
Hybrids in contractual fixed-rate period
Hybrids in adjustable period
15-year fixed rate
Greater than 15-year fixed rate
Floaters
Total
December 31, 2018
Agency MBS
Fair Value (1)
Legacy
Non-Agency MBS
Fair Value (2)
Total
MBS (1)(2)
Percent
of Total
$
308,165
$
— $
308,165
6.6%
840,498
781,625
736,498
30,390
1,204,585
1,521
706,283
25,838
2,045,083
783,146
1,442,781
56,228
44.2
16.9
31.1
1.2
$
2,697,176
$
1,938,227
$
4,635,403
100.0%
(1) Does not include principal payments receivable in the amount of $1.0 million.
(2) Does not reflect $1.4 billion of RPL/NPL MBS, which are backed primarily by securitized re-performing and non-performing loans. These
securities are generally structured such that the coupon increases from 300 - 400 basis points at 36 - 48 months from issuance or sooner.
Premiums arise when we acquire an MBS or loan at a price in excess of the aggregate principal balance of the mortgages
securing the MBS (i.e., par value) or when we acquire residential whole loans at a price in excess of their aggregate principal
balance. 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. Accretable
purchase discounts on these investments are accreted to interest income. Purchase premiums, which are primarily carried on our
Agency MBS, certain CRT securities and Non-QM loans, are amortized against interest income over the life of the investment
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 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 a loan, and the
conditional default rate (or CDR), which measures involuntary prepayments resulting from defaults. CPRs on our residential
mortgage securities and whole loans may differ significantly. For the year ended December 31, 2018, 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 15.5%. 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%. Over the last consecutive eight
quarters, ending with December 31, 2018, 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 12.3%, experienced during
the month ended December 31, 2018, with an average CPR over such quarters of 16.1%.
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
38
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.
It is generally 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, 2018, we
had net unrealized gains on our Non-Agency MBS of $450.6 million, comprised of gross unrealized gains of $459.0 million and
gross unrealized losses of $8.4 million and net unrealized losses of $36.4 million on our Agency MBS, comprised of gross unrealized
losses of $49.5 million and gross unrealized gains of $13.1 million. At December 31, 2018, 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, 2018 were comprised of Swaps.
The majority of our Swap derivative instruments are designated as cash-flow hedges against a portion of our current and
forecasted LIBOR-based repurchase agreements. While these Swaps do not extend the maturities of the associated repurchase
agreement being hedged; 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.
Recent Market Conditions and Our Strategy
At December 31, 2018, our residential mortgage asset portfolio, which includes residential mortgage securities, residential
whole loans and REO and MSR-related assets was approximately $12.1 billion compared to $9.9 billion at December 31, 2017.
In 2019, we expect to continue to seek investment opportunities primarily focused on residential whole loans and selectively in
residential mortgage securities and MSR-related assets as market opportunities arise.
The following table presents the activity for our residential mortgage asset portfolio for the year ended December 31, 2018:
(In Millions)
Residential whole loans and REO $
RPL/NPL MBS
MSR-related assets
CRT securities
Legacy Non-Agency MBS
Agency MBS
Totals
December 31,
2017
Runoff (1)
Acquisitions
Other (2)
December 31,
2018
Change
2,386
$
(691) $
923
492
664
2,611
2,825
(586)
(515)
(13)
(529)
(712)
3,135
$
1,049
635
156
7
758
102
$
4,932
$
2,546
(9)
—
(314)
(148)
(173)
1,377
612
493
1,941
2,698
454
120
(171)
(670)
(127)
$
9,901
$
(3,046) $
5,740
$
(542) $
12,053
$
2,152
(1) Primarily includes principal repayments, cash collections on purchased credit impaired loans and sales of REO.
(2) Primarily includes sales, changes in fair value, net premium amortization/discount accretion and adjustments to record lower of cost or
estimated fair value adjustments on REO. During the year ended December 31, 2018 we sold CRT securities for $299.9 million, realizing
gains of $31.4 million, sold certain Non-Agency MBS for $117.1 million, realizing gains of $36.7 million and sold certain Agency MBS for
$122.0 million, realizing losses of $6.8 million.
At December 31, 2018, our total recorded investment in residential whole loans and REO was $4.9 billion or 40.9% of our
residential mortgage asset portfolio. Of this amount, (i) $3.0 billion is presented as Residential whole loans, at carrying value (of
which $2.2 billion were purchased performing loans and $798.0 million were purchased credit impaired loans), and (ii) $1.7 billion
as Residential whole loans, at fair value in our consolidated balance sheets. For the year ended December 31, 2018, we recognized
approximately $100.9 million of income on residential whole loans held at carrying value in Interest Income on our consolidated
39
statements of operations, representing an effective yield of 5.80% (excluding servicing costs). In addition, we recorded a net gain
on residential whole loans measured at fair value through earnings of $137.6 million in Other Income, net in our consolidated
statements of operations for the year ended December 31, 2018. At December 31, 2018 and 2017, we had REO with an aggregate
carrying value $249.4 million and $152.4 million, respectively, which is included in Other assets on our consolidated balance
sheets.
At the end of 2018, the average coupon on mortgages underlying our Agency MBS was higher compared to the end of 2017,
due to upward resets on securities within the portfolio, purchases of higher coupon Agency MBS and the impact of sales of lower
coupon Agency MBS during 2018. As a result, the coupon yield on our Agency MBS portfolio increased to 3.26% for 2018 from
2.95% for 2017 and the net Agency MBS yield increased to 2.30% for 2018, from 2.00% for 2017. The net yield for our Legacy
Non-Agency MBS portfolio was 10.15% for 2018 compared to 8.95% for 2017. The increase in the net yield on our Legacy Non-
Agency MBS portfolio reflects the improved performance of loans underlying the Legacy Non-Agency MBS portfolio, which has
resulted in credit reserve releases and changes in interest rates since the prior year, 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 as well as the
impact of the cash proceeds received during 2018 in connection with the settlement of litigation related to certain residential
mortgage backed securitization trusts that were sponsored by JP Morgan Chase & Co. and affiliated entities and Lehman Brothers
Holdings Inc. The net yield for our RPL/NPL MBS portfolio was 4.69% for the year ended December 31, 2018 compared to
4.14% for the year ended December 31, 2017. The increase in the net yield primarily reflects an increase in the average coupon
yield to 4.55% for 2018 from 4.05% for 2017 and higher accretion income recognized in 2018 due to the impact of redemptions
of certain securities that had been previously purchased at a discount.
We believe that our $516.1 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 weighted average amortized cost basis of
69% of face value at December 31, 2018. 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, due partly to low levels of new home construction,
low mortgage rates and demographic-driven U.S. household formation. Lower LTVs lessen the likelihood of defaults and
simultaneously decrease loss severities. Further, during 2017 and 2018, 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 2018, $25.6 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.
We believe that the majority of the impact on interest income from the reduction in Credit Reserve will occur over the next ten
years.
Our book value per common share was $7.15 as of December 31, 2018. Book value per common share decreased from
$7.70 as of December 31, 2017 due primarily to a net reduction in unrealized gains on Legacy Non-Agency MBS (including the
impact of realization of gains on sales and discount accretion income on Legacy Non-Agency MBS that was recognized as income
and declared as dividends during the year). In addition, book value also decreased as dividend distributions to common and
preferred shareholders exceeded our GAAP net income.
During 2018, we issued approximately 50.9 million shares of common stock in a public offering, generating net proceeds
of approximately $389.4 million. While the majority of proceeds raised have been deployed by the end of the year primarily
through purchases of additional mortgage related assets, we expect to continue to focus on optimizing our capital structure through
the use of leverage as we pursue additional investment opportunities going forward.
Repurchase agreement funding for our residential mortgage investments continued to be available to us from multiple
counterparties in 2018. 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, 2018, our debt consisted of borrowings under repurchase agreements with 26 counterparties, securitized debt, Senior
Notes outstanding and payable for unsettled purchases, resulting in a debt-to-equity multiple of 2.6 times. (See table on page 58
under Results of Operations that presents our quarterly leverage multiples since March 31, 2017.)
During the year ended December 31, 2018, we completed two loan securitization transactions. As part of these transactions,
we sold residential whole loans with an aggregate unpaid principal balance of $666.8 million to two entities which we consolidate
as VIEs. In connection with these transactions, third-party investors purchased $420.0 million face amount of senior bonds (or
40
Senior Bonds) with a weighted average coupon rate of 4.04%. As a result of these transactions, we acquired $148.1 million face
amount of non-rated certificates issued by the securitization vehicles, and received $420.0 million in cash, excluding expenses,
accrued interest, and underwriting fees.
At December 31, 2018, we have access to various sources of liquidity which we estimate to be in excess of $316.7 million.
This amount includes (i) $52.0 million of cash and cash equivalents; (ii) $187.5 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) $77.2 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. In addition, we have $1.2 billion of unencumbered residential whole loans. We are evaluating potential opportunities to
finance these assets, including loan securitization. With access to multiple sources of liquidity and potential financing opportunities
for unencumbered residential whole loans, we believe that we are positioned to continue to take advantage of investment
opportunities within the residential mortgage marketplace.
During 2018, both current interest rates and expected future interest rates generally increased, impacting asset yields and
funding costs of our interest earning assets. During the fourth quarter of 2018, treasury rates declined, resulting in a flattening of
the yield curve, but the impact of widening mortgage basis and credit spreads negatively impacted values of our longer duration
Agency MBS and swap hedges, Legacy Non-Agency MBS and CRT securities.
The net interest spread of our investment portfolio was 2.23% and 2.09% for the years ended December 31, 2018 and 2017,
respectively. While the most significant driver of the change in our net interest spread was an increase in Legacy Non-Agency
MBS asset yields, primarily reflecting the ongoing strong performance of loans underlying this portfolio, our net interest spread
was also impacted by changes in market interest rates and funding spreads, as well as changes in the mix of our investments, as
portfolio run-off was re-deployed in higher yielding investments. In addition, our estimated net effective duration remained
relatively low at 0.96 as of December 31, 2018, as compared to 0.91 at December 31, 2017. We manage our net duration through
our investment selection, as well as through the use of interest rate swaps. In addition, our low leverage limits our sensitivity to
changes in interest rates.
During 2018, the U.S. unemployment rate generally continued to decline and residential home prices trended up, signaling
a general improvement in the U.S. economy, despite volatility in the equity markets. We believe that an improvement in the
economy, as demonstrated through such measures, generally improves the value of housing and the ability of borrowers to make
payments on their loans, thereby decreasing delinquencies and defaults on residential mortgage loans and securities.
For more information regarding market factors which impact our portfolio, see Part I, Item 1A. “Risk Factors” and Item 3.
“Quantitative and Qualitative Disclosures About Market Risk” of this Annual Report on Form 10-K.
41
Information About Our Assets
The table below presents certain information about our asset allocation at December 31, 2018:
ASSET ALLOCATION
Agency
MBS
Legacy
Non-Agency
MBS
RPL/NPL
MBS (1)
Credit Risk
Transfer
Securities
Residential
Whole
Loans, at
Carrying
Value (2)
Residential
Whole
Loans, at
Fair Value
MSR-
Related
Assets
Other,
net (3)
Total
$
2,698
$
1,941
$
1,377
$
493
$
3,017
$
1,666
$
612
$ 484
$12,288
(Dollars in Millions)
Fair Value/Carrying
Value
Less Payable for
Unsettled Purchases
Less Repurchase
Agreements
Less Securitized Debt
Less Senior Notes
—
—
—
—
(16)
(2,384)
(1,448)
(1,085)
(392)
—
—
—
—
—
—
—
—
(1,475)
(163)
—
(195)
(546)
(521)
—
404
—
—
(211)
(474)
(76)
(7,880)
—
—
—
(97)
(684)
(97)
$
138
$ 311
$ 3,416
Net Equity Allocated
$
314
$
493
$
292
$
101
$
1,363
$
Debt/Net Equity Ratio
(4)
7.6x
2.9x
3.7x
3.9x
1.2x
3.1x
3.4x
2.6x
(1) RPL/NPL MBS are backed primarily by securitized re-performing and non-performing loans. The securities are generally structured such that the coupon
increases from 300 - 400 basis points at 36 - 48 months from issuance or sooner. Included with the balance of Non-Agency MBS reported on our consolidated
balance sheets.
(2) Includes $798.0 million of purchased credit impaired loans, $1.4 billion of Non-QM loans, $494.6 million of Rehabilitation loans, $145.3 million of Single-
family rental loans and $224.1 million of Seasoned performing loans. At December 31, 2018, the total fair value of these loans is estimated to be
approximately $3.1 billion.
(3) Includes cash and cash equivalents and restricted cash, other assets and other liabilities.
(4) Represents the sum of borrowings under repurchase agreements, securitized debt and payable for unsettled purchases as a multiple of net equity allocated.
The numerator of our Total Debt/Net Equity Ratio also includes Senior Notes.
42
Agency MBS
The following table presents certain information regarding the composition of our Agency MBS portfolio as of
December 31, 2018 and 2017:
December 31, 2018
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Current
Face
Fair
Value (1)
Weighted
Average
Loan Age
(Months) (2)
Weighted
Average
Coupon (2)
3 Month
Average
CPR
$
$
$
$
647,482
132,713
780,195
104.4%
104.4
104.4%
100.0% $
101.1
647,406
134,220
100.2% $
781,625
711,158
711,158
104.0%
104.0%
103.6% $
103.6% $
736,498
736,498
$ 1,080,569
58,708
$
$ 2,630,630
103.5%
102.6%
103.9%
103.5% $ 1,118,638
60,415
102.9% $
102.5% $ 2,697,176
80
88
81
6
6
108
206
74
3.01%
3.50
3.09%
4.50%
4.50%
3.90%
4.05%
3.82%
8.2%
10.1
8.5%
4.7%
4.7%
20.0%
18.7%
12.5%
December 31, 2017
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Current
Face
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)
Generic
Total 15-Year Fixed Rate
30-Year Fixed Rate:
Generic
Total 30-Year Fixed Rate
Hybrid
CMO/Other
Total Portfolio
(Dollars in Thousands)
15-Year Fixed Rate:
Low Loan Balance (3)
Generic
$
948,225
104.3%
101.7% $
964,373
172,862
104.4
103.1
178,210
Total 15-Year Fixed Rate
$ 1,121,087
104.3%
101.9% $ 1,142,583
Hybrid
CMO/Other
Total Portfolio
$ 1,540,431
$
76,944
$ 2,738,462
103.5%
102.5%
103.8%
103.9% $ 1,601,107
102.8% $
79,100
103.1% $ 2,822,790
67
76
68
96
198
88
2.95%
3.51
3.04%
3.27%
3.22%
3.17%
10.3%
9.3
10.2%
17.1%
9.9%
14.1%
(1) Does not include principal payments receivable of $1.0 million and $1.9 million at December 31, 2018 and 2017, respectively.
(2) Weighted average is based on MBS current face at December 31, 2018 and 2017, respectively.
(3) Low loan balance represents MBS collateralized by mortgages with an original loan balance of less than or equal to $175,000.
43
The following table presents certain information regarding our fixed-rate Agency MBS as of December 31, 2018 and
2017:
December 31, 2018
Current
Face
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Fair
Value (1)
Weighted
Average
Loan Age
(Months) (2)
Weighted
Average
Loan Rate
Low Loan
Balance
and/or
HARP (3)
3 Month
Average
CPR
$
$
$
$
359,252
185,912
3,798
199,352
31,881
780,195
711,158
711,158
$ 1,491,353
104.1%
105.9
103.5
103.5
105.3
104.4%
98.6% $
100.3
101.4
102.4
103.3
100.2% $
354,252
186,548
3,853
204,055
32,917
781,625
104.0%
104.0%
104.2%
103.6% $
103.6% $
736,498
736,498
101.8% $ 1,518,123
December 31, 2017
73
77
98
97
101
81
6
6
45
3.03%
3.49
4.18
4.40
4.88
3.57%
5.17%
5.17%
4.33%
100%
100
100
81
34
92%
—%
—%
48%
6.4%
8.4
12.8
11.9
12.7
8.5%
4.7%
4.7%
6.8%
Current
Face
Weighted
Average
Purchase
Price
Weighted
Average
Market
Price
Fair
Value (1)
Weighted
Average
Loan Age
(Months) (2)
Weighted
Average
Loan Rate
Low Loan
Balance
and/or
HARP (3)
3 Month
Average
CPR
$
579,003
231,325
5,402
263,447
41,910
$ 1,121,087
104.0%
105.9
103.5
103.5
105.2
104.3%
581,866
100.5% $
236,316
102.2
5,587
103.4
274,783
104.3
105.1
44,031
101.9% $ 1,142,583
60
66
86
85
89
68
3.04%
3.49
4.18
4.40
4.88
3.52%
100%
100
100
80
34
93%
9.3%
9.5
23.0
12.4
10.2
10.2%
Coupon
(Dollars in Thousands)
15-Year Fixed Rate:
2.5%
3.0%
3.5%
4.0%
4.5%
Total 15-Year Fixed Rate
30-Year Fixed Rate:
4.5%
Total 30-Year Fixed Rate
Total Fixed Rate Portfolio
Coupon
(Dollars in Thousands)
15-Year Fixed Rate:
2.5%
3.0%
3.5%
4.0%
4.5%
Total 15-Year Fixed Rate
(1) Does not include principal payments receivable of $1.0 million and $1.9 million at December 31, 2018 and 2017, respectively.
(2) Weighted average is based on MBS current face at December 31, 2018 and 2017, respectively.
(3) Low Loan Balance represents MBS collateralized by mortgages with an original loan balance less than or equal to $175,000. Home Affordable Refinance
Program (or HARP) MBS are backed by refinanced loans with LTVs greater than or equal to 80% at origination.
44
The following table presents certain information regarding our Hybrid Agency MBS as of December 31, 2018 and 2017:
(Dollars in Thousands)
Hybrid
Agency 3/1
Agency 5/1
Agency 7/1
Agency 10/1
Total Hybrids
Current
Face
$
66,369
462,833
389,734
161,633
$ 1,080,569
December 31, 2018
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
102.6%
103.3
103.7
104.3
103.5%
69,478
104.7% $
482,466
104.2
403,471
103.5
163,223
101.0
103.5% $ 1,118,638
4.42%
4.30
3.62
3.20
3.90%
151
118
96
86
108
6
5
6
36
10
—%
15
20
59
22%
14.7%
20.6
23.7
11.2
20.0%
(Dollars in Thousands)
Hybrid
Agency 3/1
Agency 5/1
Agency 7/1
Agency 10/1
Total Hybrids
Current
Face
$
92,790
661,581
589,843
196,217
$ 1,540,431
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
102.5%
103.3
103.6
104.2
103.5%
97,314
104.9% $
691,660
104.5
611,207
103.6
102.4
200,926
103.9% $ 1,601,107
3.44%
3.45
3.06
3.16
3.27%
138
107
84
75
96
6
5
11
46
13
8%
23
28
57
28%
16.8%
17.5
18.4
12.0
17.1%
(1) Does not include principal payments receivable of $1.0 million and $1.9 million at December 31, 2018 and 2017, respectively.
(2) Weighted average is based on MBS current face at December 31, 2018 and 2017, 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, 2018
and 2017, respectively.
Non-Agency MBS
The following table presents information with respect to our Non-Agency MBS at December 31, 2018 and 2017:
(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,
2018
2017
$
$
3,538,804
3,318,299
2,867,703
(516,116) (1)
(155,025)
40
3,718,743
3,533,966
2,910,241
(593,227) (2)
(215,325)
50
(1) Includes discount designated as Credit Reserve of $503.3 million and OTTI of $12.8 million.
(2) Includes discount designated as Credit Reserve of $579.0 million and OTTI of $14.2 million.
45
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,
2018 and 2017:
(In Thousands)
Balance at beginning of period
Impact of RMBS Issuer settlement (2)(3)
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,
2018
2017
Discount
Designated as
Credit Reserve
and OTTI
Accretable
Discount (1)
Discount
Designated as
Credit Reserve
and OTTI
Accretable
Discount (1)
$
(593,227) $
(215,325) $
(694,241) $
(278,191)
—
—
42,246
(2,512)
12,987
(1,259)
(14,822)
70,750
—
1,685
28,336
—
—
—
49,291
(29,810)
31,730
(1,032)
—
77,513
—
18,386
17,802
—
25,649
(516,116) $
(25,649)
(155,025) $
50,835
(593,227) $
(50,835)
(215,325)
$
(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 $2.7 million of cash proceeds (a one-time payment) received by the Company during the year ended
December 31, 2018 in connection with the settlement of litigation related to certain residential mortgage backed securitization trusts that
were sponsored by Lehman Brothers Holdings Inc.
(3) Includes the impact of approximately $12.1 million of cash proceeds (a one-time payment) received by the Company during the year ended
December 31, 2018 in connection with the settlement of litigation related to certain residential mortgage backed securitization trusts that
were sponsored by JP Morgan Chase & Co. and affiliated entities.
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,
2018
2017
2016
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
6.23%
3.92
10.15%
4.55%
0.14
4.69%
5.61%
3.34
8.95%
4.05%
0.09
4.14%
5.24%
2.66
7.90%
3.80%
0.08
3.88%
(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.
46
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, 2018 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
(Dollars in Thousands)
Agency MBS:
Fannie Mae
Freddie Mac
Ginnie Mae
Total Agency MBS
$
$
—
—
—
—
—% $
—
—
—% $
34
—
—
34
1.64% $ 504,636
2.17% $1,277,576
2.87% $ 1,782,246
$ 1,762,032
2.67%
—
—
313,832
85
1.87
3.25
633,756
4,731
4.01
3.12
947,588
931,318
4,816
4,863
1.64% $ 818,553
2.06% $1,916,063
3.24% $ 2,734,650
$ 2,698,213
Non-Agency MBS
$ 41,822
11.85% $289,727
4.13% $
2,391
4.13% $2,533,763
8.30% $ 2,867,703
$ 3,318,299
Total MBS
$ 41,822
11.85% $289,761
4.13% $ 820,944
2.06% $4,449,826
6.12% $ 5,602,353
$ 6,016,512
3.34
3.13
2.90%
7.93%
5.47%
CRT Securities
At December 31, 2018, our total investment in CRT securities was $492.8 million, with a net unrealized gain of $6.6 million,
a weighted average yield of 5.85% and a weighted average time to maturity of 11.1 years. At December 31, 2017, our total
investment in CRT securities was $664.4 million, with a net unrealized gain of $56.3 million, a weighted average yield of 5.86%
and weighted average time to maturity of 9.2 years.
During 2018, we sold certain CRT securities for $299.9 million, realizing gains of $31.4 million. For the year ended December
31, 2018, the net income impact of these sales, after reversal of previously unrealized gains on CRT securities on which we had
elected the fair value option, was $15.6 million. In addition, during 2018 we purchased $155.1 million of CRT securities at a
purchase price of $156.4 million.
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, 2018 and does not reflect estimates of
prepayments or scheduled amortization. For residential purchased credit impaired loans held 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
Purchased
Performing Loans (1)
Purchased Credit
Impaired Loans
Residential Whole
Loans,
at Fair Value (1)
$
$
$
400,507
$
367
$
7,580
95,894
1,705,913
1,801,807
2,202,314
$
$
4,858
792,762
797,620
797,987
$
$
9,045
1,454,638
1,463,683
1,471,263
(1) Excludes approximately $16.4 million of purchased performing loans held at carrying value and $194.7 million of residential whole loans
held at fair value for which the closing of the purchase transaction had not occurred as of December 31, 2018.
