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Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
_____________________________________________ 
FORM 10-Q
(Mark One) 
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2018
 
or
 
o    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
 
13-3974868
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
350 Park Avenue, 20th Floor, New York, New York
 
10022
(Address of principal executive offices)
 
(Zip Code)
 
(212) 207-6400
(Registrant’s telephone number, including area code)
Not Applicable 
(Former name, former address and former fiscal year, if changed since last period)
_____________________________________________
 
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 x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o
 
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 x
 
Accelerated filer o
 
 
 
Non-accelerated filer o (Do not check if a smaller reporting company)
 
Smaller reporting company o
 
 
 
 
 
Emerging growth company o
 
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. o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  o
 
398,488,368 shares of the registrant’s common stock, $0.01 par value, were outstanding as of May 3, 2018.
 

Table of Contents

MFA FINANCIAL, INC.

TABLE OF CONTENTS
 
 
Page
 
 
PART I
FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Table of Contents



MFA FINANCIAL, INC.
CONSOLIDATED BALANCE SHEET




 (In Thousands Except Per Share Amounts)
 
March 31,
2018
 
December 31,
2017
 
 
(Unaudited)
 
 
Assets:
 
 

 
 

Mortgage-backed securities (“MBS”) and credit risk transfer (“CRT”) securities:
 
 

 
 

Agency MBS, at fair value ($2,547,350 and $2,727,510 pledged as collateral, respectively)
 
$
2,647,148

 
$
2,824,681

Non-Agency MBS, at fair value ($2,630,425 and $2,379,523 pledged as collateral, respectively)
 
3,398,254

 
3,533,966

CRT securities, at fair value ($590,551 and $595,900 pledged as collateral, respectively)
 
679,491

 
664,403

Mortgage servicing rights (“MSR”) related assets ($432,468 and $482,158 pledged as collateral, respectively)
 
455,124

 
492,080

Residential whole loans, at carrying value ($438,202 and $448,689 pledged as collateral, respectively) (1)
 
1,099,876

 
908,516

Residential whole loans, at fair value ($1,238,016 and $996,226 pledged as collateral, respectively) (1)
 
1,555,620

 
1,325,115

Securities obtained and pledged as collateral, at fair value
 
253,993

 
504,062

Cash and cash equivalents
 
214,686

 
449,757

Restricted cash
 
7,100

 
13,307

Other assets
 
303,920

 
238,847

Total Assets
 
$
10,615,212

 
$
10,954,734

 
 
 
 
 
Liabilities:
 
 
 
 
Repurchase agreements and other advances
 
$
6,558,860

 
$
6,614,701

Obligation to return securities obtained as collateral, at fair value
 
253,993

 
504,062

Payable for unsettled residential whole loans purchases
 
13,525

 
—

Other liabilities
 
553,403

 
574,335

Total Liabilities
 
$
7,379,781

 
$
7,693,098

 
 
 
 
 
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)
 
$
80

 
$
80

Common stock, $.01 par value; 886,950 shares authorized; 398,429 and 397,831 shares issued
  and outstanding, respectively
 
3,984

 
3,978

Additional paid-in capital, in excess of par
 
3,227,550

 
3,227,304

Accumulated deficit
 
(578,913
)
 
(578,950
)
Accumulated other comprehensive income
 
582,730

 
609,224

Total Stockholders’ Equity
 
$
3,235,431

 
$
3,261,636

Total Liabilities and Stockholders’ Equity
 
$
10,615,212

 
$
10,954,734

 

(1)
Includes approximately $180.0 million and $183.2 million of Residential whole loans, at carrying value and $275.6 million and $289.3 million of Residential whole loans, at fair value transferred to consolidated variable interest entities (“VIEs”) at March 31, 2018 and December 31, 2017, respectively. Such assets can be used only to settle the obligations of the VIEs.


The accompanying notes are an integral part of the consolidated financial statements.

