MFA Financial (MFA), formerly known as MFA Mortgage, is a REIT that invests in residential mortgage backed securities. If you are like me, when you hear that you think this stock must be in the dumps after the run horrible run in residential real estate over the last 2 years. However, in contrast to that reputation, MFA has raised its dividend payout by 14% over the last quarter, and the stock itself is up 19% year to date. MFA already paid a dividend in excess of 12% leading into the announcement. Of course, this does not sound like the behavior of a struggling firm.
It seems to confound what many had come to understand about the recession thus far, that debt and real estate debt in particular were toxic for companies in this environment. Meanwhile, MFA holds about $8.7 billion worth of debt related to buying mortgage backed assets supported by only $400 million in cash on hand. Clearly, MFA Financial is highly leveraged to residential real estate but perhaps their saving grace is that they are said to only deal with the high-quality mortgage backed securities. Again, that is something that the preceding crisis has made us wary of hearing, but many of the loans in MFA’s portfolio of loans have the implicit backing of the Fannie Mae (FNM) and Freddie Mac (FRE). When looking at their balance sheet as of last reporting March 31st, their assets have held up quite well over the past year. In fact, the value of their long term investments have increased from $8.115 billion as of 1Q08 to $9.944 billion as of 1Q09, an increase of 22% (meanwhile debt increased by 19% over that time).
MFA Financial has increased its debt exposure and in so doing its exposure to real estate as well. There is no doubt that the government has done all that it can to prop up the mortgage and housing market. The Fed has bought distressed mortgage backed assets, and guaranteed loans by the hundreds of billions. This served to lower mortgage rates to historic lows, which of course increased the affordability of housing and has enticed some buyers into the market. However, the drop in 30-year fixed mortgage rates has been short lived as the average rate is back into the 5.4% range more than half a point higher than just 3 months ago. If rates continue to rise, it could mow down any spouting green shoots in the housing landscape. Furthermore, we have been in a lull of mortgage rate resets, which will begin to accelerate in the next few months.
It appears that MFA has taken a significant stake in a housing recovery, and doubling down could be very profitable if they are correct but would be especially painful if they have mistimed the market. We will know more about just how aggressive they have actually been recently when they report second quarter results in the next month. Our valuation methodology, rates MFA as Undervalued based on historical valuation ranges of price-to-cash, price-to-sales and other standard metrics including the impressive dividend. No doubt a P/E ratio of just over 6x based on consensus analyst estimates for 2009 is appealing.
This is an interesting stock because on paper it looks very sexy, but we are skeptical why it continues to trade at such a low valuation. It must be that the company is simply too risky for most investors and the amount of debt they hold is a risk. If housing does take another downturn, Fannie and Freddie may be there to help MFA out, but who wants to bank on that?