47
The following table presents, at December 31, 2018, the dollar amount of certain of our residential whole loans, 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
Purchased Performing
Loans (1)(2)
Residential Whole
Loans
at Fair Value (1)(2)
$
$
432,765
1,369,042
1,801,807
$
$
876,948
586,735
1,463,683
(1) Includes loans on which borrowers have defaulted and are not making payments of principal and/or interest as of December 31, 2018.
(2) Excludes approximately $16.4 million of purchased performing loans held at carrying value and $194.7 million of residential whole loans
held at fair value for which the closing of the purchase transaction had not occurred as of December 31, 2018.
Information is not presented for purchased credit impaired loans held 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.
MSR-Related Assets
At December 31, 2018 and 2017, we had $538.5 million and $381.8 million, respectively, of term notes issued by SPVs that
have acquired the rights to receive cash flows representing the servicing fees and/or excess servicing spread associated with certain
MSRs. At December 31, 2018, these term notes had an amortized cost of $538.5 million, gross unrealized losses of approximately
$7,000, a weighted average yield of 5.32% and a weighted average term to maturity of 4.7 years. 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.
During the year ended December 31, 2018, the Company participated in a loan where the Company committed to lend $100.0
million of which approximately $73.3 million was drawn at December 31, 2018. At December 31, 2018, the coupon paid by the
borrower on the drawn amount is 5.88%, the remaining term associated with the loan is 1.7 years and the remaining commitment
period on any undrawn amount is 1.7 years.
Exposure to Financial Counterparties
We finance a significant portion of our residential mortgage assets with repurchase agreements. 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 3% - 5% of the amount borrowed for
Agency MBS collateral, up to 35% for Non-Agency MBS collateral, up to 33% for residential whole loan collateral, and up to
35% for other-interest earning assets. Consequently, while repurchase agreement financing results in our 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.
48
The table below summarizes our exposure to our counterparties at December 31, 2018, by country:
Country
(Dollars in Thousands)
European Countries: (2)
United Kingdom
Switzerland (3)
France
Holland
Total European
Other Countries:
United States
Canada (4)
Japan (5)
South Korea
China (5)
Total Other
Total
Number of
Counterparties
Repurchase
Agreement
Financing
Exposure (1)
Exposure as a
Percentage of
MFA Total Assets
2
2
2
1
7
13
2
3
1
1
20
27
$
$
$
1,103,626
896,404
416,164
82,016
2,498,210
3,692,203
1,011,959
266,360
306,404
103,978
5,380,904
7,879,114
202,924
162,784
108,980
8,446
483,134
770,085
266,872
26,582
26,641
11,190
1,101,370
1,584,504
1.63%
1.31
0.88
0.07
3.89%
6.20%
2.15
0.21
0.21
0.09
8.86%
12.75%
(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 $261.0 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.
At December 31, 2018, 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.
Tax Considerations
Current period estimated taxable income
We estimate that for 2018, our taxable income was approximately $339.9 million. Based on dividends paid or declared
during 2018, we have undistributed taxable income of approximately $36.2 million, or $0.08 per share. We have until the filing
of our 2018 tax return (due not later than October 15, 2019) to declare the distribution of any 2018 REIT taxable income not
previously distributed.
49
Key differences between GAAP net income and REIT Taxable Income for Residential Mortgage Securities 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. Further, use of fair value accounting for certain residential mortgage
securities and residential whole loans for GAAP, but not Tax, also gives rise to potential timing differences. 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
are 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 REIT taxable 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.
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).
The Tax Cuts and Jobs Act made many significant changes to the U.S. federal income tax laws applicable to businesses and
their owners, including REITs and their stockholders. 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 37%, (3) the corporate alternative
minimum tax is repealed, (4) the backup withholding rate for Domestic Owners is reduced to 24%, and (5) 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%. In addition, under proposed Treasury regulations, withholding
under the Foreign Account Tax Compliance Act (“FATCA”) will not apply to proceeds from the sale of our capital stock by Foreign
Owners. FATCA withholding continues to apply to our dividends paid to Foreign Owners if those Foreign Owners do not meet
certain disclosure requirements. In addition, Foreign Owners that are “qualified shareholders” or “qualified foreign pension funds”
50
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.
Regulatory Developments
The U.S. Congress, Federal Reserve, 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 Wall Street
Reform and Consumer Protection Act (or 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 and servicing. In addition, the Dodd-Frank Act grants enforcement authority and
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. In June 2018, the Trump Administration proposed a plan that would end
the conservatorship of Fannie Mae and Freddie Mac and privatize the GSEs. However, we cannot be certain whether alternative
plans may be proposed by the Trump Administration if any housing and/or mortgage-related legislation will emerge from committee,
or be approved by Congress, and if so, what the effect would be on our business.
51
Results of Operations
Year Ended December 31, 2018 Compared to the Year Ended December 31, 2017
General
For 2018, we had net income available to our common stock and participating securities of $286.8 million, or $0.68 per basic
and diluted common share, compared to net income available to common stock and participating securities for 2017 of $307.4
million, or $0.79 per basic and diluted common share. The decrease in net income available to common stock and participating
securities and the decrease of this item on a per share basis primarily reflects lower net Other income, primarily driven by unrealized
losses on residential mortgage securities measured at fair value through earnings, compared to unrealized gains on such securities
in the prior year period, higher net gains on our residential whole loans measured at fair value through earnings, higher net realized
gains on sale of residential mortgage securities and a decrease in net interest income. In addition, operating and other expenses
were higher for 2018, primarily due to higher costs in connection with growing and servicing our residential whole loan portfolio,
partially offset by lower compensation related expenses, as the prior year included the impact of 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.
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 investments. Interest rates and CPRs (which measure the amount of unscheduled principal
prepayment on a bond or loan as a percentage of its unpaid 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 2018, our net interest spread and margin were 2.23% and 2.64%, respectively, compared to a net interest spread and
margin of 2.09% and 2.55%, respectively, for 2017. Our net interest income decreased by $12.8 million, or 5.4%, to $223.5 million
from $236.3 million for 2017. For 2018 net interest income from Agency MBS and Non-Agency MBS declined compared to
2017 by approximately $34.8 million, 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 offset by higher net interest income on
residential whole loans at carrying value of approximately $45.7 million compared to 2017, primarily due to higher average
amounts invested in these assets. In addition, net interest income for 2018 also includes $40.5 million of interest expense associated
with residential whole loans held at fair value, reflecting a $20.8 million increase in borrowing costs related to these investments
compared to 2017. 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.
52
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, 2018, 2017 and 2016. 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,
2018
2017
2016
Average
Balance
Interest
Average
Yield/
Cost
Average
Balance
Interest
Average
Yield/
Cost
Average
Balance
Interest
Average
Yield/
Cost
$ 2,710,049
$ 62,303
2.30% $
3,272,766
$ 65,355
2.00% $ 4,258,744
$ 83,069
1.95%
Legacy Non-Agency MBS (1)
1,763,424
179,023
10.15
2,276,247
203,650
RPL/NPL MBS (1)
Total MBS
CRT securities (1)
Residential whole loans, at
carrying value (2)
MSR-related assets (1)
Cash and cash equivalents (3)
Other interest-earning assets
1,017,549
47,773
5,491,022
289,099
543,671
33,376
1,738,870
100,921
479,041
208,447
16,886
28,420
2,936
923
Total interest-earning assets
8,477,937
455,675
4.69
5.26
6.14
5.80
5.93
1.41
5.47
5.37
1,629,573
67,462
7,178,586
336,467
543,360
31,715
610,420
392,948
546,579
—
36,187
24,830
4,249
—
9,271,893
433,448
Total non-interest-earning assets
Total assets
2,708,908
$ 11,186,845
2,347,281
$ 11,619,174
8.95
4.14
4.69
5.84
5.93
6.32
0.78
—
4.67
2,941,507
2,586,495
9,786,746
271,566
389,910
36,013
291,064
—
232,500
100,321
415,890
14,770
23,916
2,100
774
—
10,775,299
457,450
2,061,281
$ 12,836,580
Liabilities and stockholders’ equity:
Interest-bearing liabilities:
Total repurchase agreements (4)
$ 6,746,570 $205,338
Securitized debt (5)
Senior Notes
540,003
96,792
18,805
8,043
Total interest-bearing liabilities
7,383,365
232,186
3.04
3.48
8.31
3.14
$
7,441,607 $186,347
96,311
96,751
2,755
8,039
7,634,669
197,141
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
Total non-interest-bearing liabilities
Total liabilities
Stockholders’ equity
456,500
7,839,865
3,346,980
Total liabilities and stockholders’ equity
$ 11,186,845
780,691
8,415,360
3,203,814
$ 11,619,174
795,121
9,871,010
2,965,570
$ 12,836,580
7.90
3.88
4.25
5.44
6.13
5.83
0.27
—
4.25
2.06
4.97
8.31
2.13
Net interest income/net interest
rate spread (6)
Net interest-earning assets/net
interest margin (7)
$223,489
2.23%
$236,307
2.09%
$264,095
2.12%
$ 1,094,572
2.64% $
1,637,224
2.55% $ 1,699,410
2.45%
(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 2018 and 2017 reflects securitized debt from our loan securitization transactions. Securitized debt for 2016 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.
53
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
Residential whole loans, at carrying value (1)
MSR-related assets
Cash and cash equivalents
Other interest earning assets
Year Ended December 31, 2018
Compared to
Year Ended December 31, 2017
Year Ended December 31, 2017
Compared to
Year Ended December 31, 2016
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
$ (12,158) $
9,106
$
(3,052)
$ (19,762) $
2,048
$
(17,714)
(49,722)
(27,787)
18
65,509
5,180
(3,552)
923
25,095
8,098
1,643
(775)
(1,590)
2,239
—
(24,627)
(19,689)
1,661
64,734
3,590
(1,313)
923
(57,019)
(39,233)
15,790
13,097
22,539
1,088
—
28,169
6,374
1,155
(826)
191
2,387
—
(28,850)
(32,859)
16,945
12,271
22,730
3,475
—
Total net change in income from interest-earning assets
$ (21,589) $ 43,816
$
22,227
$ (63,500) $ 39,498
$
(24,002)
Interest-bearing liabilities:
Agency repurchase agreements
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
Other repurchase agreements
Securitized debt
Senior Notes
Total net change in expense from interest-bearing
liabilities
Net change in net interest income
$
(9,706) $ 12,897
$
3,191
$ (13,779) $ 11,470
$
(2,309)
(9,718)
(14,473)
1,152
3,239
1,523
6,958
2,359
400
(8,195)
(7,515)
3,511
3,639
(13,682)
(18,944)
4,507
7,332
6,456
7,260
891
85
13,806
1,904
15,710
3,919
1,133
4,722
553
15,327
4
3,375
—
723
—
8,097
553
16,050
4
3,337
—
2,621
3
1,376
—
(199)
—
(7,226)
(11,684)
5,398
7,417
5,052
4,713
—
2,422
3
$
4,906
$ 30,139
$ (26,495) $ 13,677
$
$
35,045
$ (24,686) $ 28,472
(12,818)
$ (38,814) $ 11,026
$
$
3,786
(27,788)
(1) Excludes residential whole loans held at fair value which are reported as a component of non-interest-earning assets.
54
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, 2018
September 30, 2018
June 30, 2018
March 31, 2018
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
Total Interest-Earning Assets and Interest-
Bearing Liabilities
Net Interest
Spread (1)
Net Interest
Margin (2)
2.17%
2.60%
2.41
2.30
2.25
2.08
2.02
2.10
2.27
2.82
2.66
2.64
2.54
2.54
2.58
2.63
(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, 2018
2.72%
2.36%
0.36% 10.65%
3.30%
7.35%
4.82%
3.27%
1.55%
5.36%
2.82%
2.54%
September 30, 2018
June 30, 2018
March 31, 2018
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
2.21
2.03
2.21
2.08
1.97
1.96
1.98
2.22
2.04
1.91
1.79
1.75
1.57
1.49
(0.01)
10.76
(0.01)
0.30
0.29
0.22
0.39
0.49
9.89
9.44
9.12
8.93
8.85
8.90
3.29
3.30
3.29
3.29
3.26
3.28
3.05
7.47
6.59
6.15
5.83
5.67
5.57
5.85
5.01
4.52
4.36
4.27
4.43
4.18
3.87
3.10
3.19
2.94
2.72
2.69
2.46
2.27
1.91
1.33
1.42
1.55
1.74
1.72
1.60
5.49
5.16
5.06
4.85
4.74
4.68
4.58
2.73
2.64
2.53
2.44
2.41
2.29
2.15
2.76
2.52
2.53
2.41
2.33
2.39
2.43
(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 (5), 6, 9, 26, 43, 44, 49 and 60 basis points and Legacy Non-Agency cost of funding includes (4), 5, 8, 30, 45, 45, 58 and
58 basis points associated with Swaps to hedge interest rate sensitivity on these assets for the quarters ended December 31, 2018, September
30, 2018, June 30, 2018, March 31, 2018, December 31, 2017, September 30, 2017, June 30, 2017 and March 31, 2017, respectively.
(3) Reflects the difference between the net yield on average MBS and average cost of funds on MBS.
55
Interest Income
Interest income on our Agency MBS for 2018 decreased by $3.1 million, or 4.7% to $62.3 million from $65.4 million for
2017. This change primarily reflects a $562.7 million decrease in the average amortized cost of our Agency MBS portfolio to
$2.7 billion for 2018 from $3.3 billion for 2017 partially offset by an increase in the net yield on our Agency MBS to 2.30% for
2018 from 2.00% for 2017. At the end of 2018, the average coupon on mortgages underlying our Agency MBS was higher
compared to the end of 2017. In addition, during 2018, our Agency MBS portfolio experienced a 14.4% CPR and we recognized
$25.9 million of net premium amortization compared to a CPR of 15.5% and $31.3 million of net premium amortization in 2017.
At December 31, 2018, we had net purchase premiums on our Agency MBS of $103.0 million, or 3.9% of current par value,
compared to net purchase premiums of $104.0 million, or 3.8% of par value at December 31, 2017.
Interest income on our Non-Agency MBS decreased by $44.3 million, or 16.3%, for 2018 to $226.8 million compared to
$271.1 million for 2017. This decrease is primarily due to the decrease in the average amortized cost of our Non-Agency MBS
portfolio of $1.1 billion or 28.8%, to $2.8 billion for 2018, from $3.9 billion for 2017. This decrease more than offset the impact
of the higher yields generated on our Legacy Non-Agency MBS portfolio, which were 10.15% for 2018 compared to 8.95% for
2017. The increase in the net yield on our Legacy Non-Agency MBS portfolio reflects the improved performance of loans
underlying the Legacy Non-Agency MBS portfolio, which has resulted in credit reserve releases and changes in interest rates
since the prior year, higher accretion income recognized in 2018 due to the impact of redemptions of certain securities that had
been previously purchased at a discount as well as the impact of the cash proceeds received during 2018 in connection with the
settlement of litigation related to certain residential mortgage backed securitization trusts that were sponsored by JP Morgan Chase
& Co. and affiliated entities and Lehman Brothers Holdings Inc. Our RPL/NPL MBS portfolio yielded 4.69% for 2018 compared
to 4.14% for 2017. The increase in the net yield primarily reflects an increase in the average coupon yield to 4.55% for 2018 from
4.05% for 2017 and higher accretion income recognized in 2018 due to the impact of redemptions of certain securities that had
been previously purchased at a discount.
During 2018, we recognized net purchase discount accretion of $70.7 million on our Non-Agency MBS, compared to $77.5
million for 2017. At December 31, 2018, we had net purchase discounts of $670.5 million, including Credit Reserve and previously
recognized OTTI of $516.1 million, on our Legacy Non-Agency MBS, or 31.2% of par value. During 2018, we reallocated $25.6
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, 2018
September 30, 2018
June 30, 2018
March 31, 2018
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
Coupon
Yield (1)
Net
Yield (2)
3.58%
3.32
3.09
3.02
3.00
2.98
2.94
2.90
2.72%
2.21
2.03
2.21
2.08
1.97
1.96
1.98
3 Month
Average
CPR (3)
12.5%
16.8
16.2
12.7
14.1
16.2
16.3
15.1
Coupon
Yield (1)
Net
Yield (2)
6.64% 10.65%
6.32
10.76
6.09
5.91
5.82
5.63
5.52
5.50
9.89
9.44
9.12
8.93
8.85
8.90
3 Month
Average
CPR (3)
14.7%
16.8
15.8
14.9
16.3
18.7
18.2
16.8
Coupon
Yield (1)
Net
Yield (2)
4.75%
4.56
4.49
4.35
4.24
4.24
4.03
3.84
4.82%
5.01
4.52
4.36
4.27
4.43
4.18
3.87
3 Month
Average
Bond
CPR (4)
12.9%
19.6
20.4
14.0
20.1
26.2
36.2
27.1
(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.
56
Interest income on our residential whole loans held at carrying value increased by $64.7 million, or 178.9%, for 2018 to
$100.9 million compared to $36.2 million for 2017. This increase primarily reflects a $1.1 billion increase in the average balance
of this portfolio to $1.7 billion for 2018 from $610.4 million for 2017 partially offset by a decrease in the yield (net of servicing
costs) to 5.80% for 2018 from 5.93% for 2017.
Interest Expense
Our interest expense for 2018 increased by $35.0 million, or 17.8% to $232.2 million, from $197.1 million for 2017. This
increase primarily reflects an increase in financing rates on our repurchase agreement financings, an increase in our average
borrowings and securitized debt 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 our MBS portfolio. The
effective interest rate paid on our borrowings increased to 3.14% for 2018, from 2.58% for the 2017.
Payments made and/or received on our Swaps designated as hedges for accounting purposes are a component of our borrowing
costs and accounted for interest expense of $3.8 million, or five basis points, for 2018, compared to interest expense of $24.5
million, or 32 basis points, for 2017. The weighted average fixed-pay rate on our Swaps designated as hedges increased to 2.12%
for 2018 from 1.98% for 2017. The weighted average variable interest rate received on our Swaps designated as hedges increased
to 1.96% for 2018 from 1.07% for 2017.
Other Income, net
The components of Other Income, net for the years ended 2018 and 2017 are summarized in the table below:
(In Thousands)
Net gains on residential whole loans measured at fair value through earnings
Net realized gains on residential mortgage securities sold
Net unrealized (loss)/gain on residential mortgage securities measured at fair value through earnings
Liquidation gains on purchased credit impaired loans and other loan related income
Net loss on Swaps not designated as hedges for accounting purposes
Net loss on REO properties
OTTI and other
Total Other Income, net
OTTI
For the Year Ended
December 31,
2018
$ 137,619
61,307
(36,815)
13,432
(9,610)
(8,021)
63
$ 157,975
2017
$ 90,045
39,577
27,709
7,863
—
(6,542)
(665)
$ 157,987
During 2018 and 2017, we recognized OTTI charges through earnings against certain of our Non-Agency MBS of $1.2
million and $1.0 million, 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. 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.
Operating and Other Expense
For 2018, we had compensation and benefits and other general and administrative expenses of $46.1 million, or 1.38% of
average equity, compared to $49.6 million, or 1.54% of average equity, for 2017. Compensation and benefits expense decreased
$3.3 million to $28.4 million for 2018, compared to $31.7 million for 2017, which includes the impact of non-recurring expenses
recorded in 2017 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. This decrease was partially offset by higher expense
in the current period associated with employee compensation. Our other general and administrative expenses decreased by $307,000
to $17.7 million for 2018 compared to $18.0 million for 2017, primarily due to higher costs in the prior period associated with
estimated excise tax payable and loan securitization transactions and lower costs associated with deferred compensation to Directors
in the current year period, partially offset by an increase in higher professional services related costs in the current year period.
57
Operating and Other Expense during 2018 also includes $33.6 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
$11.3 million, or 50.8%, primarily due to increased loan servicing and related fees and increases in non-recoverable advances on
REO. In addition, the prior period included the impact of a reversal of allowance for loan losses recorded against purchased credit
impaired residential whole loans, while the current year period included an increase in the allowance for loan losses on purchased
credit impaired residential whole loans.
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, 2018
September 30, 2018
June 30, 2018
March 31, 2018
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
Return on
Average Total
Assets (1)
Return on
Average Total
Stockholders’
Equity (2)
1.87%
6.96%
Total Average
Stockholders’
Equity to Total
Average Assets (3)
28.65%
2.94
2.58
2.93
3.47
2.10
2.63
2.42
10.21
8.74
10.27
12.29
7.78
10.01
10.19
30.15
31.19
29.91
29.33
28.60
27.59
24.95
Dividend
Payout
Ratio (4)
Leverage
Multiple (5)
Book Value
per Share
of Common
Stock (6)
1.54
1.05
1.18
1.00
0.83
1.33
1.00
1.00
$
2.6
2.3
2.3
2.2
2.3
2.4
2.5
2.9
7.15
7.46
7.54
7.62
7.70
7.70
7.76
7.66
(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, securitized debt, payable for unsettled purchases, 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.
58
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 measured
at fair value through earnings, unrealized gains on residential mortgage securities measured at fair value through earnings, 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 included $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.
59
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) 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.
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) 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 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) Reflected the difference between the net yield on average MBS and average cost of funds on MBS.
60
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 reflected 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 included 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 reflected 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 had 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 reflected 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)
3.00%
2.98
2.94
2.90
2.86
2.83
2.80
2.78
2.08%
1.97
1.96
1.98
1.92
1.83
1.96
2.07
3 Month
Average
CPR (3)
14.1%
16.2
16.3
15.1
15.9
16.7
13.9
11.7
Coupon
Yield (1)
Net
Yield (2)
5.82%
5.63
5.52
5.50
5.40
5.28
5.19
5.09
9.12%
8.93
8.85
8.90
8.24
8.09
7.72
7.61
3 Month
Average
CPR (3)
16.3%
18.7
18.2
16.8
17.3
15.9
16.1
13.3
Coupon
Yield (1)
Net
Yield (2)
4.24%
4.24
4.03
3.84
3.82
3.83
3.81
3.73
4.27%
4.43
4.18
3.87
3.85
3.86
3.83
3.97
3 Month
Average
Bond
CPR (4)
20.1%
26.2
36.2
27.1
25.8
32.2
25.4
23.0
(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) Reflected 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.
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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 reflected 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.
Other Income, net
For 2017, Other Income, net, increased by $49.4 million, or 45.5%, to $158.0 million compared to $108.6 million for 2016.
The components of Other Income, net for the years ended 2017 and 2016 are summarized in the table below:
(In Thousands)
Net gains on residential whole loans measured at fair value through earnings
Net realized gains on residential mortgage securities sold
Net unrealized gain on residential mortgage securities measured at fair value through earnings
Liquidation gains on purchased credit impaired loans and other loan related income
Net loss on REO properties
OTTI and other
Total Other Income, net
OTTI
For the Year Ended
December 31,
2017
$ 90,045
39,577
27,709
7,863
(6,542)
(665)
$ 157,987
2016
$ 62,605
35,837
12,962
473
(4,298)
978
$ 108,557
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. 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.