1
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MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
 
Three Months Ended 
 March 31,
(In Thousands, Except Per Share Amounts)
 
2018
 
2017
Interest Income:
 
 

 
 

Agency MBS
 
$
15,293

 
$
17,894

Non-Agency MBS
 
56,102

 
79,208

CRT securities
 
9,496

 
6,376

MSR related assets
 
7,623

 
4,734

Residential whole loans held at carrying value
 
14,329

 
8,690

Cash and cash equivalent investments
 
909

 
355

Interest Income
 
$
103,752

 
$
117,257

 
 
 
 
 
Interest Expense:
 
 
 
 
Repurchase agreements and other advances
 
$
45,717

 
$
48,339

Other interest expense
 
4,837

 
2,010

Interest Expense
 
$
50,554

 
$
50,349

 
 
 
 
 
Net Interest Income
 
$
53,198

 
$
66,908

 
 
 
 
 
Other-Than-Temporary Impairments:
 
 
 
 
Total other-than-temporary impairment losses
 
$
—

 
$
(63
)
Portion of loss reclassed from other comprehensive income
 
—

 
(351
)
Net Impairment Losses Recognized in Earnings
 
$
—

 
$
(414
)
 
 
 
 
 
Other Income, net:
 
 
 
 
Net gain on residential whole loans held at fair value
 
$
38,498

 
$
13,773

Net gain on sales of investment securities
 
8,817

 
9,708

Other, net
 
345

 
4,512

Other Income, net
 
$
47,660

 
$
27,993

 
 
 
 
 
Operating and Other Expense:
 
 
 
 
Compensation and benefits
 
$
6,748

 
$
7,793

Other general and administrative expense
 
3,832

 
4,225

Loan servicing and other related operating expenses
 
6,883

 
4,409

Operating and Other Expense
 
$
17,463

 
$
16,427

 
 
 
 
 
Net Income
 
$
83,395

 
$
78,060

Less Preferred Stock Dividends
 
3,750

 
3,750

Net Income Available to Common Stock and Participating Securities
 
$
79,645

 
$
74,310

 
 
 
 
 
Earnings per Common Share - Basic and Diluted
 
$
0.20

 
$
0.20

 
 
 
 
 
Dividends Declared per Share of Common Stock
 
$
0.20

 
$
0.20


The accompanying notes are an integral part of the consolidated financial statements.

2
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MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(UNAUDITED)

 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2018
 
2017
Net income
 
$
83,395

 
$
78,060

Other Comprehensive Income/(Loss):
 
 
 
 
Unrealized loss on Agency MBS, net
 
(10,052
)
 
(8,052
)
Unrealized (loss)/gain on Non-Agency MBS, net
 
(27,488
)
 
27,521

Reclassification adjustment for MBS sales included in net income
 
(8,623
)
 
(9,971
)
Reclassification adjustment for other-than-temporary impairments included in net income
 
—

 
(414
)
Derivative hedging instrument fair value changes, net
 
19,669

 
11,897

Other Comprehensive (Loss)/Income
 
(26,494
)
 
20,981

Comprehensive income before preferred stock dividends
 
$
56,901

 
$
99,041

Dividends declared on preferred stock
 
(3,750
)
 
(3,750
)
Comprehensive Income Available to Common Stock and Participating Securities
 
$
53,151

 
$
95,291

 
The accompanying notes are an integral part of the consolidated financial statements.

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MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(UNAUDITED)

 
 
Three Months Ended March 31, 2018
(In Thousands, 
Except Per Share Amounts)
 
Preferred Stock
7.50% Series B Cumulative Redeemable - Liquidation Preference $25.00 per Share
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated
Deficit
 
Accumulated Other Comprehensive Income
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
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
 
—

 
—

 
—

 
—

 
—

 
295

 
—

 
295

Net income
 
—

 
—

 
—

 
—

 
—

 
83,395

 
—

 
83,395

Issuance of common stock, net of expenses (1)
 
—

 
—

 
849

 
6

 
1,224

 
—

 
—

 
1,230

Repurchase of shares of common stock (1)
 
—

 
—

 
(251
)
 
—

 
(1,957
)
 
—

 
—

 
(1,957
)
Equity based compensation expense
 
—

 
—

 
—

 
—

 
549

 
—

 
—

 
549

Accrued dividends attributable to stock-based awards
 
—

 
—

 
—

 
—

 
430

 
—

 
—

 
430

Dividends declared on common stock
 
—

 
—

 
—

 
—

 
—

 
(79,686
)
 
—

 
(79,686
)
Dividends declared on preferred stock
 
—

 
—

 
—

 
—

 
—

 
(3,750
)
 
—

 
(3,750
)
Dividends attributable to dividend equivalents
 
—

 
—

 
—

 
—

 
—

 
(217
)
 
—

 
(217
)
Change in unrealized gains on MBS, net
 
—

 
—

 
—

 
—

 
—

 
—

 
(46,163
)
 
