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Jonathan Moreland
Jonathan Moreland
 
REIT From Crisis: Emerges Intact

Insider buying gives comfort that the high indicated yield is sustainable.

August 17, 2009
by Jonathan Moreland

[DISCLOSURE: Readers should assume that all stocks mentioned in this column are owned by the author and/or his firm unless otherwise noted.]

MFA Financial (MFA: NYSE) released strong second-quarter results that confirmed my investment thesis and keeps this seemingly risky stock rated a buy on my newsletter’s recommended list. As the Q&A on the company’s second-quarter conference call highlighted, diligence will be required to continue managing MFA’s assets efficiently and the primary thing I’m betting on with this position is management’s ability to do so.

As some CPA Insider™ readers may not know, MFA is a real-estate investment trust (REIT) that specializes in managing leveraged portfolios of mortgage-backed securities (MBS), primarily those backed by government-sponsored agencies, like Fannie Mae, Freddie Mac and Ginnie Mae.

Those assets put MFA at the epicenter of the recent financial crisis. But the federal government’s support of agency mortgage-backed security (MBS) over the past year and the current steep slope up in the yield curve (which helps MFA’s profitability) made me bold enough to follow insiders into these shares two months ago and bet that this security’s 13-percent-plus indicated yield would help spur a respectable total return for the risk I was taking on.

So far, so good. Net-interest income increased 56 percent year-over-year in its latest quarter, to $68.7 million. That also represented an impressive 13.4 percent sequential increase.

Earnings per share (EPS) increased 50 percent year-over-year and 30 percent sequentially, to $0.30. Approximately six cents of second quarter’s EPS was garnered from a $13.5 million gain booked for asset sales.

Future entries on this line of the income statement are sure to keep MFA’s EPS difficult to predict with great specificity in future quarters. But this line item is important to monitor for how it reflects management’s views on the tricky market it is dealing with now, as well as how correct those views are.

Strategic Calls

There was no shortage of forward-looking opinions by management on its recent earnings conference call. In regards to taking on more leverage in MFA’s agency portfolio to boost returns, Chairman Stewart Zimmerman warned that “the world is still somewhat unsettled ... I think it's still important to be very cautious in terms of leverage ... If that were to change, we can kind of change on a dime also, so I'm very comfortable with where leverage is and that's really where we are.”

I find Zimmerman’s acknowledgement of and respect for the many unknowns that could affect his firm comforting and the ability of MFA to react quickly to changing circumstances a definite plus.

Management is also not assuming that the recent government-sponsored tailwinds behind the agency MBS market are keeping this asset class uniquely attractive. “We still like the agency market,” remarked Zimmerman in response to the fact that MFA purchased non-agency assets last quarter. “We still think there's going to be incredible values in the agency market, but not quite now.”

I appreciate all the glimpses behind management’s strategy and assumptions that MFA’s conference call generated and the attention management is paying to the risk side of the equation they relay. I’m sticking with this stock on the belief that management will continue to navigate their tough market well, and with the announcement of another 25-cent per-share dividend earlier this month, my belief is (literally) paying dividends. Though past performance is never a guarantee of future returns, management’s excellent strategic track record — as well as their recent stock purchases — is certainly a comforting indication that MFA isn’t likely done rewarding investors.

Institutional Strength Momentum

Adding to the optimism is the bullish reception MFA received for its recent, large secondary offering. With the company’s shares surging, it was just plain prudent for MFA’s management to tap capital markets again. But the 30-million share offering announced on July 28 represented a 13 percent increase in shares outstanding. Such dilution seemed a shoe in to put pressure on MFA’s share price in the short term.

It was insiders’ bullishness that first got me looking at MFA. But it’s always nice to see executives’ optimism backed up so obviously by deep-pocketed outsiders. And while I remain leery of chasing momentum in this summer rally, there are far worse names to chase with than a stock like MFA that still sports a (likely sustainable) indicated yield of 13 percent after its recent price spurt.

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Jonathan Moreland is the Director of Research at New York-based InsiderInsights.com. View a FREE trial issue of the firm's weekly newsletter InsiderInsights. Please note the stock recommendations in this column are solely the authorís and in no way represents the views of the AICPA or the CPA Insiderô.