Operating and Other Expense
For 2017, we had compensation and benefits and other general and administrative expenses of $49.6 million, or 1.54% 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.
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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)
3.47%
12.29%
Total Average
Stockholders’
Equity to Total
Average Assets (3)
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) 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.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our consolidated financial statements include our accounts and those of our consolidated subsidiaries. The preparation of
consolidated financial statements in accordance with GAAP requires management to make estimates, judgments and assumptions
that affect the amounts reported in the consolidated financial statements, giving due consideration to materiality. 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 policies which more significantly rely on estimates and judgments to be as
follows:
Fair Value Measurements
GAAP requires the categorization of fair value measurements into three broad levels that form a hierarchy. The following
describes the valuation methodologies used for our financial instruments categorized as level 3 in the valuation hierarchy, which
require the most significant estimates and judgments to be made.
Residential Whole Loans
We determine the fair value of our residential whole loans after considering valuations obtained from a third-party who
specializes in providing valuations of residential mortgage loans. The valuation approach applied generally depends on whether
the loan is considered performing or non-performing at the date the valuation is performed. For performing loans, estimates of
fair value are derived using a discounted cash flow approach, where estimates of cash flows are determined from the scheduled
payments, adjusted using forecasted prepayment, default and loss given default rates. For non-performing loans, asset liquidation
cash flows are derived based on the estimated time to liquidate the loan, the estimated value of the collateral, expected costs and
estimated home price appreciation. Estimated cash flows for both performing and non-performing loans are discounted at yields
considered appropriate to arrive at a reasonable exit price for the asset. Indications of loan value such as actual trades, bids, offers
and generic market color may be used in determining the appropriate discount yield. Certain short term loans are valued at their
carrying amount. The estimation of cash flows used in pricing models is inherently subjective and imprecise. Changes in market
conditions, as well as changes in the assumptions or methodology used to determine fair value, could result in a significant increase
or decrease in fair value.
Residential whole loans, at fair value are recorded on our consolidated balance sheets at fair value and changes in their fair
value are recorded through earnings. With respect to Residential whole loans, at carrying value, the fair value for these loans is
disclosed in the footnotes to the consolidated financial statements and changes in their fair value do not impact earnings.
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 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. 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.
The adjustment of the pricing spread at each valuation date, and the evaluation and weighting of the factors used in making the
adjustment, represent estimates that can significantly impact the valuation and which require considerable judgment.
These term notes are recorded on our consolidated balance sheets at fair value and changes in their fair value are recorded
through OCI and therefore do not impact earnings.
Corporate Loans Backed by MSR-Related Collateral
Our valuation process for corporate loans backed by MSR-related collateral, which are not held at fair value, considers 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 MSRs and other assets of the borrower that are pledged to secure the borrowing. The evaluation
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and weighting of the factors used in estimating fair value require considerable judgment. The fair value for these loans is disclosed
in the footnotes to the consolidated financial statements and changes in their fair value do not impact earnings.
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. We measure REO assets at the lower of cost or fair value less estimated
selling costs. Fair value is estimated through the use of broker price opinions (or BPOs), adjusted based on our experience and
knowledge of the markets. REO is illiquid in nature and its valuation is subject to significant uncertainty and judgment and is
greatly impacted by local market conditions.
Residential Mortgage Securities
Assessment of Other-Than-Temporary Impairments
Securities classified as AFS 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.
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 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 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 impairment 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, and judgments about, 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.
The payments of principal and/or 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.”)
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 securities in the future.
Interest Income
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
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determined using management’s estimate of the projected cash flows for each security, which are based on our observations 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 our 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, and these changes could be significant.
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
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 primarily comprised of pools of fixed and adjustable
rate residential mortgage loans acquired through consolidated trusts in secondary market transactions. The accounting model
utilized by 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 for purchased credit
impaired loans that are held at carrying value is typically utilized by us for purchased credit impaired loans where the underlying
borrower has a delinquency status of less than 60 days at the acquisition date. Acquisitions of loans that are performing as of the
purchase date are typically held at carrying value, but the accounting methods for income recognition and determination and
measurement of any required loan loss reserves differ from those used for purchased credit impaired loans held at carrying value.
The accounting model for residential whole loans held 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.
Residential Whole Loans at Carrying Value
Purchased Credit Impaired Loans
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 these loans generally have previously experienced payment
delinquencies and the amount owed may exceed the value of the property pledged as collateral. 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 purchased 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
66
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.
The estimation of future cash flows for purchased credit impaired loans is subject to significant judgment and uncertainty.
Actual cash flows could be materially different than our estimates, which could result in material changes to loss allowances and/
or interest income.
Purchased Performing Loans
We also have investments in loans that are not considered to be credit impaired at purchase (“Purchased Performing Loans”).
Such are initially recorded at their purchase price. Interest income on Purchased Performing Loans acquired at par is accrued
based on each loan’s current interest bearing balance and current interest rate. Interest income on such loans purchased at a
premium/discount to par is recorded each period based on the contractual coupon net of any amortization of premium or accretion
of discount, adjusted for actual prepayment activity. For loans acquired with related servicing rights retained by the seller, interest
income is reported net of related serving costs.
An allowance for loan losses is recorded when, based on current information and events, it is probable that we will be unable
to collect all amounts due according to the existing contractual terms of the loan agreement. Any required loan loss allowance
would reduce the carrying value of the loan with a corresponding charge to earnings. Significant judgments are required in
determining any allowance for loan loss, including assumptions regarding the loan cash flows expected to be collected, the value
of the underlying collateral and our ability to collect on any other forms of security, such as a personal guaranty provided either
by the borrower or an affiliate of the borrower. Income recognition is suspended for loans at the earlier of the date at which
payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes
doubtful. When the ultimate collectability of the principal of an impaired loan is in doubt, all payments are applied to principal
under the cost recovery method. When the ultimate collectability of the principal of an impaired loan is not in doubt, interest
income is recorded under the cash basis method as interest payments are received. Interest accruals are resumed when the loan
becomes contractually current and performance is demonstrated to be resumed. A loan is written off when it is no longer realizable
and/or it is legally discharged.
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, as described above under Fair Value Measurements. Cash received reflecting coupon payments
on residential whole loans held at fair value is not included in Interest Income, but rather is included in Net gain on residential
whole loans measured at fair value through earnings on our consolidated statements of operations.
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RECENT ACCOUNTING STANDARDS TO BE ADOPTED IN FUTURE PERIODS
Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement
In August 2018, the FASB issued Accounting Standards Update (or ASU) 2018-13, Disclosure Framework - Changes to the
Disclosure Requirements for Fair Value Measurements (or ASU 2018-13). The amendments in ASU 2018-13 eliminate, add and
modify certain disclosure requirements for fair value measurements as part of the FASB’s disclosure framework project, which
aims to improve the effectiveness of disclosures in the notes to financial statements by focusing on requirements that are the most
important to the users. The guidance in this ASU is effective for all entities for fiscal years, and interim periods within those fiscal
years, beginning after December 15, 2019, but entities are permitted to early adopt either the entire standard or only the provisions
that eliminate or modify the requirements. The guidance on changes in unrealized gains and losses for the period included in other
comprehensive income for recurring Level 3 measurements, the range and weighted average of significant unobservable inputs
used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied
prospectively. All other amendments should be applied retrospectively. We determined to early adopt ASU 2018-13 effective on
January 1, 2019 and its adoption did not have a significant impact on our financial position or financial statement disclosures.
Compensation - Stock Compensation - Improvements to Nonemployee Share-Based Payment Accounting
In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting (or ASU
2018-07). The amendments in this ASU simplify the accounting for share-based payments to nonemployees by aligning it with
the accounting for share-based payments to employees, with certain exceptions. The amendments in ASU 2018-07 do not change
existing guidance on accounting for share-based payment transactions for employees. ASU 2018-07 is effective for public business
entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is
permitted, but no earlier than an entity’s adoption of FASB Accounting Standards Codification Topic 606, Revenue from Contracts
with Customers. An entity should apply the amendments of this ASU to all new awards granted after the date of adoption. In
addition, entities will apply the new guidance to equity-classified nonemployee awards for which a measurement date has not
been established and liability-classified nonemployee awards that have not been settled as of date of adoption by recognizing a
cumulative-effect adjustment to retained earnings as of the beginning of the annual period of adoption. We adopted ASU 2018-07
on January 1, 2019 and its adoption did not have a significant impact on our financial position or financial statement disclosures.
Derivatives and Hedging - Targeted Improvements to Accounting for Hedging Activities
In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities (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 adopted ASU 2017-12 on January 1, 2019 and its adoption did not have a significant impact on our financial
statements or financial statement disclosures.
Receivables - Nonrefundable Fees and Other Costs
In March 2017, the FASB issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities (or ASU
2017-08). The amendments in this ASU shorten the amortization period for certain purchased callable debt securities held at a
premium to the earliest call date. ASU 2017-08 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 on the date of adoption using a modified retrospective
approach through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. We
adopted ASU 2017-08 on January 1, 2019 and its adoption did not have a significant impact on our financial statements or financial
statement disclosures.
68
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. 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. We are currently in the process of updating our systems and processes to meet the new
requirements of this ASU. We will continue to monitor and evaluate the potential effects that ASU 2016-13 will have on our
consolidated financial statements and related disclosures.
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. 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
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. We do not expect that transition to the new available-for-sale
debt securities guidance will result in a material change to our retained earnings.
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 purchased credit impaired loans held 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. In addition, we expect that the guidance will
result in an increase in the allowance for credit losses for our purchased performing loans, with a resulting negative adjustment
to retained earnings.
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. We adopted ASU 2016-02 on January 1, 2019 and, given the relatively limited
nature and extent of lease financing transactions that we have entered into, its adoption did not have a material impact on our
financial position or financial statement disclosures.
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, 2018, we had 11.8 million shares of common stock available for issuance pursuant to our DRSPP shelf
registration statement. During 2018, we issued 379,903 shares of common stock through our DRSPP, raising net proceeds of
approximately $2.8 million. During 2018, we issued approximately $50.9 million shares of common stock in a public offering,
generating net proceeds of approximately $389.4 million.
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, residential whole loans and MSR-related assets, 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, 2018 and 2017:
At December 31, 2018
Repurchase agreement borrowings secured by:
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
CRT securities
Residential whole loans
MSR-related assets
Other
At December 31, 2017
Repurchase agreement borrowings secured by:
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
U.S. Treasury securities
CRT securities
Residential whole loans
MSR-related assets
Weighted
Average
Haircut
Low
High
4.60%
3.00%
5.00%
21.38
21.31
20.01
16.55
21.88
21.15
Weighted
Average
Haircut
15.00
15.00
17.00
8.00
20.00
20.00
35.00
30.00
25.00
33.00
30.00
35.00
Low
High
4.65%
3.00%
8.00%
21.87
22.05
1.47
22.16
26.10
33.19
15.00
20.00
1.00
15.00
20.00
30.00
35.00
27.50
2.00
25.00
35.00
50.00
Over the course of 2018, the weighted average haircut requirements for the respective underlying collateral types for our
repurchase agreements have remained fairly consistent compared to the end of 2017. Weighted average haircuts have decreased
on MSR-related assets, residential whole loans and CRT securities.
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, 2018, we had a total of $9.4 billion of MBS, CRT securities, residential whole loans and MSR-related
assets and $36.7 million of restricted cash pledged against our repurchase agreements and Swaps. At December 31, 2018 we have
access to various sources of liquidity which we estimate exceeds $316.7 million. This includes (i) $52.0 million of cash and cash
equivalents; (ii) $187.5 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) $77.2 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. In addition, we have $1.2 billion of unencumbered residential
whole loans. We are evaluating potential opportunities to finance these assets, including loan securitization.
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, 2018
September 30, 2018
June 30, 2018
March 31, 2018
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
December 31, 2016
September 30, 2016
June 30, 2016
March 31, 2016
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
$ 7,672,309
$ 7,879,087
$ 7,879,087
$
699,207
$
684,420
$
702,377
6,594,050
6,189,916
6,519,390
6,661,020
7,022,913
7,612,393
8,494,853
8,684,803
8,868,173
9,102,457
9,238,772
7,278,270
5,892,228
6,558,860
6,614,701
6,871,443
7,040,844
8,137,102
8,687,268
8,697,756
9,038,087
9,143,645
7,278,270
6,319,178
6,558,860
6,760,360
7,023,702
7,763,860
8,564,493
8,815,846
8,917,550
9,114,859
9,205,547
665,572
432,283
357,819
212,445
139,276
30,414
—
—
—
8,520
18,425
714,203
518,655
351,278
363,944
137,327
143,698
—
—
—
—
11,821
744,521
523,490
361,002
363,944
141,088
143,698
—
—
—
8,568
18,247
(1) Securitized debt amounts presented for 2018 and 2017 reflect our loan securitization transactions for those respective periods. Securitized
debt amounts presented for 2016 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, 2018
Our cash, cash equivalents and restricted cash decreased by $375.0 million during the year ended December 31, 2018,
reflecting: $2.2 billion used in our investing activities; $147.9 million provided by our operating activities; and $1.6 billion
provided by our financing activities.
At December 31, 2018, our debt-to-equity multiple was 2.6 times compared to 2.3 times at December 31, 2017. At
December 31, 2018, we had borrowings under repurchase agreements of $7.9 billion with 26 counterparties, of which $2.4 billion
were secured by Agency MBS, $1.4 billion were secured by Legacy Non-Agency MBS, $1.1 billion were secured by RPL/NPL
MBS, $391.6 million were secured by CRT securities, $2.0 billion were secured by residential whole loans, $474.1 million were
secured by MSR-related assets and $76.4 million were secured by other interest-earning assets. We continue to have available
capacity under our repurchase agreement credit lines. In addition, at December 31, 2018, we had securitized debt of $684.4 million
in connection with our loan securitization transactions. 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, $1.0 billion were secured by residential whole loans and $317.3 million were secured by
MSR-related assets. In addition, at December 31, 2017, we had $363.9 million in connection with our loan securitization
transactions.
During 2018, $2.2 billion was used in our investing activities. We paid $3.1 billion for purchases of residential whole loans,
loan related investments and capitalized advances and purchased $634.7 million of MSR-related assets, $1.1 billion of Non-Agency
MBS, $795.9 million of Agency MBS, and $156.4 million of CRT securities funded with cash and repurchase agreement borrowings.
In addition, during 2018, we received cash of $2.3 billion from prepayments and scheduled amortization on our MBS, CRT
securities and MSR-related assets, of which $712.9 million was attributable to Agency MBS, $1.1 billion was from Non-Agency
MBS, $12.6 million was from CRT securities and $515.1 million was attributable to MSR-related assets, and we sold certain of
our investments securities for $538.7 million, realizing net gains of $61.3 million. While we generally intend to hold our MBS
72
and CRT securities as long-term investments, we may sell certain of our securities in order to manage our interest rate risk and
liquidity needs, meet other operating objectives and adapt to market conditions. In addition, during 2018 we received $531.9
million of principal payments on residential whole loans and $121.3 million of proceeds on sales of REO.
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 assets pledged as collateral fluctuates reflecting changes in: (i) the face (or par) value
of our assets; (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 assets 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 (1)
(In Thousands)
December 31, 2018
September 30, 2018
June 30, 2018
March 31, 2018
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
$
14,452
61,492
44,278
40,831
$
— $
3,005
—
—
$
14,452
64,497
44,278
40,831
$
23,760
8,294
20,001
18,835
9,308
(56,203)
(24,277)
(21,996)
(1) Excludes variation margin payments on the Company’s cleared Swaps which are treated as a legal settlement of the exposure under the Swap
contract.
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, 2018.
During 2018, we paid $329.8 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 12, 2018, we declared our fourth quarter 2018 dividend on our
common stock of $0.20 per share; on January 31, 2019, we paid this dividend, which totaled $90.2 million, including dividend
equivalents of approximately $241,000.
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)
2019
2020
Due During the Year Ending December 31,
2022
2021
2023
Thereafter
Total
Repurchase agreements
Interest expense on repurchase agreements (1)
$ 7,974,792
43,535
$
— $
—
— $
—
— $
—
— $
—
— $
—
7,974,792
43,535
Securitized debt (2)
Interest expense on securitized debt (1)
Senior Notes (3)
Interest expense on Senior Notes (1)
Payable for unsettled purchases
Long-term lease obligations (4)
Total
374,674
18,891
—
8,000
211,129
2,553
101,321
173,361
16,911
14,258
9,207
—
8,000
—
2,553
3,487
—
8,000
—
1,292
1,042
—
8,000
—
—
531
—
8,000
—
—
7,762
99
100,000
148,000
—
—
688,287
33,257
100,000
188,000
211,129
6,398
$ 8,633,574
$
121,081
$
186,140
$
25,953
$
22,789
$
255,861
$
9,245,398
(1) Interest expense based on the interest rate in effect at December 31, 2018.
(2) Securitized debt is contractually scheduled to mature by 2057. However, the weighted average life of the securitized debt is estimated to be 1.35 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.
(4) Table excludes amounts related to the lease agreement for new office space as we are not contractually obligated to make rental payments until 14 months
after a temporary certificate of occupancy is delivered to the landlord, which is currently expected to occur on or before October 2020.
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.
74
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.
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 - 400 basis points at 36 - 48 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-QM loans and Single-family rental loans are dependent on the value of the underlying real estate
collateral, as well as the level of interest rates. Because these loans are primarily newly or recently originated performing loans,
we believe these investments exhibit positive duration. Given the short duration of our Rehabilitation loans, we believe the fair
value of these loans exhibits little sensitivity to changes in interest rates. We estimate the duration of these other loans held at
carrying value 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, 2018, MFA’s $4.6 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)
$
1,041,557
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
127,815
9,681
1,179,053
781,625
736,498
—
1,518,123
2,697,176
$
$
$
$
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)
5
40
78
10
21.2% $
1,230,423
11.1
0.1
—
—
19.9% $
1,230,423
8.5% $
1,521
4.7
—
659,248
47,035
6.8% $
707,804
12.5% $
1,938,227
5
—
—
5
15.5% $
2,271,980
—
—
127,815
9,681
15.5% $
2,409,476
24.0% $
783,146
13.1
15.6
1,395,746
47,035
13.3% $
2,225,927
14.7% $
4,635,403
5
40
78
7
17.9%
11.1
0.1
17.5%
8.5%
9.1
15.6
9.0%
13.5%
(1) Excludes $1.4 billion of RPL/NPL MBS. Refer to table below for further information.
(2) Does not include principal payments receivable of $1.0 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, 2018:
(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)
$
$
94,644
1,282,606
1,377,250
4.34%
4.86
4.83%
28
26
26
1.0%
13.9
12.9%
(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, 2018, our CRT securities and MSR-related assets had a fair value of $492.8 million and $611.8 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, 2018 and 2017. 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, 2018 and
2017.
December 31, 2018
Change in Interest Rates
(Dollars in Thousands)
+100 Basis Point Increase
+ 50 Basis Point Increase
Actual at December 31, 2018
- 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
- 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
12,001,744
12,123,276
12,230,474
12,323,338
12,401,867
$
$
$
$
$
77,527
$
12,079,271
35,721
$
(6,085) $
(47,891) $
(89,697) $
12,158,997
12,224,389
12,275,447
12,312,170
$
$
$
$
$
(145,118)
(65,392)
—
51,058
87,781
(4.04)%
(1.51)%
—
1.15 %
0.34 %
(1.19)%
(0.53)%
—
0.42 %
0.72 %
December 31, 2017
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
$
10,334,812
14,757
$
(11,424) $
(37,606) $
(63,787) $
10,385,705
10,434,340
10,480,716
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 %
(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, 2018 and 2017. 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 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, 2018 and 2017, 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, 2018, the impact on portfolio value was an approximated using estimated net effective duration (i.e., the
price sensitivity to changes in interest rates), including the effect of Swaps and securitized debt, of 0.96, which is the weighted
average of 2.04 for our Agency MBS, 0.94 for our Non-Agency investments, 2.17 for our Residential whole loans, (2.15) for our
Swaps and securitized debt, and 0.19 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 (0.47), which is the weighted average of (0.86) for
our Agency MBS, zero for our Swaps and securitized debt, (0.12) for our Non-Agency MBS, (0.60) for our Residential whole
loans, and zero for our Other assets and cash and cash equivalents. 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, 0.85 for our Non-Agency investments, 2.55 for our
Residential whole loans, (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, zero for our Residential whole loans
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, CRT securities, and
residential whole loans and to a lesser extent our investments in RPL/NPL MBS and MSR-related assets. Our exposure to credit
risk from our credit sensitive investments is discussed in more detail below:
Legacy Non-Agency MBS
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, 2018. 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
RPL/NPL MBS
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 or sponsored by Fannie Mae and
Freddie Mac. While CRT securities are issued by or sponsored by 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 a reference pool exceed the
credit enhancement on the underlying CRT security owned by us or if an actual pool of loans experiences losses. We assess the
credit risk associated with our investments in CRT securities by assessing the current and expected future performance of the
associated loan pool.
Residential Whole Loans
We are also exposed to credit risk from our investments in residential whole loans. Our investment process for non-performing
and purchased credit impaired residential whole loans is generally similar to that used for Legacy Non-Agency MBS and is likewise
focused on quantifying and pricing credit risk. Non-performing and purchased credit impaired loans are acquired at purchase
prices that are generally discounted 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 mortgage-servicing
rights associated with these loans, our process is also focused on selecting a sub-servicer with the appropriate expertise to mitigate
losses and maximize our overall 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 delinquencies and defaults on these loans 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.
Credit risk on purchased performing loans is mitigated through our process to underwrite the loan before it is purchased and
includes an assessment of the borrower’s financial condition and ability to repay the loan, nature of the collateral and relatively
low LTV, including after-repair LTV for the majority of our Rehabilitation loans.
80
The following table presents certain information about our Residential whole loans, at carrying value at December 31, 2018:
(Dollars in Thousands)
Carrying value
Unpaid principal balance (UPB)
Weighted average coupon (2)
Weighted average term to maturity (months)
Weighted average LTV (3)
Loans 90+ days delinquent
Purchased Performing Loans (1)
Purchased Credit Impaired Loans
Loans with an LTV:
Loans with an LTV:
80% or Below
$ 2,111,069
$ 2,082,855
$
$
Above 80%
91,245
80% or Below
420,131
$
93,037
$
485,266
Above 80%
377,856
Total
$ 3,000,301
516,995
$ 3,178,153
$
$
6.2%
259
62.6%
6.4%
317
93.1%
4.4%
276
58.8%
4.3%
327
111.3%
5.7%
275
70.7%
$
9,759
$
— $
32,717
$
50,275
$
92,751
(1) Excludes approximately $16.4 million of purchased performing loans held at carrying value for which the closing of the purchase transaction
had not occurred as of December 31, 2018.
(2) Weighted average is calculated based on the interest bearing principal balance of each loan within the related category. For loans acquired
with servicing rights released by the seller, interest rates included in the calculation do not reflect loan servicing fees. For loans acquired
with servicing rights retained by the seller, interest rates included in the calculation are net of servicing fees.