(46,163
)
Derivative hedging instrument fair value changes, net
 
—

 
—

 
—

 
—

 
—

 
—

 
19,669

 
19,669

Balance at March 31, 2018
 
8,000

 
$
80

 
398,429

 
$
3,984

 
$
3,227,550

 
$
(578,913
)
 
$
582,730

 
$
3,235,431


 
 
Three Months Ended March 31, 2017
(In Thousands, 
Except Per Share Amounts)
 
Preferred Stock
7.50% Series B Cumulative Redeemable - Liquidation Preference $25.00 per Share
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated
Deficit
 
Accumulated Other Comprehensive Income
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2016
 
8,000

 
$
80

 
371,854

 
$
3,719

 
$
3,029,062

 
$
(572,641
)
 
$
573,682

 
$
3,033,902

Net income
 
—

 
—

 
—

 
—

 
—

 
78,060

 
—

 
78,060

Issuance of common stock, net of expenses (1)
 
—

 
—

 
1,457

 
9

 
3,947

 
—

 
—

 
3,956

Repurchase of shares of common stock (1)
 
—

 
—

 
(492
)
 
—

 
(3,859
)
 
—

 
—

 
(3,859
)
Equity based compensation expense
 
—

 
—

 
—

 
—

 
1,024

 
—

 
—

 
1,024

Accrued dividends attributable to stock-based awards
 
—

 
—

 
—

 
—

 
429

 
—

 
—

 
429

Dividends declared on common stock
 
—

 
—

 
—

 
—

 
—

 
(74,569
)
 
—

 
(74,569
)
Dividends declared on preferred stock
 
—

 
—

 
—

 
—

 
—

 
(3,750
)
 
—

 
(3,750
)
Dividends attributable to dividend equivalents
 
—

 
—

 
—

 
—

 
—

 
(227
)
 
—

 
(227
)
Change in unrealized gains on MBS, net
 
—

 
—

 
—

 
—

 
—

 
—

 
9,084

 
9,084

Derivative hedging instruments fair value changes, net
 
—

 
—

 
—

 
—

 
—

 
—

 
11,897

 
11,897

Balance at March 31, 2017
 
8,000

 
$
80

 
372,819

 
$
3,728

 
$
3,030,603

 
$
(573,127
)
 
$
594,663

 
$
3,055,947


(1)  For the three months ended March 31, 2018 and 2017, includes approximately $2.0 million (250,946 shares) and $3.9 million (492,447 shares), respectively surrendered for tax purposes related to equity-based compensation awards.

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MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2018
 
2017
Cash Flows From Operating Activities:
 
 

 
 

Net income
 
$
83,395

 
$
78,060

Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 
Gain on sales of MBS and U.S. Treasury securities
 
(8,817
)
 
(9,708
)
Gain on sales of real estate owned
 
(1,993
)
 
(875
)
Gain on liquidation of residential whole loans
 
(5,279
)
 
(868
)
Other-than-temporary impairment charges
 
—

 
414

Accretion of purchase discounts on MBS and CRT securities, residential whole loans and MSR related assets
 
(19,793
)
 
(23,682
)
Amortization of purchase premiums on MBS and CRT securities
 
5,392

 
8,029

Depreciation and amortization on real estate, fixed assets and other assets
 
423

 
210

Equity-based compensation expense
 
553

 
1,106

Unrealized gain on residential whole loans at fair value
 
(13,747
)
 
(2,948
)
(Increase)/decrease in other assets and other
 
(22,010
)
 
7,013

Decrease in other liabilities
 
(12,228
)
 
(12,392
)
Net cash provided by operating activities
 
$
5,896

 
$
44,359

 
 
 
 
 
Cash Flows From Investing Activities:
 
 

 
 

Principal payments on MBS, CRT securities and MSR related assets
 
$
484,334

 
$
762,747

Proceeds from sales of MBS and U.S. Treasury securities
 
19,362

 
160,697

Purchases of MBS, CRT securities, MSR related assets and U.S. Treasury securities
 
(194,328
)
 
(244,582
)
Purchases of residential whole loans and capitalized advances
 
(513,851
)
 
(5,027
)
Principal payments on residential whole loans
 
71,865

 
35,453

Proceeds from sales of real estate owned
 
19,307

 
10,438

Purchases of real estate owned and capital improvements
 
(2,678
)
 
(774
)
Redemption of Federal Home Loan Bank stock
 
—

 
10,422

Additions to leasehold improvements, furniture and fixtures
 
(171
)
 