(3) LTV represents the ratio of the total unpaid principal balance of the loan to the estimated value of the collateral securing the related loan
as of the most recent date available, which may be the origination date. For Rehabilitation loans, the LTV presented is the ratio of the
maximum unpaid principal balance of the loan, including unfunded commitments, to the estimated “after repaired” value of the collateral
securing the related loan, where available. For certain Rehabilitation loans, totaling $79.0 million, an after repaired valuation was not
obtained and the loan was underwritten based on an“as is” valuation. The LTV of these loans based on the current unpaid principal balance
and the valuation obtained during underwriting, is 67%. Excluded from the calculation of weighted average LTV are certain low value
loans secured by vacant lots, for which the LTV ratio is not meaningful.
The following table presents the five largest geographic concentrations by state of our residential whole loan portfolio at
December 31, 2018:
Property Location
California
Florida
New York
New Jersey
Maryland
Percent of Interest-Bearing
Unpaid Principal Balance (1)
32.8%
10.6%
9.6%
6.0%
3.4%
(1) Excludes approximately $211.1 million of residential whole loans for which the closing of the purchase transaction had not occurred as of
December 31, 2018.
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 participated in a loan agreement to provide financing to an entity that originates residential loans and owns the
related MSRs. We assess the credit risk associated with this loan participation 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.
81
Credit Spread Risk
Credit spreads measure the additional yield demanded by investors in financial instruments based on the credit risk associated
with an instrument relative to benchmark interest rates. They are impacted by the available supply and demand for instruments
with various levels of credit risk. Widening credit spreads would result in higher yields being required by investors in financial
instruments. Credit spread widening generally results in lower values of the financial instruments we hold at that time, but will
generally result in a higher yield on future investments with similar credit risk. It is possible that the credit spreads on our assets
and liabilities, including hedges, will not always move in tandem. Consequently, changes in credit spreads can result in volatility
in our financial results and reported book value.
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, 2018, we had access to various sources of liquidity which we estimate to be in excess of $316.7
million, an amount which includes: (i) $52.0 million of cash and cash equivalents, (ii) $187.5 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) $77.2 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. In addition, we have $1.2 billion of unencumbered residential whole loans. We are evaluating
potential opportunities to finance these assets including loan securitization. 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. 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 an MBS or loan at a price in excess of the aggregate principal balance of the mortgages
securing the MBS (i.e., par value) or when we acquire residential whole loans at a price in excess of their aggregate principal
balance. Conversely, discounts arise when we acquire an MBS or loan 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 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, certain CRT securities and Non-QM loans,
are amortized against interest income over the life of the investment 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 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.
In addition, increased prepayments are generally associated with decreasing market interest rates as borrowers are able
refinance their mortgages at lower rates. Therefore, increased prepayments on our investments may accelerate the redeployment
of our capital to generally lower yielding investments. Similarly, decreased prepayments are generally associated with increasing
market interest rates and may slow our ability to redeploy capital to generally higher yielding investments.
82
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, 2018 and December 31, 2017
Consolidated Statements of Operations for the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Comprehensive Income/(Loss) for the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2018, 2017 and 2016
Consolidated Statements of Cash Flows for the years ended December 31, 2018, 2017 and 2016
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
84
85
86
87
88
90
92
142
83
Report of Independent Registered Public Accounting Firm
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, 2018 and 2017, 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, 2018, 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, 2018 and 2017, and the results of their operations and their cash flows for each of the years in the three year
period ended December 31, 2018, 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, 2018, 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 21, 2019 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 21, 2019
84
MFA FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
2018
December 31,
2017
(In Thousands, Except Per Share Amounts)
Assets:
Residential mortgage securities:
Agency MBS, at fair value ($2,575,331 and $2,727,510 pledged as collateral, respectively)
Non-Agency MBS, at fair value ($3,248,900 and $2,379,523 pledged as collateral, respectively)
$ 2,698,213
$ 2,824,681
3,318,299
3,533,966
Credit Risk Transfer (“CRT”) securities, at fair value ($480,315 and $595,900 pledged as collateral, respectively)
Residential whole loans, at carrying value ($1,645,372 and $448,689 pledged as collateral, respectively) (1)
Residential whole loans, at fair value ($738,638 and $996,226 pledged as collateral, respectively) (1)
Mortgage servicing rights (“MSR”) related assets ($611,807 and $482,158 pledged as collateral, respectively)
Cash and cash equivalents
Restricted cash
Other assets
Total Assets
Liabilities:
Repurchase agreements
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; 449,787 and 397,831 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
492,821
3,016,715
1,665,978
611,807
51,965
36,744
527,785
664,403
908,516
1,325,115
492,080
449,757
13,986
742,230
$ 12,420,327
$ 10,954,734
$ 7,879,087
1,125,139
$ 9,004,226
$ 6,614,701
1,078,397
$ 7,693,098
$
80
$
80
4,498
3,623,275
(632,040)
420,288
$ 3,416,101
$ 12,420,327
3,978
3,227,304
(578,950)
609,224
$ 3,261,636
$ 10,954,734
(1) Includes approximately $209.4 million and $183.2 million of Residential whole loans, at carrying value and $694.7 million and $289.3 million of Residential whole
loans, at fair value transferred to consolidated VIEs at December 31, 2018 and 2017, respectively. Such assets can be used only to settle the obligations of each
respective VIE.
The accompanying notes are an integral part of the consolidated financial statements.
85
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
Interest Income:
Agency MBS
Non-Agency MBS
CRT securities
Residential whole loans held at carrying value
MSR-related assets
Cash and cash equivalent investments
Other interest-earning assets
Interest Income
Interest Expense:
Repurchase agreements
Other interest expense
Interest Expense
Net Interest Income
Other Income, net:
For the Year Ended December 31,
2018
2017
2016
$
62,303
$
65,355
$
83,069
226,796
33,376
100,921
28,420
2,936
923
271,112
332,821
31,715
36,187
24,830
4,249
—
14,770
23,916
2,100
774
—
$
455,675
$
433,448
$
457,450
$
$
$
205,338
26,848
232,186
223,489
$
$
$
186,347
10,794
197,141
236,307
$
$
$
184,986
8,369
193,355
264,095
Net gain on residential whole loans measured at fair value through earnings
$
137,619
$
90,045
$
Net realized gain on sales of residential mortgage securities
Net unrealized (loss)/gain on residential mortgage securities measured at fair value through earnings
Net loss on Swaps not designated as hedges for accounting purposes
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
61,307
(36,815)
(9,610)
5,474
39,577
27,709
—
656
62,605
35,837
12,962
—
(2,847)
$
157,975
$
157,987
$
108,557
$
28,423
$
31,673
$
17,653
33,587
79,663
301,801
15,000
286,801
0.68
$
$
$
$
17,960
22,268
71,901
322,393
15,000
307,393
0.79
$
$
$
$
$
$
$
$
29,281
16,331
14,372
59,984
312,668
15,000
297,668
0.80
The accompanying notes are an integral part of the consolidated financial statements.
86
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(In Thousands)
Net income
Other Comprehensive Income/(Loss):
Unrealized loss on Agency MBS, net
Unrealized (loss)/gain on Non-Agency MBS, CRT securities and MSR term notes, 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
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,
2018
2017
2016
$
301,801
$
322,393
$
312,668
(17,891)
(132,751)
(51,580)
(1,259)
14,545
(188,936)
(39,158)
79,142
(38,707)
(1,032)
35,297
35,542
$
$
112,865
(15,000)
97,865
$
$
357,935
(15,000)
342,935
$
$
(9,322)
81,882
(36,922)
(485)
22,678
57,831
370,499
(15,000)
355,499
The accompanying notes are an integral part of the consolidated financial statements.
87
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the Year Ended December 31, 2018
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, 2017
8,000
$
80
397,831
$ 3,978
$ 3,227,304
$
(578,950) $
609,224
$ 3,261,636
Cumulative effect adjustment on adoption
of new accounting standard for revenue
recognition
Net income
Issuance of common stock, net of
expenses
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, 2018
8,000
$
—
—
—
—
—
—
—
—
—
—
—
80
—
—
—
—
—
—
295
301,801
52,420
(464)
—
—
—
—
—
—
—
520
391,625
—
—
—
—
—
—
—
—
(3,392)
7,999
(261)
—
—
—
—
—
—
—
—
—
(339,244)
(15,000)
(942)
—
—
—
—
—
—
—
—
—
—
—
295
301,801
392,145
(3,392)
7,999
(261)
(339,244)
(15,000)
(942)
(203,481)
(203,481)
14,545
14,545
449,787
$ 4,498
$ 3,623,275
$
(632,040) $
420,288
$ 3,416,101
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
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, 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
88
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
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, 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
(1) For the year ended December 31, 2018, includes approximately $3.4 million (464,429 shares) surrendered for tax purposes related to equity-based compensation
awards. 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.
The accompanying notes are an integral part of the consolidated financial statements.
89
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 residential mortgage securities 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 residential mortgage securities, residential whole loans and
MSR-related assets
Amortization of purchase premiums on residential mortgage securities and residential whole loans
Depreciation and amortization on real estate, fixed assets and other assets
Equity-based compensation expense
Unrealized gain on residential whole loans at fair value
Unrealized losses/(gains) on residential mortgage securities and swaps
(Increase)/decrease in other assets
Increase/(decrease) in other liabilities
Net cash provided by operating activities
Cash Flows From Investing Activities:
For the Year Ended December 31,
2018
2017
2016
$
301,801
$
322,393
$
312,668
(61,307)
(7,715)
(22,409)
1,259
(82,904)
29,270
1,825
8,007
(36,725)
43,234
(26,487)
32
(39,577)
(4,475)
(11,868)
1,032
(86,318)
30,330
1,519
8,033
(33,617)
(27,091)
21,964
(5,813)
(35,837)
(3,229)
—
485
(84,615)
36,725
964
9,162
(31,254)
(7,640)
(11,095)
(6,943)
$
147,881
$
176,512
$
179,391
Principal payments on residential mortgage securities and MSR-related assets
$
2,327,817
$
3,996,489
$
3,339,597
Proceeds from sales of residential mortgage securities and U.S. Treasury securities
538,668
243,081
85,594
Purchases of residential mortgage securities, MSR-related assets and U.S. Treasury securities
(2,604,234)
(1,583,130)
(1,997,838)
Purchases of residential whole loans, loan related investments and capitalized advances
(3,058,839)
(1,065,981)
(677,003)
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 (used in)/provided by investing activities
Cash Flows From Financing Activities:
Principal payments on repurchase agreements and other advances
Proceeds from borrowings under repurchase agreements
Proceeds from issuance of securitized debt
Principal payments on securitized debt
Payments made for securitization related costs
Payments made for settlements on interest rate swap agreements (“Swaps”)
Proceeds from settlements on Swaps
Proceeds from issuances of common stock
Payments made for costs related to common stock issuances
Dividends paid on preferred stock
Dividends paid on common stock and dividend equivalents
Net cash provided by/(used in) financing activities
Net (decrease)/increase in cash, cash equivalents and restricted cash
Cash, cash equivalents and restricted cash at beginning of period
Cash, cash equivalents and restricted cash at end of period
90
531,909
121,304
(13,367)
—
—
(1,133)
160,469
75,671
(19,801)
10,422
—
(872)
103,997
34,200
(2,825)
51,400
(1,805)
(708)
$ (2,157,875) $
1,816,348
$
934,609
(67,063,283)
(72,563,218)
(82,408,484)
68,327,462
70,490,091
81,706,806
419,970
(97,969)
(2,497)
(61,502)
65,393
392,474
(329)
(15,000)
(329,759)
382,847
(16,562)
(2,646)
(11,424)
—
197,223
(415)
(15,000)
(308,588)
—
(22,057)
—
—
—
4,660
—
(15,000)
(297,895)
$
$
$
$
1,634,960
$ (1,847,692) $ (1,031,970)
(375,034) $
145,168
463,743
88,709
$
$
318,575
463,743
$
$
$
82,030
236,545
318,575
Supplemental Disclosure of Cash Flow Information
Interest Paid
$
232,657
$
198,159
$
194,626
Non-cash Investing and Financing Activities:
Net (decrease)/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
Payable for unsettled residential whole loans purchases
$
$
$
$
(505,850) $
134,100
215,038
90,198
211,129
$
$
$
$
$
$
136,734
79,771
— $
5,385
91,896
74,657
—
The accompanying notes are an integral part of the consolidated financial statements.
91
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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(o)
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 mortgage-backed securities (“MBS”) (See Note 3), valuation of
MBS, CRT securities and MSR- related assets (See Notes 3 and 14), income recognition and valuation of residential whole loans
(See Notes 4 and 14), valuation of derivative instruments (See Notes 5(c) and 14) and income recognition on certain Non-Agency
MBS (defined below) purchased at a discount. (See Note 3) In addition, estimates are used in the determination of taxable income
used in the assessment of REIT compliance and contingent liabilities for related taxes, penalties and interest. (See Note 2(o))
Actual results could differ from those estimates.
The Company has one reportable segment as it manages its business and analyzes and reports its results of operations on the
basis of one operating segment; investing, on a leveraged basis, in residential mortgage assets.
The consolidated financial statements of the Company include the accounts of all subsidiaries; all intercompany accounts
and transactions have been eliminated. In addition, the Company consolidates entities established to facilitate transactions related
to the acquisition and securitization of residential whole loans as well as MBS resecuritization transactions completed in prior
years. Certain prior period amounts have been reclassified to conform to the current period presentation.
(b) Residential Mortgage Securities
The Company has investments in residential MBS that are issued or guaranteed as to principal and/or interest by a federally
chartered corporation, such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage
Corporation (“Freddie Mac”), or an agency of the U.S. Government, such as the Government National Mortgage Association
(“Ginnie Mae”) (collectively, “Agency MBS”), and residential MBS that are not guaranteed by any agency of the U.S. Government
or any federally chartered corporation (“Non-Agency MBS”). In addition, the Company has investments in CRT securities that
are issued or sponsored by Fannie Mae and Freddie Mac. The coupon payments on CRT securities are paid by Fannie Mae and
Freddie Mac and the principal payments received are dependent on the performance of loans in either a reference pool or an actual
pool of loans. As the loans in the underlying pool are paid, the principal balance of the CRT securities is paid. As an investor in
a CRT security, the Company may incur a principal loss if the performance of the actual or reference pool loans results in either
an actual or calculated loss that exceeds the credit enhancement of the security owned by the Company.
Designation
MBS that the Company generally intends to hold until maturity, but that it may sell from time to time as part of the overall
management of its business, are designated as “available-for-sale” (“AFS”). Such MBS are carried at their fair value with unrealized
gains and losses excluded from earnings (except when an OTTI is recognized, as discussed below) and reported in Accumulated
other comprehensive income/(loss) (“AOCI”), a component of Stockholders’ Equity.
92
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
Upon the sale of an AFS security, any unrealized gain or loss is reclassified out of AOCI to earnings as a realized gain or
loss using the specific identification method.
The Company has elected the fair value option for certain of its Agency MBS that it does not intend to hold to maturity.
These securities are carried at their fair value with changes in fair value included in earnings for the period and reported in Other
Income, net on the Company’s consolidated statements of operations.
The Company has elected the fair value option for certain of its CRT securities as it considers this method of accounting to
more appropriately reflect the risk sharing structure of these securities. Such securities are carried at their fair value with changes
in fair value included in earnings for the period and reported in Other Income, net on the Company’s consolidated statements of
operations.
Revenue Recognition, Premium Amortization and Discount Accretion
Interest income on securities is accrued based on the outstanding principal balance and their contractual terms. Premiums
and discounts associated with Agency MBS and Non-Agency MBS assessed as high credit quality at the time of purchase are
amortized into interest income over the life of such securities using the effective yield method. Adjustments to premium amortization
are made for actual prepayment activity.
Interest income on the Non-Agency MBS that were purchased at a discount to par value and/or are considered to be of less
than high credit quality is recognized based on the security’s effective interest rate which is the security’s internal rate of return
(“IRR”). The IRR is determined using management’s estimate of the projected cash flows for each security, which are based on
the Company’s observation of current information and events and include assumptions related to fluctuations in interest rates,
prepayment speeds and the timing and amount of credit losses. On at least a quarterly basis, the Company reviews and, if appropriate,
makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and
its judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash
flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the IRR/
interest income recognized on these securities or in the recognition of OTTIs. (See Note 3)
Based on the projected cash flows from the Company’s Non-Agency MBS purchased at a discount to par value, a portion
of the purchase discount may be designated as non-accretable purchase discount (“Credit Reserve”), which effectively mitigates
the Company’s risk of loss on the mortgages collateralizing such MBS and is not expected to be accreted into interest income.
The amount designated as Credit Reserve may be adjusted over time, based on the actual performance of the security, its underlying
collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a
security with a Credit Reserve is more favorable than forecasted, a portion of the amount designated as Credit Reserve may be
reallocated to accretable discount and recognized into interest income over time. Conversely, if the performance of a security with
a Credit Reserve is less favorable than forecasted, the amount designated as Credit Reserve may be increased, or impairment
charges and write-downs of such securities to a new cost basis could result.
Determination of Fair Value for Residential Mortgage Securities
In determining the fair value of the Company’s residential mortgage securities, management considers a number of observable
market data points, including prices obtained from pricing services, brokers and repurchase agreement counterparties, dialogue
with market participants, as well as management’s observations of market activity. (See Note 14)
93
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
Impairments/OTTI
When the fair value of an AFS security is less than its amortized cost at the balance sheet date, the security is considered
impaired. The Company assesses its impaired securities on at least a quarterly basis and designates such impairments as either
“temporary” or “other-than-temporary.” If the Company intends to sell an impaired security, or it is more likely than not that it
will be required to sell the impaired security before its anticipated recovery, then the Company must recognize an OTTI through
charges to earnings equal to the entire difference between the investment’s amortized cost and its fair value at the balance sheet
date. If the Company does not expect to sell an other-than-temporarily impaired security, only the portion of the impairment related
to credit losses is recognized through charges to earnings with the remainder recognized through AOCI on the consolidated balance
sheets. Impairments recognized through other comprehensive income/(loss) (“OCI”) do not impact earnings. Following the
recognition of an OTTI through earnings, a new cost basis is established for the security, which may not be adjusted for subsequent
recoveries in fair value through earnings. However, OTTIs recognized through charges to earnings may, upon recovery, be accreted
back to the amortized cost basis of the security on a prospective basis through interest income. The determination as to whether
an OTTI exists and, if so, the amount of credit impairment recognized in earnings is subjective, as such determinations are based
on factual information available at the time of assessment as well as the Company’s estimates of future performance and cash flow
projections. As a result, the timing and amount of OTTIs constitute material estimates that are susceptible to significant change.
(See Note 3)
Non-Agency MBS that are assessed to be of less than high credit quality and on which impairments are recognized have
experienced, or are expected to experience, credit-related adverse cash flow changes. The Company’s estimate of cash flows for
its Non-Agency MBS is based on its review of the underlying mortgage loans securing the MBS. The Company considers
information available about the past and expected future performance of underlying mortgage loans, including timing of expected
future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, year of
origination, loan-to-value ratios (“LTVs”), geographic concentrations and dialogue with market participants. As a result, significant
judgment is used in the Company’s analysis to determine the expected cash flows for its Non-Agency MBS. In determining the
OTTI related to credit losses for securities that were purchased at significant discounts to par and/or are considered to be of less
than high credit quality, the Company compares the present value of the remaining cash flows expected to be collected at the
purchase date (or last date previously revised) against the present value of the cash flows expected to be collected at the current
financial reporting date. The discount rate used to calculate the present value of expected future cash flows is the current yield
used for income recognition purposes. Impairment assessment for Non-Agency MBS that were purchased at prices close to par
and/or are otherwise considered to be of high credit quality involves comparing the present value of the remaining cash flows
expected to be collected against the amortized cost of the security at the assessment date. The discount rate used to calculate the
present value of the expected future cash flows is based on the instrument’s IRR.
Balance Sheet Presentation
The Company’s residential mortgage securities pledged as collateral against repurchase agreements and Swaps are included
on the consolidated balance sheets with the fair value of the securities pledged disclosed parenthetically. Purchases and sales of
securities are recorded on the trade date.
(c) Residential Whole Loans (including Residential Whole Loans transferred to consolidated VIEs)
Residential whole loans included in the Company’s consolidated balance sheets are primarily comprised of pools of fixed
and adjustable rate residential mortgage loans acquired through consolidated trusts in secondary market transactions. The
accounting model utilized by the Company is determined at the time each loan package is initially acquired and is generally based
on the delinquency status of the majority of the underlying borrowers in the package at acquisition. The accounting model described
below for purchased credit impaired loans that are held at carrying value is typically utilized by the Company for purchased credit
impaired loans where the underlying borrower has a delinquency status of less than 60 days at the acquisition date. The Company
also acquires purchased performing loans that are typically held at carrying value, but the accounting methods for income recognition
and determination and measurement of any required loan loss reserves (as discussed below) differ from those used for purchased
credit impaired loans held at carrying value. The accounting model described below for residential whole loans held at fair value
is typically utilized by the Company for loans where the underlying borrower has a delinquency status of 60 days or more at the
acquisition date. The accounting model initially applied is not subsequently changed.
The Company’s residential whole loans pledged as collateral against repurchase agreements are included in the consolidated
balance sheets with amounts pledged disclosed parenthetically. Purchases and sales of residential whole loans are recorded on the
94
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
trade date, with amounts recorded reflecting management’s current estimate of assets that will be acquired or disposed at the closing
of the transaction. This estimate is subject to revision at the closing of the transaction, pending the outcome of due diligence
performed prior to closing. Recorded amounts of residential whole loans for which the closing of the purchase transaction is yet
to occur are not eligible to be pledged as collateral against any repurchase agreement financing until the closing of the purchase
transaction. (See Notes 4, 6, 7, 14 and 15)
Residential Whole Loans at Carrying Value
Purchased Performing Loans
Acquisitions of purchased performing loans to date have been primarily comprised of: (i) loans to finance (or refinance) one-
to-four family residential properties that are not considered to meet the definition of a “Qualified Mortgage” in accordance with
guidelines adopted by the Consumer Financial Protection Bureau (“Non-QM loans”), (ii) short-term business purpose loans
collateralized by residential properties made to non-occupant borrowers who intend to rehabilitate and sell the property for a profit
(“Rehabilitation loans” or “Fix and Flip loans”), (iii) loans to finance (or refinance) non-owner occupied one-to four-family
residential properties that are rented to one or more tenants (“Single-family rental loans”), and (iv) previously originated loans
secured by residential real estate that is generally owner occupied (“Seasoned performing loans”). Purchased performing loans
are initially recorded at their purchase price. Interest income on purchased performing loans acquired at par is accrued based on
each loan’s current interest bearing balance and current interest rate, net of related servicing costs. Interest income on such loans
purchased at a premium/discount to par is recorded each period based on the contractual coupon net of any amortization of premium
or accretion of discount, adjusted for actual prepayment activity. For loans acquired with related servicing rights retained by the
seller, interest income is reported net of related serving costs.
An allowance for loan losses is recorded when, based on current information and events, it is probable that the Company
will be unable to collect all amounts due according to the existing contractual terms of the loan agreement. Any required loan loss
allowance would typically be measured based on the fair value of the collateral securing the loan and would reduce the carrying
value of the loan with a corresponding charge to earnings. Significant judgments are required in determining any allowance for
loan loss, including assumptions regarding the loan cash flows expected to be collected, the value of the underlying collateral and
the ability of the Company to collect on any other forms of security, such as a personal guaranty provided either by the borrower
or an affiliate of the borrower. Income recognition is suspended for loans at the earlier of the date at which payments become 90
days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful. When the ultimate
collectability of the principal of an impaired loan is in doubt, all payments are applied to principal under the cost recovery method.
When the ultimate collectability of the principal of an impaired loan is not in doubt, interest income is recorded under the cash
basis method as interest payments are received. Interest accruals are resumed when the loan becomes contractually current and
performance is demonstrated to be resumed. A loan is written off when it is no longer realizable and/or it is legally discharged.
Purchased Credit Impaired Loans
The Company has elected to account for these loans as credit impaired as they were acquired at discounted prices that reflect,
in part, the impaired credit history of the borrower. Substantially all of these loans have previously experienced payment
delinquencies and the amount owed may exceed the value of the property pledged as collateral. Consequently, these loans generally
have a higher likelihood of default than newly originated mortgage loans with LTVs of 80% or less to creditworthy borrowers.
The Company believes that amounts paid to acquire these loans represent fair market value at the date of acquisition. Loans
considered credit impaired are initially recorded at the purchase price with no allowance for loan losses. Subsequent to acquisition,
the recorded amount for these loans reflects the original investment amount, plus accretion of interest income, less principal and
interest cash flows received. These loans are presented on the Company’s consolidated balance sheets at carrying value, which
reflects the recorded amount reduced by any allowance for loan losses established subsequent to acquisition.
Under the application of the accounting model for purchased credit impaired loans, the Company may aggregate into pools
loans acquired in the same fiscal quarter that are assessed as having similar risk characteristics. For each pool established, or on
an individual loan basis for loans not aggregated into pools, the Company estimates at acquisition and periodically on at least a
quarterly basis, the principal and interest cash flows expected to be collected. The difference between the cash flows expected to
be collected and the carrying amount of the loans is referred to as the “accretable yield.” This amount is accreted as interest income
over the life of the loans using an effective interest rate (level yield) methodology. Interest income recorded each period reflects
the amount of accretable yield recognized and not the coupon interest payments received on the underlying loans. The difference
between contractually required principal and interest payments and the cash flows expected to be collected is referred to as the
95
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
“non-accretable difference,” and includes estimates of both the effect of prepayments and expected credit losses over the life of
the underlying loans.
A decrease in expected cash flows in subsequent periods may indicate impairment at the pool and/or individual loan level,
thus requiring the establishment of an allowance for loan losses by a charge to the provision for loan losses. The allowance for
loan losses generally represents the present value of cash flows expected at acquisition, adjusted for any increases due to changes
in estimated cash flows, that are subsequently no longer expected to be received at the relevant measurement date. Under the
accounting model applied to purchased credit impaired loans, a significant increase in expected cash flows in subsequent periods
first reduces any previously recognized allowance for loan losses and then will result in a recalculation in the amount of accretable
yield. The adjustment of accretable yield due to a significant increase in expected cash flows is accounted for prospectively as a
change in estimate and results in reclassification from nonaccretable difference to accretable yield.
Residential Whole Loans at Fair Value
Certain of the Company’s residential whole loans are presented at fair value on its consolidated balance sheets as a result of
a fair value election made at the time of acquisition. For the majority of these loans, there is significant uncertainty associated
with estimating the timing of and amount of cash flows that will be collected. Further, the cash flows ultimately collected may
be dependent on the value of the property securing the loan. Consequently, the Company considers that accounting for these loans
at fair value should result in a better reflection over time of the economic returns for the majority of these loans. The Company
determines the fair value of its residential whole loans held at fair value after considering portfolio valuations obtained from a
third-party who specializes in providing valuations of residential mortgage loans and trading activity observed in the market place.
Subsequent changes in fair value are reported in current period earnings and presented in Net gain on residential whole loans
measured at fair value through earnings on the Company’s consolidated statements of operations.
Cash received representing coupon payments on residential whole loans held at fair value is not included in Interest Income,
but rather is included in Net gain on residential whole loans measured at fair value through earnings on the Company’s consolidated
statements of operations. Cash outflows associated with loan related advances made by the Company on behalf of the borrower
are included in the basis of the loan and are reflected in unrealized gains or losses reported each period.
(d) MSR-Related Assets
The Company has investments in financial instruments whose cash flows are considered to be largely dependent on underlying
MSRs that either directly or indirectly act as collateral for the investment. These financial instruments, which are referred to as
MSR-related assets are discussed in more detail below. The Company’s MSR-related assets pledged as collateral against repurchase
agreements are included in the consolidated balance sheets with the amounts pledged disclosed parenthetically. Purchases and
sales of MSR-related assets are recorded on the trade date. (See Notes 3, 6, 7 and 14)
Term Notes Backed by MSR-Related Collateral
The Company has invested in term notes that are issued by special purpose vehicles (“SPV”) that have acquired rights to
receive cash flows representing the servicing fees and/or excess servicing spread associated with certain MSRs. The Company
considers payment of principal and interest on these term notes to be largely dependent on the cash flows generated by the underlying
MSRs as this impacts the cash flows available to the SPV that issued the term notes. Credit risk borne by the holders of the term
notes is also mitigated by structural credit support in the form of over-collateralization. Credit support is also provided by a
corporate guarantee from the ultimate parent or sponsor of the SPV that is intended to provide for payment of interest and principal
to the holders of the term notes should cash flows generated by the underlying MSRs be insufficient.
The Company’s term notes backed by MSR-related collateral are treated as AFS securities and reported at fair value on the
Company’s consolidated balance sheets with unrealized gains and losses excluded from earnings and reported in AOCI. Interest
income is recognized on an accrual basis on the Company’s consolidated statements of operations. The Company’s valuation
process for such notes considers a number of factors, including a comparable bond analysis performed by a third-party pricing
service which involves determining a pricing spread at issuance of the term note. The pricing spread is used at each subsequent
valuation date to determine an implied yield to maturity of the term note, which is then used to derive an indicative market value
for the security. This indicative market value is further reviewed by the Company and may be adjusted to ensure it reflects a
realistic exit price at the valuation date given the structural features of these securities. Other factors taken into consideration
include indicative values provided by repurchase agreement counterparties, estimated changes in fair value of the related underlying
96
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
MSR collateral and the financial performance of the ultimate parent or sponsoring entity of the issuer, which has provided a
guarantee that is intended to provide for payment of interest and principal to the holders of the term notes should cash flows
generated by the related underlying MSR collateral be insufficient.
Corporate Loans
The Company has made or participated in loans to provide financing to entities that originate residential mortgage loans and
own the related MSRs. These corporate loans are generally secured by certain MSRs, as well as certain other unencumbered assets
owned by the borrower.
Corporate loans are recorded on the Company’s consolidated balance sheets at the drawn amount, on which interest income
is recognized on an accrual basis on the Company’s consolidated statements of operations. Commitment fees received on the
undrawn amount are deferred and recognized as interest income over the remaining loan term at the time of draw. At the end of
the commitment period, any remaining deferred commitment fees are recorded as Other Income on the Company’s consolidated
statements of operations. The Company evaluates the recoverability of its corporate loans on a quarterly basis considering various
factors, including the current status of the loan, changes in the fair value of the MSRs that secure the loan and the recent financial
performance of the borrower.
(e) 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 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, 2018 and 2017. At December 31, 2018 and
2017, the Company had cash and cash equivalents of $52.0 million and $449.8 million, respectively. The Company’s investments
in overnight money market funds, which are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance
Corporation (“FDIC”) or any other government agency, were $30.0 million and $354.0 million at December 31, 2018 and 2017,
respectively. In addition, deposits in FDIC insured accounts generally exceed insured limits. (See Notes 7 and 14)
(f) Restricted Cash
Restricted cash represents the Company’s cash held by its counterparties in connection with certain of the Company’s Swaps
and/or repurchase agreements that is not available to the Company for general corporate purposes. Restricted cash may be applied
against amounts due to repurchase agreement and/or Swap counterparties, or may be returned to the Company when the related
collateral requirements are exceeded or at the maturity of the Swap and/or repurchase agreement. The Company had aggregate
restricted cash held as collateral or otherwise in connection with its repurchase agreements and/or Swaps of $36.7 million and
$14.0 million at December 31, 2018 and 2017, respectively. (See Notes 5(c), 6, 7 and 14)
(g) Goodwill
At December 31, 2018 and 2017, the Company had goodwill of $7.2 million, which represents the unamortized portion of
the excess of the fair value of its common stock issued over the fair value of net assets acquired in connection with its formation
in 1998. Goodwill ,which is no longer subject to amortization, is tested for impairment at least annually, or more frequently under
certain circumstances, at the entity level. Through December 31, 2018, the Company had not recognized any impairment against
its goodwill. Goodwill is included in Other assets on the Company’s consolidated balance sheets.
(h) Real Estate Owned (“REO”)
REO represents real estate acquired by the Company, including through foreclosure, deed in lieu of foreclosure, or purchased
in connection with the acquisition of residential whole loans. REO acquired through foreclosure or deed in lieu of foreclosure is
initially recorded at fair value less estimated selling costs. REO acquired in connection with the acquisition of residential whole
loans is initially recorded at its purchase price. Subsequent to acquisition, REO is reported, at each reporting date, at the lower of
the current carrying amount or fair value less estimated selling costs and for presentation purposes is included in Other assets on
the Company’s consolidated balance sheets. Changes in fair value that result in an adjustment to the reported amount of an REO
property that has a fair value at or below its carrying amount are reported in Other Income, net on the Company’s consolidated
statements of operations. (See Note 5(b))
97
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
(i) 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.
(j) Loan Securitization and Other Debt Issuance Costs
Loan securitization related costs are costs associated with the issuance of beneficial interests by consolidated VIEs and
incurred by the Company in connection with various financing transactions completed by the Company. Other debt issuance and
related costs include costs incurred by the Company in connection with issuing 8% Senior Notes due 2042 (“Senior Notes”) and
certain other repurchase agreement financings. These costs may include underwriting, rating agency, legal, accounting and other
fees. Such costs, which reflect deferred charges, are included on the Company’s consolidated balance sheets as a direct deduction
from the corresponding debt liability. These deferred charges are amortized as an adjustment to interest expense using the effective
interest method. For Senior Notes and other repurchase agreement financings, such costs are amortized over the shorter of the
period to the expected or stated legal maturity of the debt instruments. The Company periodically reviews the recoverability of
these deferred costs and in the event an impairment charge is required, such amount will be included in Operating and Other
Expense on the Company’s consolidated statements of operations.
(k) 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, in an amount which is equal to a specified percentage of the
fair value of the pledged collateral, while the Company retains beneficial ownership of the pledged collateral. At the maturity of
a repurchase financing, unless the repurchase financing is renewed with the same counterparty, the Company is required to repay
the loan including any accrued interest and concurrently receives back its pledged collateral from the lender. With the consent of
the lender, the Company may renew a repurchase financing at the then prevailing financing terms. Margin calls, whereby a lender
requires that the Company pledge additional assets or cash as collateral to secure borrowings under its repurchase financing with
such lender, are routinely experienced by the Company when the value of the assets pledged as collateral declines as a result of
principal amortization and prepayments or due to changes in market interest rates, spreads or other market conditions. The Company
also may make margin calls on counterparties when collateral values increase.
The Company’s repurchase financings typically have terms ranging from one month to six months at inception, but may also
have longer or shorter terms. Should a counterparty decide not to renew a repurchase financing at maturity, the Company must
either refinance elsewhere or be in a position to satisfy the obligation. If, during the term of a repurchase financing, a lender should
default on its obligation, the Company might experience difficulty recovering its pledged assets which could result in an unsecured
claim against the lender for the difference between the amount loaned to the Company plus interest due to the counterparty and
the fair value of the collateral pledged by the Company to such lender, including accrued interest receivable on such collateral.
(See Notes 6, 7 and 14)
In addition to the repurchase agreement financing arrangements discussed above, as part of its financing strategy for Non-
Agency MBS, the Company in prior periods entered into contemporaneous repurchase and reverse repurchase agreements with a
single counterparty. Under a typical reverse repurchase agreement, the Company buys securities from a borrower for cash and
agrees to sell the same securities in the future for a price that is higher than the original purchase price. The difference between
the purchase price the Company originally paid and the sale price represents interest received from the borrower. In contrast, the
contemporaneous repurchase and reverse repurchase transactions effectively resulted in the Company pledging Non-Agency MBS
as collateral to the counterparty in connection with the repurchase agreement financing and obtaining U.S. Treasury securities as
collateral from the same counterparty in connection with the reverse repurchase agreement. No net cash was exchanged between
the Company and counterparty at the inception of the transactions. Securities obtained and pledged as collateral are recorded in
98
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
Other assets 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. The Company’s liability to the counterparty in prior
periods in connection with this financing arrangement is recorded in Other liabilities on the Company’s consolidated balance sheets
and disclosed as “Obligation to return securities obtained as collateral, at fair value.” (See Note 5(a))
(l) 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.
Beginning in 2014, the Company has made annual grants of restricted stock units (“RSUs”) certain of which cliff vest after
a three-year period, subject only to continued employment, and others of which cliff vest after a three-year period, subject to both
continued employment and the achievement of certain performance criteria based on a formula tied to the Company’s achievement
of average total shareholder return during that three-year period, as well as the total shareholder return (“TSR”) of the Company
relative to the TSR of a group of peer companies (over the three-year period) selected by the Compensation Committee of the
Company’s Board of Directors (the “Compensation Committee”) at the date of grant. The features in these awards related to the
attainment of total shareholder return over a specified period constitute a “market condition” which impacts the amount of
compensation expense recognized for these awards. Specifically, the uncertainty regarding the achievement of the market condition
was reflected in the grant date fair valuation of the RSUs, which is recognized as compensation expense over the relevant vesting
period. The amount of compensation expense recognized is not dependent on whether the market condition was or will be achieved.
The Company makes dividend equivalent payments in connection with certain of its equity-based awards. A dividend
equivalent is a right to receive a distribution equal to the dividend distributions that would be paid on a share of the Company’s
common stock. Dividend equivalents may be granted as a separate instrument or may be a right associated with the grant of another
award (e.g., an RSU) under the Company’s Equity Compensation Plan (the “Equity Plan”), and they are paid in cash or other
consideration at such times and in accordance with such rules, terms and conditions, as the Compensation Committee may determine
in its discretion. Payments pursuant to dividend equivalents are generally charged to Stockholders’ Equity to the extent that the
attached equity awards are expected to vest. Compensation expense is recognized for payments made for dividend equivalents to
the extent that the attached equity awards (i) do not or are not expected to vest and (ii) grantees are not required to return payments
of dividends or dividend equivalents to the Company. (See Notes 2(m) and 13)
(m) 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)
(n) 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.
99
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
(o) 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 is conducted through one or more TRS, its net taxable income earned by TRS, if any, is subject
to corporate income taxation. To maintain the Company’s REIT election, no more than 20% of the value of a REIT’s assets at the
end of each calendar quarter may consist of stock or securities in TRS. For purposes of the determination of U. S. federal and
state income taxes, the Company’s subsidiaries that elected to be treated as a TRS record current or deferred income taxes based
on differences (both permanent and timing) between the determination of their taxable income and net income under GAAP. No
net deferred tax benefit was recorded by the Company in 2018 or 2017, related to the net taxable losses in the TRS, since a valuation
allowance for the full amount of the associated deferred tax asset of approximately $22.3 million was recognized as its recovery
is not considered more likely than not. The related net operating loss carryforwards generated prior to 2018 will begin to expire
in 2034; those generated in 2018 do not expire.
Based on its analysis of any potential uncertain tax positions, the Company concluded that it does not have any material
uncertain tax positions that meet the relevant recognition or measurement criteria as of December 31, 2018, 2017 or 2016. The
Company filed its 2017 tax return prior to October 15, 2018. The Company’s tax returns for tax years 2015 through 2017 are open
to examination.
(p) 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, the majority which are designated as cash flow hedges against the interest rate risk associated with its
borrowings.
Swaps
The Company documents its risk-management policies, including objectives and strategies, as they relate to its hedging
activities and the relationship between the hedging instrument and the hedged liability for all Swaps designated as hedging
transactions. The Company assesses, both at the inception of a hedge and on a quarterly basis thereafter, whether or not the hedge
is “highly effective.”
100
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
Swaps are carried on the Company’s consolidated balance sheets at fair value, in Other assets, if their fair value is positive,
or in Other liabilities, if their fair value is negative. Beginning in January 2017, variation margin payments on the Company’s
Swaps that have been novated to a clearing house are treated as a legal settlement of the exposure under the Swap contract.
Previously such payments were treated as collateral pledged against the exposure under the Swap contract. The effect of this
change is to reduce what would have otherwise been reported as the fair value of the Swap. All of the Company’s Swaps have
been novated to a central clearing house. Changes in the fair value of the Company’s Swaps designated in hedging transactions
are recorded in OCI provided that the hedge remains effective. 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. Periodic payments accrued in connection with Swaps designated as hedges
are included in interest expense, and are treated as an operating cash flow.
The Company discontinues hedge accounting on a prospective basis and recognizes changes in fair value through earnings
when: (i) it is determined that the derivative is no longer effective in offsetting cash flows of a hedged item (including forecasted
transactions); (ii) it is no longer probable that the forecasted transaction will occur; or (iii) it is determined that designating the
derivative as a hedge is no longer appropriate. (See Notes 5(c), 7 and 14)
Changes in the fair value of the Company’s Swaps not designated in hedging transactions are recorded in Other income,
net on the Company’s consolidated statements of operations.
(q) 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, Agency MBS and CRT securities at the time of acquisition. Subsequent changes in the
fair value of these financial instruments are reported in Other income, net, in the Company’s consolidated statements of operations.
A decision to elect the fair value option for an eligible financial instrument, which may be made on an instrument by instrument
basis, is irrevocable. (See Notes 2(b), 2(c), 3, 4 and 14)
(r) 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 the additional subordinated financial support of other parties; or (ii) as a group,
the holders of the equity investment at risk lack (a) the power to direct the activities of an entity that most significantly impact the
entity’s economic performance; (b) the obligation to absorb the expected losses; or (c) the right to receive the expected residual
returns; or (iii) the holders of the equity investment at risk have disproportional voting rights and the entity’s activities are conducted
on behalf of the investor that has disproportionately few voting rights.
The Company consolidates a VIE when it has both the power to direct the activities that most significantly impact the economic
performance of the VIE and a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE.
The Company is required to reconsider its evaluation of whether to consolidate a VIE each reporting period, based upon changes
in the facts and circumstances pertaining to the VIE.
The Company has entered into several financing transactions which resulted in the Company forming entities to facilitate
these transactions. In determining the accounting treatment to be applied to these transactions, the Company concluded that the
entities used to facilitate these transactions are VIEs and that they should be consolidated. If the Company had determined that
consolidation was not required, it would have then assessed whether the transfers of the underlying assets would qualify as sale
or should be accounted for as secured financings under GAAP. (See Note 15)
101
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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.
(s) Offering Costs Related to Issuance and Redemption of Preferred Stock
Offering costs related to the issuance of preferred stock are recorded as a reduction in Additional paid-in capital, a component
of Stockholders’ Equity, at the time such preferred stock is issued. On redemption of preferred stock, any excess of the fair value
of the consideration transferred to the holders of the preferred stock over the carrying amount of the preferred stock in the Company’s
consolidated balance sheets is included in the determination of Net Income Available to Common Stock and Participating Securities
in the calculation of EPS.
(t) New Accounting Standards and Interpretations
Accounting Standards Adopted in 2018
Compensation - Stock Compensation - Scope of Modification Accounting
In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-09,
Scope of Modification Accounting (“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. The Company adopted ASU 2017-09 on January 1, 2018 and its adoption did not have an impact on its financial
position or financial statement disclosures.
Statement of Cash Flows - Restricted Cash
In November 2016, the FASB issued ASU 2016-18, Restricted Cash (“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. The Company adopted ASU 2016-18 on January 1, 2018 and its adoption did not have a significant
impact on its 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 (“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. The
Company adopted ASU 2016-15 on January 1, 2018 and its adoption did not have a significant impact on its financial position or
financial statement disclosures.
102
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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
(“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
was effective for the Company for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017.
The Company’s adoption of this ASU on January 1, 2018 did not have a significant impact on the Company’s financial position
or financial statement disclosures as the classification and measurement of its 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 (“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 replaced most existing revenue recognition guidance in GAAP when it
became effective. The Company adopted this ASU on January 1, 2018 and its adoption did not have a material impact on the
Company’s financial position or financial statement disclosures as the majority of the Company’s revenues are generated by
financial instruments that are explicitly scoped out of this ASU. On adoption of the new standard on January 1, 2018, the Company
recorded a transition adjustment, under the modified retrospective approach, of approximately $295,000 to the opening balance
of retained earnings in order to reflect the recognition of a gain on sale of REO that was previously deferred under the prior
accounting guidance.
103
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
3.
Residential Mortgage Securities and MSR-Related Assets
Agency and Non-Agency MBS
The Company’s MBS are comprised of Agency MBS and Non-Agency MBS which include MBS issued prior to 2008
(“Legacy Non-Agency MBS”). These MBS are secured by: (i) hybrid mortgages (“Hybrids”), which have interest rates that are
fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index;
(ii) adjustable-rate mortgages (“ARMs”), which have interest rates that reset annually or more frequently (collectively, “ARM-
MBS”); and (iii) 15 and 30 year fixed-rate mortgages for Agency MBS and, for Non-Agency MBS, 30-year and longer-term fixed-
rate mortgages. In addition, the Company’s MBS are also comprised of MBS backed by securitized re-performing/non-performing
loans (“RPL/NPL MBS”), where the cash flows of the bond may not reflect the contractual cash flows of the underlying collateral.
The Company’s RPL/NPL MBS are generally structured with a contractual coupon step-up feature where the coupon increases
from 300 - 400 basis points at 36 - 48 months from issuance or sooner. The Company pledges a significant portion of its MBS as
collateral against its borrowings under repurchase agreements and Swaps. (See Note 7)
Agency MBS: Agency MBS are guaranteed as to principal and/or interest by a federally chartered corporation, such as
Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae. The payment of principal and/or interest
on Ginnie Mae MBS is explicitly backed by the full faith and credit of the U.S. Government. Since the third quarter of 2008,
Fannie Mae and Freddie Mac have been under the conservatorship of the Federal Housing Finance Agency, which significantly
strengthened the backing for these government-sponsored entities.
Non-Agency MBS: The Company’s Non-Agency MBS are primarily secured by pools of residential mortgages, which are
not guaranteed by an agency of the U.S. Government or any federally chartered corporation. Credit risk associated with Non-
Agency MBS is regularly assessed as new information regarding the underlying collateral becomes available and based on updated
estimates of cash flows generated by the underlying collateral.
CRT Securities
CRT securities are debt obligations issued or sponsored by Fannie Mae and Freddie Mac. The payments of principal and
interest on the CRT securities are paid by Fannie Mae or Freddie Mac, as the case may be, on a monthly basis and are dependent
on the performance of loans in either a reference pool or an actual pool of loans. As the loans in the underlying pool are paid, the
principal balance of the CRT securities is paid. As an investor in a CRT security, the Company may incur a principal loss if the
performance of the actual or reference pool loans results in either an actual or calculated loss that exceeds the credit enhancement
of the security owned by the Company.
The Company assesses the credit risk associated with CRT securities by assessing the current and expected future performance
of the associated loan pool. The Company pledges a portion of its CRT securities as collateral against its borrowings under
repurchase agreements. (See Note 7)
104
and 2017:
(In Thousands)
Agency MBS: (3)
Fannie Mae
Freddie Mac
Ginnie Mae
Total Agency MBS
Non-Agency MBS:
(In Thousands)
Agency MBS: (3)
Fannie Mae
Freddie Mac
Ginnie Mae
Total Agency MBS
Non-Agency MBS:
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following tables present certain information about the Company’s residential mortgage securities at December 31, 2018
December 31, 2018
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)
$
1,716,340
$
65,930
$
(24)
$
— $
1,782,246
$
1,762,032
$
12,107
$
(32,321)
$
(20,214)
909,561
4,729
36,991
87
2,630,630
103,008
Expected to Recover Par (4)(5)
1,536,485
Expected to Recover Less than
Par (4)
Total Non-Agency MBS (6)
Total MBS
CRT securities (7)
2,002,319
3,538,804
6,169,434
476,744
40
—
40
103,048
9,321
—
—
(24)
(21,725)
(133,300)
(155,025)
(155,049)
107
—
—
—
—
947,588
4,816
931,318
4,863
907
47
(17,177)
(16,270)
—
47
2,734,650
2,698,213
13,061
(49,498)
(36,437)
1,514,800
1,527,700
20,520
(7,620)
12,900
(516,116)
1,352,903
(516,116)
2,867,703
(516,116)
5,602,353
1,790,599
3,318,299
6,016,512
—
486,172
492,821
438,465
458,985
472,046
12,545
(769)
(8,389)
(57,887)
(5,896)
437,696
450,596
414,159
6,649
Total MBS and CRT securities
$
6,646,178
$
112,369
$
(154,942)
$
(516,116)
$
6,088,525
$
6,509,333
$
484,591
$
(63,783)
$
420,808
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
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)
—
—
—
—
—
—
(40)
(22,737)
(192,588)
(215,325)
(215,365)
(3,550)
Expected to Recover Par (4)(5)
1,128,808
Expected to Recover Less than
Par (4)
Total Non-Agency MBS (6)
Total MBS
CRT securities (7)
2,589,935
3,718,743
6,457,205
602,799
50
—
50
104,116
8,887
1,106,121
1,132,205
26,518
(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
(434)
(19)
(453)
(43,590)
(23)
26,084
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
(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, 2018 reflect Credit Reserve of $503.3 million and OTTI of $12.8 million. Amounts disclosed at December 31, 2017 reflect Credit Reserve of
$579.0 million and OTTI of $14.2 million.
(2) Includes principal payments receivable of $1.0 million and $1.9 million at December 31, 2018 and 2017, respectively, which are not included in the Principal/
Current Face.
(3) Amounts disclosed at December 31, 2018 include Agency MBS with a fair value of $736.5 million for which the fair value option has been elected. Such
securities had no unrealized gains and gross unrealized losses of approximately $3.3 million at December 31, 2018. The Company did not have any Agency
MBS for which the fair value option had been elected at December 31, 2017.
(4) Based on management’s current estimates of future principal cash flows expected to be received.
(5) Includes RPL/NPL MBS, which at December 31, 2018 had a $1.4 billion Principal/Current face, $1.4 billion amortized cost and $1.4 billion fair value. At
December 31, 2017, RPL/NPL MBS had a $922.0 million Principal/Current face, $920.1 million amortized cost and $923.1 million fair value.
(6) At December 31, 2018 and 2017, the Company expected to recover approximately 85% and 84%, respectively, of the then-current face amount of Non-Agency
MBS.
(7) Amounts disclosed at December 31, 2018 includes CRT securities with a fair value of $477.4 million for which the fair value option has been elected. Such
securities had gross unrealized gains of approximately $12.5 million and gross unrealized losses of approximately $5.6 million at December 31, 2018. Amounts
disclosed at December 31, 2017 includes CRT securities with a fair value of $528.9 million for which the fair value option had 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.
105
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
Sales of Residential Mortgage Securities
During 2018, the Company sold certain Agency MBS for $122.0 million, realizing losses of $6.8 million. The Company
also sold certain CRT securities during 2018 for $299.9 million, realizing gains of $31.4 million. In addition, during 2018, the
Company sold certain Non-Agency MBS for $117.1 million, realizing gains of $36.7 million. During 2017, the Company sold
certain Non-Agency MBS for $104.0 million, realizing gains of $39.9 million. During 2016, the Company sold certain Non-
Agency MBS for $85.6 million realizing gains of $35.8 million. The Company has no continuing involvement with any of the
sold MBS.
Unrealized Losses on Residential Mortgage Securities
The following table presents information about the Company’s residential mortgage securities that were in an unrealized
loss position at December 31, 2018:
(Dollars in Thousands)
Agency MBS: (1)
Fannie Mae
Freddie Mac
Total Agency MBS
Non-Agency MBS:
Expected to Recover Par (2)
Expected to Recover Less than Par (2)
Total Non-Agency MBS
Total MBS
CRT securities (3)
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
$ 282,850
$
608,458
891,308
1,193,422
54,223
1,247,645
2,138,953
167,195
1,215
3,331
4,546
6,187
660
6,847
11,393
5,896
67
15
82
31
11
42
124
41
$ 919,504
$
31,106
287,637
1,207,141
13,846
44,952
91,469
2,028
93,497
1,433
109
1,542
1,300,638
46,494
—
—
293
123
416
9
1
10
426
—
$ 1,202,354
$
32,321
896,095
2,098,449
1,284,891
56,251
1,341,142
3,439,591
167,195
17,177
49,498
7,620
769
8,389
57,887
5,896
Total MBS and CRT securities
$ 2,306,148
$
17,289
165
$ 1,300,638
$
46,494
426
$ 3,606,786
$
63,783
(1) Amounts disclosed at December 31, 2018 include Agency MBS with a fair value of $736.5 million on which the fair value option has been elected. Such
securities had unrealized losses of $3.3 million at December 31, 2018.
(2) Based on management’s current estimates of future principal cash flows expected to be received.
(3) Amounts disclosed at December 31, 2018 includes CRT securities with a fair value of $151.8 million for which the fair value option has been elected. Such
securities had unrealized losses of $5.6 million at December 31, 2018.
At December 31, 2018, 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 $49.5 million at December 31, 2018. 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, 2018 any unrealized losses on its Agency MBS were temporary.
Gross unrealized losses on the Company’s Non-Agency MBS were $8.4 million at December 31, 2018. 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.
106
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The Company recognized credit-related OTTI losses through earnings related to its Non-Agency MBS of $1.3 million, $1.0
million, and $485,000 during the years ended December 31, 2018, 2017, and 2016, 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 loans, year of origination, LTVs,
geographic concentrations, and dialogue with market participants. Changes in the Company’s evaluation of each of these factors
impacts the cash flows expected to be collected at the OTTI assessment date. For Non-Agency MBS purchased at a discount to
par that were assessed for and had no OTTI recorded this period, such cash flow estimates indicated that the amount of expected
losses decreased compared to the previous OTTI assessment date. These positive cash flow changes are primarily driven by recent
improvements in LTVs due to loan amortization and home price appreciation, which, in turn, positively impacts the Company’s
estimates of default rates and loss severities for the underlying collateral. In addition, voluntary prepayments (i.e., loans that
prepay in full with no loss) have generally trended higher relative to the Company’s assumptions for these MBS which also
positively impacts the Company’s estimate of expected loss. Overall, the combination of higher voluntary prepayments and lower
LTVs supports the Company’s assessment that such MBS are not other-than-temporarily impaired.
The following table presents the composition of OTTI charges recorded by the Company for the years ended December 31,
2018, 2017 and 2016:
(In Thousands)
Total OTTI losses
OTTI recognized in/(reclassified from) OCI
OTTI recognized in earnings
For the Year Ended December 31,
2018
2017
2016
$
$
(1,259) $
—
(1,259) $
(63) $
(969)
(1,032) $
(1,255)
770
(485)
The following table presents a roll-forward of the credit loss component of OTTI on the Company’s Non-Agency MBS for
which a non-credit component of OTTI was previously recognized in OCI. Changes in the credit loss component of OTTI are
presented based upon whether the current period is the first time OTTI was recorded on a security or a subsequent OTTI charge
was recorded.
(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,
2018
2017
2016
$
$
38,337
$
37,305
$
36,820
1,259
—
63
969
314
171
39,596
$
38,337
$
37,305
107
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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, 2018 and 2017:
For the Year Ended December 31,
2018
2017
(In Thousands)
Balance at beginning of period
Impact of RMBS Issuer settlement (2)(3)
Accretion of discount
Realized credit losses
Purchases
Sales
Net impairment losses recognized in earnings
Transfers/release of credit reserve
Balance at end of period
$
Discount
Designated as
Credit Reserve
and OTTI
$
(593,227) $
—
—
42,246
(2,512)
12,987
(1,259)
25,649
(516,116) $
Accretable
Discount (1)
Discount
Designated as
Credit Reserve
and OTTI
Accretable
Discount (1)
(215,325) $
(14,822)
70,750
—
1,685
28,336
—
(25,649)
(155,025) $
(694,241) $
—
—
49,291
(29,810)
31,730
(1,032)
50,835
(593,227) $
(278,191)
—
77,513
—
18,386
17,802
—
(50,835)
(215,325)
(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 $2.7 million of cash proceeds (a one-time payment) received by the Company during the year ended
December 31, 2018 in connection with the settlement of litigation related to certain residential mortgage backed securitization trusts that
were sponsored by Lehman Brothers Holdings Inc.
(3) Includes the impact of approximately $12.1 million of cash proceeds (a one-time payment) received by the Company during the year ended
December 31, 2018 in connection with the settlement of litigation related to certain residential mortgage backed securitization trusts that
were sponsored by JP Morgan Chase & Co. and affiliated entities.
MSR-Related Assets
(a) Term Notes Backed by MSR-Related Collateral
At December 31, 2018 and 2017, the Company had $538.5 million and $381.8 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, 2018, these term notes had an amortized cost of $538.5 million, gross unrealized losses of approximately
$7,000, a weighted average yield of 5.32% and a weighted average term to maturity of 4.7 years. 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.
108
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
(b) Corporate Loans
The Company has made or participated in loans to provide financing to entities that originate residential mortgage loans and
own the related MSRs. These corporate loans are secured by MSRs, as well as certain other unencumbered assets owned by the
borrower.
During the year ended December 31, 2018, the Company participated in a loan where the Company committed to lend $100.0
million of which approximately $73.3 million was drawn at December 31, 2018. At December 31, 2018, the coupon paid by the
borrower on the drawn amount is 5.88%, the remaining term associated with the loan is 1.7 years and the remaining commitment
period on any undrawn amount is 1.7 years. During the remaining commitment period, the Company receives a commitment fee
between 0.25% and 1.0% based on the undrawn amount of the loan.
In December 2016, the Company entered into a loan agreement under the terms of which it had committed to lend $130.0
million, of which approximately $111.2 million was drawn at December 31, 2017. This loan was paid in full during 2018, at which
time any remaining commitment was extinguished.
For the year ended December 31, 2018, the Company recognized interest income on its corporate loans of $5.0 million
including discount accretion and commitment fee income of $1.3 million. In addition, the Company recorded $136,000 of Other
Income consisting of deferred commitment fees recognized upon repayment of a corporate loan during the year ended December 31,
2018. For the year ended December 31, 2017, the Company recognized interest income on its corporate loans of approximately
$7.9 million including discount accretion and commitment fee income of approximately $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,
2018, 2017, and 2016:
(In Thousands)
AOCI from AFS securities:
Unrealized gain on AFS securities at beginning of period
Unrealized loss on Agency MBS, net
Unrealized (loss)/gain on Non-Agency MBS, net
Unrealized (loss)/gain on MSR term notes, net
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,
2018
2017
2016
$
$
620,648
(17,891)
(131,939)
(812)
(51,580)
(1,259)
(203,481)
417,167
$
$
620,403
(39,158)
78,337
805
(38,707)
(1,032)
245
585,250
(9,322)
81,882
—
(36,922)
(485)
35,153
$
620,648
$
620,403
109
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
Interest Income on Residential Mortgage Securities and MSR-Related Assets
The following table presents components of interest income on the Company’s residential mortgage securities and MSR-
related assets for the years ended December 31, 2018, 2017 and 2016:
(In Thousands)
Agency MBS
Coupon interest
Effective yield adjustment (1)
Interest income
Legacy Non-Agency MBS
Coupon interest
Effective yield adjustment (2)(3)
Interest income
RPL/NPL MBS
Coupon interest
Effective yield adjustment (1)(4)
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,
2018
2017
2016
$
$
$
$
$
$
$
$
$
$
88,233
(25,930)
62,303
109,714
69,309
179,023
46,339
1,434
47,773
30,628
2,748
33,376
27,176
1,244
28,420
$
$
$
$
$
$
$
$
$
$
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
(1) Includes amortization of premium paid net of accretion of purchase discount. For Agency MBS, RPL/NPL MBS and the corporate loan
secured by MSRs, interest income is recorded at an effective yield, which reflects net premium amortization/accretion based on actual
prepayment activity.
(2) The effective yield adjustment is the difference between the net income calculated using the net yield, which is based on management’s
estimates of the amount and timing of future cash flows, less the current coupon yield.
(3) Includes accretion income recognized due to the impact of redemptions of certain securities that had been previously been purchased at a
discount of $2.7 million, $1.7 million and $7,000 during the years ended December 31, 2018, 2017 and 2016, respectively.
(4) Includes accretion income recognized due to the impact of redemptions of certain securities that had been previously been purchased at a
discount of $1.4 million, $1.2 million and $1.6 million during the years ended December 31, 2018, 2017 and 2016, respectively.
4.
Residential Whole Loans
Included on the Company’s consolidated balance sheets as of December 31, 2018 and 2017 are approximately $4.7 billion
and $2.2 billion, respectively, of residential whole loans arising from the Company’s interests in certain trusts established to acquire
the loans and certain entities established in connection with its loan securitization transactions. The Company has assessed that
these entities are required to be consolidated for financial reporting purposes.
110
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
Residential Whole Loans, at Carrying Value
The following table presents the components of the Company’s Residential whole loans, at carrying value at December 31,
2018 and 2017:
(Dollars In Thousands)
Purchased performing loans:
Non-QM loans
Rehabilitation loans
Single-family rental loans
Seasoned performing loans
Total purchased performing loans
Purchased credit impaired loans
(In Thousands)
Purchased performing loans:
Non-QM loans
Rehabilitation loans
Single-family rental loans
Seasoned performing loans
Total purchased performing loans
Purchased credit impaired loans
Total Residential whole loans, at carrying value
$
Number of loans
11,149
4,792
The following table presents components of interest income on the Company’s Residential whole loans, at carrying value
for the years ended December 31, 2018, 2017 and 2016:
December 31, 2018
December 31, 2017
$
1,354,774
$
494,576
145,327
224,051
2,218,728
797,987
3,016,715
For the Year Ended December 31,
2018
2017
2016
$
$
31,036
15,975
3,315
5,818
56,144
44,777
$
84
431
15
—
530
35,657
55,612
56,706
5,319
—
117,637
790,879
908,516
—
—
—
—
—
23,916
23,916
Residential whole loans, at carrying value
$
100,921
$
36,187
$
111
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table presents additional information regarding the Company’s Residential whole loans, at carrying value at
December 31, 2018:
December 31, 2018
Unpaid
Principal
Balance
(“UPB”)
Weighted
Average
Coupon
(1)
Carrying
Value
Weighted
Average
Term to
Maturity
(Months)
Weighted
Average
LTV
Ratio (2)
Aging by UPB
Past Due Days
Current
30-59
60-89
90+
(Dollars In Thousands)
Purchased performing loans: (3)
Non-QM loans
Rehabilitation loans
Single-family rental loans
Seasoned performing loans
$1,338,360
$ 1,293,805
6.19%
494,576
145,327
224,051
494,576
144,972
242,539
7.39
5.92
4.25
4.38
Purchased credit impaired loans
797,987
1,002,261
Residential whole loans, at
carrying value, total or weighted
average
$3,000,301
$ 3,178,153
5.68%
66% $1,271,410
$ 14,535
$
4,802
$
3,058
65
70
47
86
465,033
143,226
233,105
N/A
18,353
1,225
6,439
N/A
6,451
—
1,618
N/A
4,739
521
1,377
N/A
361
9
355
191
302
275
(1) Weighted average is calculated based on the interest bearing principal balance of each loan within the related category. For loans acquired
with servicing rights released by the seller, interest rates included in the calculation do not reflect loan servicing fees. For loans acquired
with servicing rights retained by the seller, interest rates included in the calculation are net of servicing fees.
(2) LTV represents the ratio of the total unpaid principal balance of the loan to the estimated value of the collateral securing the related loan
as of the most recent date available, which may be the origination date. For Rehabilitation loans, the LTV presented is the ratio of the
maximum unpaid principal balance of the loan, including unfunded commitments, to the estimated “after repaired” value of the collateral
securing the related loan, where available. For certain Rehabilitation loans, totaling $79.0 million, an after repaired valuation was not
obtained and the loan was underwritten based on an“as is” valuation. The LTV of these loans based on the current unpaid principal balance
and the valuation obtained during underwriting, is 67%. Excluded from the calculation of weighted average LTV are certain low value
loans secured by vacant lots, for which the LTV ratio is not meaningful.
(3) Excluded from the table above are approximately $16.4 million of purchased performing loans held at carrying value for which the closing
of the purchase transaction had not occurred as of December 31, 2018.
Purchased Performing Loans
As of December 31, 2018, there were 28 loans held at carrying value, that have been placed on non-accrual status as they
are more than 90 days delinquent and had not yet become current with respect to the contractually required payments under the
loan. Such loans have an unpaid balance of approximately $9.7 million. These non-accrual loans represent approximately 0.2%
of the total outstanding principal balance of all of the Company’s Purchased Performing Loans. Management has assessed the
recoverability of these loans and based on estimates of the value of the underlying collateral, no allowance for loan loss reserves
has been recorded as of December 31, 2018.
In connection with purchased Rehabilitation loans, the Company has unfunded commitments of $49.8 million.
Purchased Credit Impaired Loans
As of December 31, 2018 and 2017, the Company had established an allowance for loan losses of approximately $968,000
and $330,000, respectively, on its purchased credit impaired loans held at carrying value. For the year ended December 31, 2018,
a provision for loan losses of approximately $638,000 was recorded, and for the years ended December 31, 2017 and 2016, a net
reversal of provisions 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.
112
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table presents the activity in the Company’s allowance for loan losses on its purchased credit impaired loans
held at carrying value for the years ended December 31, 2018, 2017 and 2016:
(In Thousands)
Balance at the beginning of period
Provisions/(reversal of provisions) for loan losses
Balance at the end of period
For the Year Ended December 31,
2018
2017
2016
$
$
330
638
968
$
$
990
(660)
330
$
$
1,165
(175)
990
The following table presents information regarding the estimates of the contractually required payments, the cash flows
expected to be collected, and the estimated fair value of the purchased credit impaired loans held at carrying value acquired by
the Company for the years ended December 31, 2018 and 2017:
(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,
2018
2017
$
$
154,911
(15,378)
139,533
(41,947)
97,586
$
$
534,112
(129,547)
404,565
(137,378)
267,187
The following table presents accretable yield activity for the Company’s purchased credit impaired loans held at carrying
value for the years ended December 31, 2018 and 2017:
(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,
2018
2017
$
$
421,872
41,947
(44,777)
(35,156)
31,443
415,329
$
$
334,379
137,378
(35,657)
(16,356)
2,128
421,872
Accretable yield for purchased credit impaired 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, 2018 is not necessarily indicative
of future results.
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 measured at fair value through earnings on the Company’s consolidated statements
of operations.
113
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table presents information regarding the Company’s residential whole loans held at fair value at December 31,
2018 and 2017:
(Dollars in Thousands)
Less than 60 Days Past Due:
Outstanding principal balance
Aggregate fair value
Weighted Average LTV Ratio (2)
Number of loans
60 Days to 89 Days Past Due:
Outstanding principal balance
Aggregate fair value
Weighted Average LTV Ratio (2)
Number of loans
90 Days or More Past Due:
Outstanding principal balance
Aggregate fair value
Weighted Average LTV Ratio (2)
Number of loans
Total Residential whole loans, at fair value
December 31, 2018 (1)
December 31, 2017
$
$
$
$
$
$
$
610,290
561,770
76.18%
2,898
63,938
54,947
82.86%
285
970,758
854,545
90.24%
3,531
1,471,262
$
$
$
$
$
$
$
488,600
446,616
74.98%
2,323
45,955
37,927
89.25%
207
1,027,818
840,572
94.50%
3,984
1,325,115
(1) Excluded from the table above are approximately $194.7 million of residential whole loans held at fair value for which the closing of the
purchase transaction had not occurred as of December 31, 2018.
(2) LTV represents the ratio of the total unpaid principal balance of the loan, to the estimated value of the collateral securing the related loan.
Excluded from the calculation of weighted average LTV are certain low value loans secured by vacant lots, for which the LTV ratio is not
meaningful.
The following table presents the components of Net gain on residential whole loans measured at fair value through earnings
for the years ended December 31, 2018, 2017 and 2016:
(In Thousands)
Coupon payments and other income received (1)
Net unrealized gains
Net gain on payoff/liquidation of loans
Net gain on transfers to REO
Total
For the Year Ended December 31,
2018
2017
2016
$
$
$
70,515
36,725
11,087
19,292
$
41,399
33,617
4,958
10,071
137,619
$
90,045
$
23,017
31,254
5,413
2,921
62,605
(1) Primarily includes recovery of delinquent interest upon the liquidation of non-performing loans, recurring coupon interest payments received
on mortgage loans that are contractually current, and cash payments received from private mortgage insurance on liquidated loans.
114
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
5. Other Assets
The following table presents the components of the Company’s Other assets at December 31, 2018 and 2017:
(In Thousands)
Securities obtained and pledged as collateral, at fair value
REO
MBS and loan related receivables
Other interest earning assets
Goodwill
Other
Total Other Assets
December 31, 2018
$
— $
December 31, 2017
504,062
249,413
127,154
92,022
7,189
52,007
$
527,785
$
152,356
54,640
—
7,189
23,983
742,230
(a) Securities Obtained and Pledged as Collateral/Obligation to Return Securities Obtained as Collateral
In connection with its financing strategy for Non-Agency MBS, in prior periods the Company obtained securities as collateral
under collateralized financing arrangements. Securities obtained as collateral in connection with these transactions are recorded
at fair value, with a liability, representing the obligation to return the collateral obtained, recorded in Other liabilities. While
beneficial ownership of securities obtained remains with the counterparty, the Company had the right to transfer the collateral
obtained or to pledge it as part of a subsequent collateralized financing transaction. During the year ended December 31, 2018,
these financing arrangements were unwound and the related securities obtained as collateral were returned to the counterparty.
(b) Real Estate Owned
During the years ended December 31, 2018 and 2017, the Company reclassified 1,078 and 698 mortgage loans, respectively
to REO at an aggregate estimated fair value less estimated selling costs of $215.0 million and $136.7 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, 2018, $242.0 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 $49.0 million of residential whole loans held at carrying
value and $720.1 million of residential whole loans held at fair value at December 31, 2018.
During the year ended December 31, 2018, the Company sold 705 REO properties for consideration of $123.2 million, realizing
net gains of approximately $7.7 million. 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. These
amounts are included in Other Income, 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, 2018 and 2017, an aggregate downward adjustment of approximately $15.9 million and
$11.0 million was recorded to reflect certain REO properties at the lower of cost or estimated fair value as of December 31, 2018
and 2017, respectively.
115
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table presents the activity in the Company’s REO for the years ended December 31, 2018 and 2017:
(Dollars 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
Number of properties
For the Year Ended December 31,
2018
2017
$
$
152,356
(15,929)
215,038
13,367
(115,419)
249,413
$
$
80,503
(11,018)
136,734
19,801
(73,664)
152,356
1,093
709
(1) Includes net gain recorded on transfer of approximately $19.6 million and $10.2 million, respectively, for the years ended December 31,
2018 and 2017.
(c) Derivative Instruments
The Company’s derivative instruments are currently comprised of Swaps, the majority of which are designated as cash flow
hedges against the interest rate risk associated with its borrowings. In addition, in connection with managing risks associated with
purchases of longer duration Agency MBS, the Company has also entered into Swaps that are not designated as hedges for
accounting purposes. The following table presents the fair value of the Company’s derivative instruments and their balance sheet
location at December 31, 2018 and 2017:
Derivative Instrument (1)
Designation
Balance Sheet
Location
Notional
Amount
Fair Value
Notional
Amount
Fair Value
December 31,
2018
2017
(In Thousands)
Swaps
Swaps
Swaps
Hedging
Hedging
Other assets
$ 1,900,000
Non-Hedging
Other liabilities
Other liabilities
$
$
722,000
595,000
$
$
$
— $
750,000
— $ 1,800,000
$
$
— $
— $
—
—
—
(1) Represents 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.
Swaps
The following table presents the assets pledged as collateral against the Company’s Swap contracts at December 31, 2018
and 2017:
(In Thousands)
Agency MBS, at fair value
Restricted cash
Total assets pledged against Swaps
December 31,
2018
2017
$
$
2,735
30,068
32,803
$
$
21,756
7,084
28,840
Swaps designated as hedges, 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
116
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
December 31, 2018, all of the Company’s derivatives that were designated in a hedging relationship were deemed effective for
hedging purposes.
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, 2018.
At December 31, 2018, the Company had Swaps with an aggregate notional amount of $3.2 billion and extended 32 months
on average with a maximum term of approximately 120 months.
The following table presents information about the Company’s Swaps at December 31, 2018 and 2017:
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
Over 60 months to 72 months
Over 72 months to 84 months
Over 84 months
$
Notional
Amount
—
100,000
100,000
—
1,630,000
822,000
—
395,000
—
—
170,000
December 31, 2018
December 31, 2017
Weighted
Average
Fixed-Pay
Interest Rate
Weighted
Average
Variable
Interest Rate (2)
—%
—% $
1.71
1.71
—
2.27
2.57
—
2.88
—
—
3.00
2.50
2.50
—
2.50
2.64
—
2.63
—
—
2.66
Notional
Amount
—
—
50,000
500,000
200,000
1,500,000
200,000
—
100,000
—
—
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
—
—
Total Swaps
$ 3,217,000
2.42%
2.56% $ 2,550,000
2.04%
1.50%
(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.
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, 2018, 2017 and 2016:
(Dollars in Thousands)
Interest expense attributable to Swaps
Weighted average Swap rate paid
Weighted average Swap rate received
For the Year Ended December 31,
2018
$
3,780
$
2017
24,524
$
2016
40,898
2.12%
1.96%
1.98%
1.07%
1.82%
0.48%
During the year ended December 31, 2018, the Company recorded net losses on Swaps not designated in hedging relationships
of $9.6 million. This amount is included in Other income, net on the Company’s consolidated statements of operations. All of
the Company’s Swaps were designated in hedging relationships during the years ended December 31, 2017 and 2016.
117
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
Impact of Derivative Hedging Instruments on AOCI
The following table presents the impact of the Company’s derivative hedging instruments on its AOCI for the years ended
December 31, 2018, 2017 and 2016:
(In Thousands)
AOCI from derivative hedging instruments:
Balance at beginning of period
Net gain on Swaps
Balance at end of period
6.
Repurchase Agreements
For the Year Ended December 31,
2018
2017
2016
$
$
(11,424) $
14,545
3,121
$
(46,721) $
35,297
(11,424) $
(69,399)
22,678
(46,721)
The Company’s repurchase agreements are accounted for as secured borrowings and bear interest that is generally LIBOR-
based. (See Notes 2(k) and 7) At December 31, 2018, the Company’s borrowings under repurchase agreements had a weighted
average remaining term-to-interest rate reset of 31 days and an effective repricing period of 8 months, including the impact of
related Swaps. 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.
118
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table presents information with respect to the Company’s borrowings under repurchase agreements and
associated assets pledged as collateral at December 31, 2018 and 2017:
(Dollars in Thousands)
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)
December 31,
2018
$ 2,384,357
December 31,
2017
$ 2,501,340
$ 2,572,597
$ 2,705,754
4.60%
4.65%
Repurchase agreement borrowings secured by Legacy Non-Agency MBS
$ 1,447,585
$ 1,256,033
Fair value of Legacy Non-Agency MBS pledged as collateral under repurchase agreements
$ 1,817,650
$ 1,652,983
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 residential whole loans (2)
Fair value of residential whole loans pledged as collateral under repurchase agreements (3)(4)
Weighted average haircut on residential whole loans (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 other interest-earning assets
Fair value of other interest-earning assets pledged as collateral under repurchase agreements
Weighted average haircut on other interest-earning assets (1)
21.38%
21.87%
$ 1,084,532
$ 1,377,250
$
$
567,140
726,540
$
$
$
$
21.31%
22.05%
— $
470,334
— $
472,095
—%
1.47%
391,586
480,315
$
$
459,058
595,900
20.01%
22.16%
$ 2,020,508
$ 2,441,931
$ 1,043,747
$ 1,474,704
$
$
$
$
16.55%
26.10%
474,127
611,807
21.88%
76,419
81,494
21.15%
$
$
$
$
317,255
482,158
33.19%
—
—
—%
(1) Haircut represents the percentage amount by which the collateral value is contractually required to exceed the loan amount.
(2) Excludes $27,000 and $206,000 of unamortized debt issuance costs at December 31, 2018 and 2017, respectively.
(3) At December 31, 2018 includes Non-Agency MBS with an aggregate fair value of $27.0 million obtained in connection with the Company’s
loan securitization transactions that are eliminated in consolidation.
(4) At December 31, 2018 and 2017, includes residential whole loans held at carrying value with an aggregate fair value of $1.7 billion and
$478.5 million and aggregate amortized cost of $1.6 billion and $448.7 million, respectively and residential whole loans held at fair value
with an aggregate fair value and amortized cost of $738.6 million and $996.2 million, respectively.
In addition, the Company had cash pledged as collateral in connection with it’s repurchase agreements of $6.7 million and
$6.9 million at December 31, 2018 and 2017, respectively.
119
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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, 2018 and 2017:
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, 2018
December 31, 2017
Balance
Weighted
Average
Interest Rate
Balance
Weighted
Average
Interest Rate
$
6,747,166
368,857
763,091
3.35% $
3.10
4.18
6,161,008
453,899
—
$
7,879,114
3.42% $
6,614,907
27
206
$
7,879,087
$
6,614,701
2.39%
2.76
—
2.42%
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, 2018 and does not reflect the impact of derivative contracts
that hedge such repurchase agreements:
December 31, 2018
Contractual Maturity
(Dollars in Thousands)
Agency MBS
Legacy Non-Agency MBS
RPL/NPL MBS
CRT securities
Residential whole loans
MSR-related assets
Other
Total (1)
Overnight
Within 30 Days
Over 30 Days
to 3 Months
Over 3 Months
to 12 Months
Over 12
months
Total
$
— $ 2,152,612
$
231,745
$
— $
—
—
—
—
—
—
1,402,625
1,081,192
385,597
911,445
342,227
5,850
44,960
3,340
5,989
198,665
131,900
—
—
—
—
910,398
—
70,569
— $ 2,384,357
—
1,447,585
—
—
—
—
—
1,084,532
391,586
2,020,508
474,127
76,419
$
— $ 6,281,548
$
616,599
$
980,967
$
— $ 7,879,114
Weighted Average Interest Rate
—%
3.31%
3.41%
4.18%
—%
3.42%
(1) Excludes $27,000 of unamortized debt issuance costs at December 31, 2018.
Undrawn Financing Commitment
In connection with the financing of MSR-related assets, the Company has obtained a financing commitment of up to $75.0
million, of which $55.0 million was utilized and was outstanding as of December 31, 2018. The Company pays a commitment
fee ranging from 0.125% to 0.5% of the undrawn amount, depending on the amount of financing utilized.
120
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The Company had repurchase agreement borrowings with 26 and 31 counterparties at December 31, 2018 and 2017,
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, 2018:
Counterparty
(Dollars in Thousands)
Goldman Sachs (3)
RBC (4)
Wells Fargo (5)
Barclay's Bank
December 31, 2018
Counterparty
Rating (1)
Amount at
Risk (2)
Weighted
Average Months
to Maturity for
Repurchase
Agreements
Percent of
Stockholders’
Equity
BBB+/A3/A $
AA-/Aa2/AA
A+/Aa2/AA-
BBB/Aa3/A
319,685
251,802
188,901
174,998
1
1
2
4
9.4%
7.4
5.5
5.1
(1) As rated at December 31, 2018 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 $190.4 million at risk with Goldman Sachs Bank USA and $129.3 million at risk with Goldman Sachs Lending Partners.
(4) Includes $248.4 million at risk with RBC Barbados and $3.4 million at risk with RBC New York. Counterparty ratings are not published for
RBC Barbados and RBS Capital Market LLC.
(5) Includes $187.6 million at risk with Wells Fargo Bank, NA and $1.3 million at risk with Wells Fargo Securities LLC.
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.
The Company’s assets pledged as collateral are described in Notes 2(f) - Restricted Cash, 5(c) - Derivative Instruments and
6 - Repurchase Agreements. The total fair value of assets pledged as collateral with respect to the Company’s borrowings under
repurchase agreements and derivative hedging instruments was $9.4 billion and $8.1 billion at December 31, 2018 and 2017,
respectively. An aggregate of $33.1 million and $19.6 million of accrued interest on those assets had also been pledged as of
December 31, 2018 and 2017, respectively. In addition, at December 31, 2017, $688.1 million of Legacy Non-Agency MBS
were pledged as collateral and $504.1 million of U.S. Treasury securities were held as collateral in connection with
contemporaneous repurchase and reverse repurchase agreements entered into with a single counterparty.
121
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
8. Offsetting Assets and Liabilities
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. In
the Company’s consolidated balance sheets, all balances associated with repurchase agreements are presented on a gross basis.
The fair value of financial instruments pledged against the Company’s repurchase agreements was $9.4 billion and $8.1
billion at December 31, 2018 and 2017, 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. The fair value of financial instruments pledged against the Company’s Swaps was $2.7
million and $21.8 million at December 31, 2018 and 2017, respectively. In addition, cash that has been pledged as collateral
against repurchase agreements and Swaps is reported as Restricted cash on the Company’s consolidated balance sheets. (See Notes
2(f), 5(c) and 6)
9. Other Liabilities
The following table presents the components of the Company’s Other liabilities at December 31, 2018 and 2017:
(In Thousands)
Securitized debt (1)
Obligation to return securities held as collateral, at fair value
Senior Notes
Dividends and dividend equivalents payable
Accrued interest payable
Payable for unsettled residential whole loans purchases
Accrued expenses and other
Total Other Liabilities
December 31, 2018
684,420
$
December 31, 2017
363,944
$
—
96,816
90,198
16,280
211,129
26,296
504,062
96,773
79,771
12,263
—
21,584
$
1,125,139
$
1,078,397
(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.)
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, 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 and other financing arrangements, to the extent of the value
of the collateral securing such indebtedness.
122
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
10. Commitments and Contingencies
(a) Lease Commitments
The Company currently pays monthly rent pursuant to two office leases. In November 2018, the Company amended the
lease for its corporate headquarters in New York, New York, under the same terms and conditions, to extend the expiration date
for the lease by up to one year, through June 30, 2021. For the year ended December 31, 2018, the Company recorded an expense
of approximately $2.7 million in connection with lease rental for its current corporate headquarters. 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.
In addition, in November 2018, the Company executed a lease agreement on new office space in New York, New York. The
Company plans to relocate its corporate headquarters to this new office space upon the substantial completion of the building. The
changes and growth the Company has experienced over the past several years has resulted in an increase in its space requirements
in the ten year period since its previous office lease was entered into. Accordingly, the new lease is for approximately 50% more
space than the Company’s current corporate headquarters. The lease term specified in the agreement is fifteen years with an option
to renew for an additional five years. The Company’s current estimate of annual lease rental expense under the new lease, excluding
escalation charges which at this point are unknown, is approximately $4.6 million. The Company currently expects to relocate to
the space in the fourth fiscal quarter of 2020, but this timing as well as when it is required to begin making payments and recognize
rental and other expenses under new lease, is dependent on when the building is actually available for use.
The Company recognized lease expense of $2.7 million, $2.7 million and $2.5 million for the years ended December 31,
2018, 2017 and 2016, respectively, which is included in Other general and administrative expense within the consolidated statements
of operations. At December 31, 2018, 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 (1)
(In Thousands)
2019
2020
2021
2022
2023
Thereafter
Total
$
$
2,553
2,553
1,292
—
—
—
6,398
(1) Table excludes amounts related to the lease agreement for new office space discussed above as the Company is not contractually obligated
to make rental payments until fourteen months after a temporary certificate of occupancy is delivered to the landlord, which is currently
expected to occur on or before October 2020.
(b) Representations and Warranties in Connection with Loan Securitization Transactions
In connection with the loan securitization transactions entered into by the Company 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, 2018, 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. (See Note 15)
(c) Corporate Loan
The Company has participated in a loan to provide financing to an entity that originates loans and owns MSRs, as well as
certain other unencumbered assets owned by the borrower. Under the terms of the participation agreement, the Company has
committed to lend $100.0 million of which approximately $73.3 million was drawn at December 31, 2018. (See Note 3)
123
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
(d) Rehabilitation Loan Commitments
At December 31, 2018, the Company had unfunded commitments of $49.8 million in connection with its purchased
Rehabilitation loans. (See Note 4)
(e) Residential Whole Loan Purchase Commitments
At December 31, 2018, the Company has agreed, subject to the completion of due diligence and customary closing conditions,
to purchase residential whole loans with an aggregate estimated purchase price of $211.1 million, of which $194.7 million is
presented in residential whole loans held at fair value and $16.4 million in other loans held at carrying value with a corresponding
liability recorded in Other liabilities and included in Payable for unsettled residential whole loan purchases.
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.
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, 2016
through December 31, 2018:
Year
2018
Declaration Date
November 26, 2018
August 20, 2018
Record Date
Payment Date
December 7, 2018
September 7, 2018
December 28, 2018
September 28, 2018
Dividend Per Share
$0.46875
0.46875
May 17, 2018
June 4, 2018
February 20, 2018
March 2, 2018
June 29, 2018
March 30, 2018
2017
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
2016
November 22, 2016
December 6, 2016
December 30, 2016
August 12, 2016
May 18, 2016
September 2, 2016
June 3, 2016
September 30, 2016
June 30, 2016
February 12, 2016
February 29, 2016
March 31, 2016
0.46875
0.46875
$0.46875
0.46875
0.46875
0.46875
$0.46875
0.46875
0.46875
0.46875
124
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
(b) Dividends on Common Stock
The following table presents cash dividends declared by the Company on its common stock from January 1, 2016 through
December 31, 2018:
Year
2018
Declaration Date
December 12, 2018
September 13, 2018
June 7, 2018
March 7, 2018
Record Date
December 28, 2018
October 1, 2018
June 29, 2018
March 29, 2018
Payment Date
January 31, 2019
October 31, 2018
July 31, 2018
April 30, 2018
2017
December 13, 2017
December 28, 2017
January 31, 2018
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
Dividend Per Share
$0.20
0.20
(1)
0.20
0.20
$0.20
0.20
0.20
0.20
$0.20
0.20
0.20
0.20
(1) At December 31, 2018, the Company had accrued dividends and dividend equivalents payable of $90.2 million related to the common stock
dividend declared on December 12, 2018.
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, 2018, 2017 and 2016, the portions of the Company’s common stock
dividends that were deemed to be capital gains were $0.1290, $0.0831 and $0.0361 per share of common stock, respectively.
(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 years ended December 31, 2018 and 2017.
Share Issue Date
Shares Issued
Gross Proceeds
Per Share
Gross Proceeds
(In Thousands, Except Per Share Amounts)
August 7, 2018
May 10, 2017
50,875 (1) $
$
23,000
7.78
7.85
$
$
395,807 (1)
180,550 (2)
(1) Includes approximately 875,000 shares issued on September 5, 2018 pursuant to the exercise of the underwriters’ option to purchase additional
shares. The Company incurred approximately $6.4 million of underwriting discounts and related expenses in connection with this equity
offering.
(2) The Company incurred approximately $2.3 million of underwriting discounts and related expenses in connection with this equity offering.
125
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
(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, 2018, approximately 11.8 million shares of common stock remained available for
issuance pursuant to the DRSPP shelf registration statement.
During the years ended December 31, 2018, 2017 and 2016, the Company issued 379,903, 2,293,192 and 653,793 shares of
common stock through the DRSPP, raising net proceeds of approximately $2.8 million, $18.5 million and $1.2 million, respectively.
From the inception of the DRSPP in September 2003 through December 31, 2018, the Company issued 34,055,880 shares pursuant
to the DRSPP, raising net proceeds of $284.2 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, 2018. At December 31, 2018, 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, 2018, 2017 and 2016:
Net
Unrealized
Gain/
(Loss) on
AFS
Securities
2018
Net
Gain/
(Loss)
on Swaps
Total
AOCI
For the Year Ended December 31,
Net
Unrealized
Gain/
(Loss) on
AFS
Securities
2017
Net
Gain/
(Loss)
on Swaps
Net
Unrealized
Gain/
(Loss) on
AFS
Securities
2016
Net
Gain/
(Loss)
on Swaps
Total
AOCI
Total
AOCI
(In Thousands)
Balance at beginning of period
$ 620,648
$ (11,424) $609,224
$ 620,403
$ (46,721) $573,682
$ 585,250
$ (69,399) $515,851
OCI before reclassifications
(150,642)
14,545
(136,097)
39,984
35,297
75,281
72,560
22,678
95,238
Amounts reclassified from
AOCI (1)
(52,839)
— (52,839)
(39,739)
— (39,739)
(37,407)
— (37,407)
Net OCI during period (2)
(203,481)
14,545
(188,936)
245
35,297
35,542
35,153
22,678
57,831
Balance at end of period
$ 417,167
$
3,121
$420,288
$ 620,648
$ (11,424) $609,224
$ 620,403
$ (46,721) $573,682
(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).
126
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table presents information about the significant amounts reclassified out of the Company’s AOCI for the years
ended December 31, 2018, 2017, and 2016:
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,
2018
2017
2016
(In Thousands)
AFS Securities:
Realized gain on sale of securities
OTTI recognized in earnings
Total AFS Securities
Total reclassifications for period
$
$
$
(51,580) $
(38,707) $
(36,922)
Net realized gain on sales of
residential mortgage
securities
(1,259)
(52,839) $
(52,839) $
(1,032)
(39,739) $
(39,739) $
(485) Other, net
(37,407)
(37,407)
On securities for which OTTI had been recognized in prior periods, the Company had $224,000 unrealized losses recorded
in AOCI at December 31, 2018 and did not have any unrealized losses recorded in AOCI at December 31, 2017.
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, 2018, 2017 and 2016:
(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 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,
2018
2017
2016
301,801
(15,000)
(1,864)
284,937
$
$
322,393
(15,000)
(1,708)
305,685
$
$
312,668
(15,000)
(1,628)
296,040
418,934
388,357
371,122
0.68
$
0.79
$
0.80
$
$
$
(1) At December 31, 2018, the Company had approximately 2.1 million equity instruments outstanding that were not included in the calculation
of diluted EPS for the year ended December 31, 2018, 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 $6.78. 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.
127
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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,
2018, approximately 5.2 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, 2018 are designated to be settled in shares of the Company’s common stock. All RSUs outstanding at
December 31, 2018 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, 2018 and 2017, the Company had unrecognized compensation expense of
$5.2 million and $4.1 million, respectively, related to RSUs. The unrecognized compensation expense at December 31, 2018 is
expected to be recognized over a weighted average period of 1.7 years.
128
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table presents information with respect to the Company’s RSUs during the years ended December 31, 2018,
2017 and 2016:
Weighted
Average
Grant Date
Fair Value
7.67
$
Outstanding at beginning of year:
Granted (1)
Settled
Cancelled/forfeited
RSUs With
Service
Condition
1,025,028
428,802
(237,384)
(10,000)
Outstanding at end of year
1,206,446
RSUs vested but not settled at
end of year
RSUs unvested at end of year
708,946
497,500
$
$
$
Weighted
Average
Grant Date
Fair Value
7.38
$
Outstanding at beginning of year:
Granted (2)
Settled
Cancelled/forfeited
RSUs With
Service
Condition
1,194,299
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
$
$
$
Weighted
Average
Grant Date
Fair Value
7.71
$
Outstanding at beginning of year:
Granted (3)
Settled
Cancelled/forfeited
RSUs With
Service
Condition
1,138,930
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
$
$
$
For the Year Ended December 31, 2018
RSUs With
Market and
Service
Conditions
1,021,250
415,000
(275,000)
(10,000)
1,151,250
290,000
861,250
Weighted
Average
Grant Date
Fair Value
5.80
$
6.91
5.73
5.64
6.21
4.81
6.69
$
$
$
For the Year Ended December 31, 2017
RSUs With
Market and
Service
Conditions
863,800
451,250
(293,800)
—
1,021,250
275,000
746,250
Weighted
Average
Grant Date
Fair Value
5.45
$
6.48
5.83
—
5.80
5.73
5.82
$
$
$
For the Year Ended December 31, 2016
RSUs With
Market and
Service
Conditions
736,800
307,500
(175,500)
(5,000)
863,800
293,800
570,000
Weighted
Average
Grant Date
Fair Value
5.66
$
4.81
5.21
5.27
5.45
5.83
5.25
$
$
$
Total
RSUs
2,046,278
843,802
(512,384)
(20,000)
2,357,696
998,946
1,358,750
Total
RSUs
2,058,099
898,945
(910,766)
—
2,046,278
861,419
1,184,859
Total
RSUs
1,875,730
728,195
(535,826)
(10,000)
2,058,099
911,318
1,146,781
Total
Weighted
Average
Grant Date
Fair Value
6.73
$
7.29
6.86
6.44
6.90
6.70
7.06
$
$
$
Total
Weighted
Average
Grant Date
Fair Value
6.57
$
7.22
6.84
—
6.73
7.26
6.35
$
$
$
Total
Weighted
Average
Grant Date
Fair Value
6.90
$
5.96
6.92
6.29
6.57
6.93
6.28
$
$
$
7.65
8.17
7.23
7.57
7.47
7.71
7.96
7.32
—
7.67
7.98
7.25
6.81
7.75
7.32
7.38
7.45
7.30
(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 692,500 of these awards granted in 2018, the Company applied: (i) a weighted average volatility estimate of approximately
17%, 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 2.36% based on the continuously compounded
129
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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 151,302 awards with a service condition only was estimated based on the closing price of
the Company’s common stock at the grant date of $7.70. 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 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 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
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.
(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 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.
Restricted Stock
At December 31, 2018 and 2017, the Company did not have any unvested shares of restricted common stock outstanding.
The total fair value of restricted shares vested during the years ended December 31, 2018, 2017 and 2016 was approximately $3.0
million, $2.0 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,
2018, 2017 and 2016:
For the Year Ended December 31,
2018
2017
2016
Outstanding at beginning of year:
Granted
Vested (2)
Cancelled/forfeited
450,193
(450,193)
—
Shares of
Restricted
Stock
Weighted
Average
Grant Date
Fair Value (1)
—
— $
Shares of
Restricted
Stock
28,968
214,859
(243,827)
—
Weighted
Average
Grant Date
Fair Value (1)
7.12
$
Shares of
Restricted
Stock
110,920
Weighted
Average
Grant Date
Fair Value (1)
7.41
$
8.06
7.95
—
—
487,216
(567,851)
(1,317)
28,968
$
7.66
7.64
7.12
7.12
6.74
6.74
—
—
Outstanding at end of year
— $
— $
(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 years ended December 31, 2018 and 2017 and made payments of
approximately $5,000 during the year ended December 31, 2016.
130
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table presents information about the Company’s dividend equivalents rights awarded as separate instruments
at and for the year ended December 31, 2016. No such awards were granted during 2018 and 2017:
Outstanding at beginning of year:
Granted
Cancelled, forfeited or expired
Outstanding at end of year
For the Year Ended December 31, 2016
Number of Dividend Equivalent Rights
8,215
—
(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%.
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, 2018, 2017 and 2016:
(In Thousands)
RSUs (1)
Restricted shares of common stock
Dividend equivalent rights
Total
For the Year Ended December 31,
2018
2017
2016
$
$
4,974
3,033
—
8,007
$
$
6,098
1,935
—
8,033
$
$
4,792
4,326
44
9,162
(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, 2018, the Company had employment agreements with four 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.
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.
131
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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 the years ended
December 31, 2018, 2017 and 2016:
(In Thousands)
Non-employee directors
Total
For the Year Ended December 31,
2017
2016
2018
$
$
(165) $
(165) $
171
171
$
$
231
231
The Company distributed cash of $123,700 to the participants of the Deferred Plans during the year ended December 31,
2018. 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 to the participants of the Deferred Plans during the year ended December 31, 2016.
The following table presents the aggregate amount of income deferred by participants of the Deferred Plans through December 31,
2018 and 2017 that had not been distributed and the Company’s associated liability for such deferrals at December 31, 2018 and
2017:
(In Thousands)
Non-employee directors
Total
December 31, 2018
December 31, 2017
Undistributed
Income
Deferred (1)
$
$
2,263
2,263
Liability Under
Deferred Plans
2,417
$
2,417
$
$
$
Undistributed
Income
Deferred (1)
1,688
1,688
Liability Under
Deferred Plans
2,056
$
2,056
$
(1) Represents the cumulative amounts that were deferred by participants through December 31, 2018 and 2017, 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,
2018, 2017 and 2016, the Company recognized expenses for matching contributions of $371,000, $363,000 and $359,000,
respectively.
132
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
14. Fair Value of Financial Instruments
GAAP requires the categorization of fair value measurements into three broad levels that form a hierarchy. 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.
Residential Mortgage 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 the Company’s 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.
133
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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 that specializes in providing valuations of residential mortgage loans. The valuation approach applied generally
depends on whether the loan is considered performing or non-performing at the date the valuation is performed. For performing
loans, estimates of fair value are derived using a discounted cash flow approach, where estimates of cash flows are determined from
the scheduled payments, adjusted using forecasted prepayment, default and loss given default rates. For non-performing loans,
asset liquidation cash flows are derived based on the estimated time to liquidate the loan, expected costs and home price appreciation.
Estimated cash flows for both performing and non-performing loans are discounted at yields considered appropriate to arrive at a
reasonable exit price for the asset. Indications of loan value such as actual trades, bids, offers and generic market color may be
used in determining the appropriate discount yield. The Company’s residential whole loans held at fair value are classified as Level
3 in the fair value hierarchy.
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
obtaining market quotes from a third-party pricing service. 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, as applicable, 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. As this process includes
significant unobservable inputs, due to the relative illiquidity of the market, these securities are classified as Level 3 in the fair value
hierarchy.
Swaps
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 the 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.
134
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following tables present the Company’s financial instruments carried at fair value on a recurring basis as of
December 31, 2018 and 2017, on the consolidated balance sheets by the valuation hierarchy, as previously described:
Fair Value at December 31, 2018
(In Thousands)
Assets:
Agency MBS
Non-Agency MBS
CRT securities
Residential whole loans, at fair value
Term notes backed by MSR-related collateral
Securities obtained and pledged as collateral
Total assets carried at fair value
Liabilities:
Obligation to return securities obtained as collateral
Total liabilities carried at fair value
Level 1
Level 2
Level 3
Total
$
$
$
— $
2,698,213
$
— $
2,698,213
—
—
—
—
—
3,318,299
492,821
—
—
—
—
—
1,665,978
538,499
—
3,318,299
492,821
1,665,978
538,499
—
— $
6,509,333
$
2,204,477
$
8,713,810
—
— $
—
— $
—
— $
—
—
Fair Value at December 31, 2017
(In Thousands)
Assets:
Agency MBS
Non-Agency MBS, including MBS transferred to
consolidated VIEs
CRT securities
Residential whole loans, at fair value
Term notes backed by MSR-related collateral
Securities obtained and pledged as collateral
Total assets carried at fair value
Liabilities:
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
504,062
504,062
504,062
$
$
$
$
3,533,966
664,403
—
—
—
7,023,050
$
—
—
1,325,115
381,804
—
1,706,919
$
3,533,966
664,403
1,325,115
381,804
504,062
9,234,031
—
— $
—
— $
504,062
504,062
135
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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, 2018 and 2017 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 measured at fair value through earnings
Collection of principal, net of liquidation gains/losses
Repurchases
Transfer to REO
Balance at end of period
Residential Whole Loans, at Fair Value
For the Year Ended December 31,
2018 (1)
2017
$
1,325,115
$
500,004
36,725
(199,203)
(1,807)
(189,571)
1,471,263
$
$
814,682
683,735
33,617
(87,072)
(2,716)
(117,131)
1,325,115
(1) Excluded from the table above are approximately $194.7 million of residential whole loans held at fair value for which the closing of the
purchase transaction had not occurred as of December 31, 2018.
The following table presents additional information for the years ended December 31, 2018 and 2017 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,
2018
2017 (1)
$
$
$
381,804
548,404
(390,898)
(811)
—
538,499
—
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 had 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, 2018.
136
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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, 2018 and 2017:
(Dollars in Thousands)
Fair Value (1)
Valuation Technique
Unobservable Input
Weighted
Average (2)
Range
December 31, 2018
Residential whole loans, at
fair value
$
700,250 Discounted cash flow
Discount rate
Prepayment rate
Default rate
Loss severity
$
683,252 Liquidation model
Discount rate
Annual change in home
prices
Liquidation timeline (in
years)
Current value of
5.2%
4.8%
4.1%
12.9%
8.0%
3.5%
1.8
4.5-8.0%
0.9-15.9%
0.0-24.1%
0.0-100.0%
6.1-50.0%
(0.5)-12.2%
0.1-4.5
Total
$
1,383,502
underlying properties (3)
$
802
$2-$7,950
(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)
Current value of
underlying properties (3)
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
$
772
$0-$9,900
Total
$
951,811
(1) Excludes approximately $282.5 million and $373.3 million of loans for which management considers the purchase price continues to reflect
the fair value of such loans at December 31, 2018 and 2017, 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
$400,000 and $336,000 as of December 31, 2018 and 2017, respectively.
137
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table presents the carrying values and estimated fair values of the Company’s financial instruments at
December 31, 2018 and 2017:
(In Thousands)
Financial Assets:
Agency MBS
Non-Agency MBS
CRT securities
Residential whole loans, at carrying value
Residential whole loans, at fair value
MSR-related assets
Securities obtained and pledged as collateral
Cash and cash equivalents
Restricted cash
Financial Liabilities (1):
Repurchase agreements
Securitized debt
Obligation to return securities obtained as collateral
Senior Notes
December 31, 2018
December 31, 2017
Carrying
Value
Estimated
Fair Value
Carrying
Value
Estimated
Fair Value
$
2,698,213
$
2,698,213
$
2,824,681
$
2,824,681
3,318,299
492,821
3,016,715
1,665,978
611,807
—
51,965
36,744
7,879,087
684,420
—
96,816
3,318,299
492,821
3,104,401
1,665,978
611,807
—
51,965
36,744
7,896,672
680,209
—
99,951
3,533,966
3,533,966
664,403
908,516
664,403
988,688
1,325,115
1,325,115
492,080
504,062
449,757
13,986
6,614,701
363,944
504,062
96,773
493,026
504,062
449,757
13,986
6,623,255
366,109
504,062
103,729
(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 133-137, 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 generally determines the fair value of its residential whole loans
held at carrying value using the same approach applied for residential whole loans held at fair value. Given the short duration of
the Company’s Rehabilitation loans, these investments are determined to have a carrying value which approximates fair value. The
Company’s residential whole loans held at carrying value are classified as Level 3 in the fair value hierarchy.
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, 2018 and 2017, 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 and are classified
as Level 1 in the fair value hierarchy.
Corporate Loans: The Company determines the fair value of its Corporate loans, included in MSR-related assets along with
the term notes, 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 Corporate loans are 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.
138
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
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,
2018 and 2017, the Company’s REO had an aggregate carrying value of $249.4 million and $152.4 million, and an aggregate
estimated fair value of $273.4 million and $175.8 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 these transactions. See Note 2(r) for a discussion of the accounting policies applied to the consolidation
of VIEs and transfers of financial assets in connection with financing transactions.
The Company has engaged in loan securitizations and, in prior years, 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.
Loan Securitization Transactions
During the year ended December 31, 2018, the Company completed two loan securitization transactions. As part of these
transactions, the Company sold residential whole loans with an aggregate unpaid principal balance of $666.8 million to two entities
which it consolidates as VIEs. In connection with these transactions, third-party investors purchased $420.0 million face amount
of senior bonds (“Senior Bonds”) with a weighted average coupon rate of 4.04%. As a result of these transactions, the Company
acquired $148.1 million face amount of non-rated certificates issued by the securitization vehicles, and received $420.0 million
in cash, excluding expenses, accrued interest, and underwriting fees.
139
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
The following table summarizes the key details of the Company’s loan securitization transactions as of December 31, 2018
and 2017:
(Dollars in Thousands)
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
Weighted average fixed rate for Senior Bonds issued
Weighted average contractual maturity of Senior Bonds
Face amount of Senior Support Certificates received by the Company (3)
Cash received
$
$
$
$
$
December 2018
December 2017
1,290,029
$
620,924
802,817
684,420
$
(1) $
3.66% (2)
31 years (2)
275,174
802,815
$
$
382,847
363,944
(1)
3.14% (2)
32 years (2)
127,001
382,845
(1) Net of $3.8 million and $2.3 million of deferred financing costs at December 31, 2018 and 2017, respectively.
(2) At December 31, 2018 and 2017, $582.8 million and $233.7 million, respectively, of Senior Bonds sold in securitization transactions contained
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.
(3) Provides credit support to the Senior Bonds sold to third-party investors in the securitization transactions.
As of December 31, 2018 and 2017, as a result of the transactions described above, securitized loans with a carrying value
of approximately $209.4 million and $183.2 million are included in “Residential whole loans, at carrying value,” securitized loans
with a fair value of approximately $694.7 million and $289.3 million are included in “Residential whole loans, at fair value,” and
REO with a carrying value of approximately $79.0 million and $5.5 million are included in “Other assets” on the Company’s
consolidated balance sheets. As of December 31, 2018 and 2017, the aggregate carrying value of Senior Bonds issued by
consolidated VIEs was $684.4 million and $363.9 million , respectively. 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 with respect 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.
The Company concluded that the entities created to facilitate the loan securitization transactions are VIEs. The Company
then completed an analysis of whether each VIE created to facilitate the securitization 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 the loan securitization transactions.
Residential Whole Loans and REO (including Residential Whole Loans and REO transferred to consolidated VIEs)
Included on the Company’s consolidated balance sheets as of December 31, 2018 and 2017 are a total of $4.7 billion and
$2.2 billion of residential whole loans, of which approximately $3.0 billion and $908.5 million are reported at carrying value and
$1.7 billion and $1.3 billion are reported at fair value, respectively. In addition, at December 31, 2018 and 2017, the Company
had REO with an aggregate carrying value of $249.4 million and $152.4 million, and an aggregate estimated fair value $273.4
million and $175.8 million, respectively. These assets are directly owned by certain trusts established by the Company to acquire
the loans and entities established in connection with the Company’s loan securitization transactions. The Company has assessed
that these entities are required to be consolidated. (See Notes 4 and 5(b))
140
MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018
16. Summary of Quarterly Results of Operations (Unaudited)
(In Thousands, Except per Share Amounts)
Interest income
Interest expense
Net interest income
Net gain on residential whole loans measured at fair
value through earnings
Net realized gain on sales of residential mortgage
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 gain on residential whole loans measured at fair
value through earnings
Net realized gain on sales of residential mortgage
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
$
$
$
$
2018 Quarter Ended
March 31
June 30
September 30
December 31
$
103,752
(50,554)
53,198
$
101,747
(51,810)
49,937
$
117,432
(58,878)
58,554
132,744
(70,944)
61,800
38,498
32,443
34,942
31,736
8,817
345
(17,463)
83,395
(3,750)
7,429
1,134
(20,548)
70,395
(3,750)
16,415
(2,998)
(19,781)
87,132
(3,750)
28,646
(39,432)
(21,871)
60,879
(3,750)
79,645
0.20
$
$
66,645
0.17
$
$
83,382
0.19
$
$
57,129
0.13
2017 Quarter Ended
March 31
June 30
September 30
December 31
$
117,257
(50,349)
66,908
$
110,157
(49,022)
61,135
$
105,133
(49,275)
55,858
100,901
(48,495)
52,406
13,773
16,208
18,679
41,385
9,708
4,098
(16,427)
78,060
(3,750)
5,889
14,229
(17,526)
79,935
(3,750)
14,933
(4,515)
(21,150)
63,805
(3,750)
9,047
14,553
(16,798)
100,593
(3,750)
$
$
74,310
0.20
$
$
76,185
0.20
$
$
60,055
0.15
$
$
96,843
0.24
141
Schedule IV - Mortgage Loans on Real Estate
December 31, 2018
Asset Type
(Dollars in Thousands)
Residential Whole Loans, at Carrying
Value (1)
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 (1)
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
3,360
3,781
2,205
1,766
11,112
2,172
2,280
1,515
0.00% - 13.08%
9/1/2016-8/25/2058
$
272,407
$
0.00% - 11.00%
8/1/2018-11/1/2064
1.30% - 11.13%
10/1/2018-5/1/2062
679,899
704,255
1.30% - 9.50%
6/19/2018-1/1/2059
1,343,740
$ 3,000,301
0.00% - 14.99% 6/1/2009-11/25/2058
$
165,419
$
$
1.00% - 12.38%
7/1/2009-10/1/2058
0.00% - 10.80%
1/1/2015-11/1/2058
392,509
461,389
451,945
$ 1,471,262
$
16,726
42,262
39,720
23,946
122,654
92,672
243,609
304,731
329,746
970,758
Original loan balance greater than $449,999
747
1.63% - 10.20%
9/1/2013-7/1/2058
6,714
17,826
$ 4,471,563 (2) $
1,093,412
(1) Excluded from the table above are approximately $16.4 million of purchased performing loans held at carrying value and $194.7 million of
residential whole loans held at fair value for which the closing of the purchase transaction had not occurred as of December 31, 2018.
(2) The federal income tax basis is approximately $4.3 billion.
142
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, 2018:
(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
measured at fair value through earnings
Provision for loan loss
Repurchases
Transfer to REO
Ending Balance
For the Year Ended December 31, 2018
Residential Whole Loans, at
Carrying Value
Residential Whole Loans, at
Fair Value
$
908,516
$
1,325,115
2,467,398
4,741
(355,413)
N/A
(638)
(1,597)
(6,292)
$
3,016,715
$
741,113
N/A
(199,203)
36,725
N/A
(1,807)
(189,571)
1,712,372
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, 2018, 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, 2018. 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
143
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, 2018. 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, 2018, 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.
(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 2018 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, 2018, 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, 2018, 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, 2018 and 2017, 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, 2018, and the related notes and Schedule IV - Mortgage Loans on Real Estate
(collectively, the consolidated financial statements), and our report dated February 21, 2019 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 21, 2019
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 2019 (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 22, 2019. 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 “Overview” 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 83 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, 2018.
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.
SPECIAL NOTE REGARDING EXHIBITS
In reviewing the agreements included as exhibits to this Annual Report on Form 10-K, please remember they are included to
provide you with information regarding their terms and are not intended to provide any other factual or disclosure information
about the Company or the other parties to the agreements. The agreements contain representations and warranties by each of the
parties to the applicable agreement. These representations and warranties have been made solely for the benefit of the other parties
to the applicable agreement and:
•
•
should not in all instances be treated as categorical statements of fact, but rather as a way of allocating the risk to one of
the parties if those statements proved to be inaccurate;
have been qualified by disclosures that were made to the other party in connection with the negotiation of the applicable
agreement, which disclosures are not necessarily reflected in the agreement;
• may apply standards of materiality in a way that is different from what may be viewed as material to you or other investors;
•
and
were made only as of the date of the applicable agreement or such other date or dates as may be specified in the agreement
and are subject to more recent developments.
Accordingly, these representations and warranties may not describe the actual state of affairs as of the date they were made or at
any other time. Additional information about the Company may be found elsewhere in this Annual Report on Form 10-K and the
Company’s other public filings, which are available without charge through the SEC’s website at http://www.sec.gov.
The Company acknowledges that, notwithstanding the inclusion of the foregoing cautionary statements, it is responsible for
considering whether additional specific disclosures of material information regarding material contractual provisions are required
to make the statements in this report not misleading.
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 21, 2019
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 21, 2019
Date: February 21, 2019
Date: February 21, 2019
Date: February 21, 2019
Date: February 21, 2019
Date: February 21, 2019
Date: February 21, 2019
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 21, 2019
By
/s/ Laurie Goodman
Date: February 21, 2019
Date: February 21, 2019
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 10.19 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 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)).
10.2
Amendment No. 1, dated March 28, 2018, to Employment Agreement, entered into as of November, 4, 2016,
by and between the Company and Craig L. Knutson (incorporated herein by reference to Exhibit 10.1 to the Company’s Form 8-
K, filed April 2, 2018 (Commission File No. 1-13991).
10.3
Employment Agreement, entered into as of March 28, 2018, by and between the Company and Gudmundur
Kristjansson (incorporated herein by reference to Exhibit 10.2 to the Company’s Form 8-K filed April 2, 2018 (Commission File
No. 1-13991)).
10.4
Employment Agreement, entered into as of March 28, 2018, by and between the Company and Bryan Wulfsohn
(incorporated herein by reference to Exhibit 10.3 to the Form 8-K filed April 2, 2018 (Commission File No. 1-13991)).
10.5
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)).
10.6
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)).
10.7
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)).
10.8
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)).
10.9
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)).
10.10
Form of Phantom Share Award Agreement (Time-Based Vesting) (Knutson) relating to the Company’s 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)).
10.11
Form of Phantom Share Award Agreement (Performance-Based Vesting) (Knutson) relating to the Company’s
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)).
10.12
Form of Phantom Share Award Agreement (Performance-Based Vesting) (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)).
10.13
Form of Phantom Share Award Agreement (Vested Award) relating to the Company’s 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)).
10.14
Form of Phantom Share Award Agreement (Time-Based Vesting) relating to the Company’s Equity
Compensation Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Form 8-K, dated December 27, 2018
(Commission File No. 1-13991)).
10.15
Form of Phantom Share Award Agreement (Performance-Based Vesting) relating to the Company’s 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)).
151
10.16
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 December 27, 2018
(Commission File No. 1-13991)).
10.17
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)).
10.18
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)).
10.19
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)).
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
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.
152
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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, 2013 to December 31, 2018.
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, 2013, and that all dividends were reinvested.
$175
150
125
100
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17
12/31/18
MFA Financial, Inc.
S&P 500 Index
BBG REIT Mortgage Index
S&P 500 Financials Index
MFA Financial, Inc.
S&P 500 Index
BBG REIT Mortgage Index
S&P 500 Financials Index
12/31/2013
12/31/2014
12/31/2015
12/31/2016
12/31/2017
12/31/2018
$100.00
$125.03
$115.09
$148.55
$100.00
$113.68
$115.24
$129.02
$169.77
$157.17
$100.00
$119.43
$107.61
$131.58
$158.25
$100.00
$115.18
$113.38
$139.17
$169.98
$159.63
$150.27
$153.65
$147.82
Source: Bloomberg
175
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.
150
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.
125
100
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.
Stephen R. Blank
Independent Director
James A. Brodsky
Member
Weiner Brodsky Kider PC
Richard J. Byrne
President
Benefit Street Partners LLC
EXECUTIVE OFFICERS
Craig L. Knutson
Chief Executive Officer and President
Ronald A. Freydberg
Executive Vice President
Gudmundur Kristjansson
Senior Vice President and
Co-Chief Investment Officer
Bryan Wulfsohn
Senior Vice President and
Co-Chief Investment Officer
Stephen D. Yarad
Chief Financial Officer
Kathleen A. Hanrahan
Senior Vice President and
Chief Accounting Officer
S TOCK HOL DER I N FOR M AT ION
Laurie Goodman
Co-Director
Housing Finance Policy Center
Urban Institute
Alan L. Gosule
Partner
Clifford Chance US LLP
Robin Josephs
Independent Director
Terence B. Meyers
Senior Vice President and
Director of Tax
Harold E. Schwartz
Senior Vice President,
General Counsel and Secretary
Sunil Yadav
Senior Vice President
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 2019 Annual Meeting of Stockholders will be
held on Wednesday, May 22, 2019, 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 2018 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
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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.