(133
)
Net cash (used in)/provided by investing activities
 
$
(116,160
)
 
$
729,241

 
 
 
 
 
Cash Flows From Financing Activities:
 
 

 
 

Principal payments on repurchase agreements and other advances
 
$
(16,609,092
)
 
$
(20,513,712
)
Proceeds from borrowings under repurchase agreements and other advances
 
16,553,139

 
19,963,451

Principal payments on securitized debt
 
(12,817
)
 
—

Payments made for settlements on interest rate swap agreements (“Swaps”)
 
(10,666
)
 
(34,942
)
Proceeds from settlements on Swaps
 
30,711

 
—

Proceeds from issuances of common stock
 
1,230

 
3,952

Dividends paid on preferred stock
 
(3,750
)
 
(3,750
)
Dividends paid on common stock and dividend equivalents
 
(79,769
)
 
(74,622
)
Net cash used in financing activities
 
$
(131,014
)
 
$
(659,623
)
Net (decrease)/increase in cash, cash equivalents, and restricted cash
 
$
(241,278
)
 
$
113,977

Cash, cash equivalents, and restricted cash at beginning of period
 
$
463,064

 
$
318,575

Cash, cash equivalents, and restricted cash at end of period
 
$
221,786

 
$
432,552

 
 
 
 
 
Non-cash Investing and Financing Activities:
 
 
 
 
Net (decrease)/increase in securities obtained as collateral/obligation to return securities obtained as collateral
 
$
(248,650
)
 
$
4,155

Transfer from residential whole loans to real estate owned
 
$
54,822

 
$
31,098

Dividends and dividend equivalents declared and unpaid
 
$
79,905

 
$
74,830

 
The accompanying notes are an integral part of the consolidated financial statements.

5
Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 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 Note 2(p))
 
2.   Summary of Significant Accounting Policies
 
(a)  Basis of Presentation and Consolidation
 
The interim unaudited consolidated financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted according to these SEC rules and regulations.  Management believes that the disclosures included in these interim unaudited consolidated financial statements are adequate to make the information presented not misleading.  The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.  In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31, 2018 and results of operations for all periods presented have been made.  The results of operations for the three months ended March 31, 2018 should not be construed as indicative of the results to be expected for the full year.
 
The accompanying consolidated financial statements of the Company have been prepared on the accrual basis of accounting in accordance with GAAP.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Although the Company’s estimates contemplate current conditions and how it expects them to change in the future, it is reasonably possible that actual conditions could differ from those estimates, which could materially impact the Company’s results of operations and its financial condition.  Management has made significant estimates in several areas, including other-than-temporary impairment (“OTTI”) on MBS (See Note 3), valuation of MBS, CRT securities and MSR related assets (See Notes 3 and 14), income recognition and valuation of residential whole loans (See Notes 4 and 14), valuation of derivative instruments (See Notes 5(b) and 14) and income recognition on certain Non-Agency MBS (defined below) purchased at a discount. (See Note 3)  In addition, estimates are used in the determination of taxable income used in the assessment of REIT compliance and contingent liabilities for related taxes, penalties and interest. (See Note 2(p))  Actual results could differ from those estimates.

The Company has one reportable segment as it manages its business and analyzes and reports its results of operations on the basis of one operating segment; investing, on a leveraged basis, in residential mortgage assets.
 
The consolidated financial statements of the Company include the accounts of all subsidiaries; all intercompany accounts and transactions have been eliminated. In addition, the Company consolidates entities established to facilitate 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.
 

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

(b)  MBS and CRT Securities
 
The Company has investments in residential MBS that are issued or guaranteed as to principal and/or interest by a federally chartered corporation, such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”), or an agency of the U.S. Government, such as the Government National Mortgage Association (“Ginnie Mae”) (collectively, “Agency MBS”), and residential MBS that are not guaranteed by any agency of the U.S. Government or any federally chartered corporation (“Non-Agency MBS”). In addition, the Company has investments in CRT securities that are issued by Fannie Mae and Freddie Mac. The coupon payments on CRT securities are paid by Fannie Mae and Freddie Mac and the principal payments received are based on the performance of loans in a reference pool of previously securitized MBS. As the loans in the underlying reference pool are paid, the principal balance of the CRT securities is paid. As an investor in a CRT security, the Company may incur a loss if certain defined credit events occur, including, for certain CRT securities, if the loans in the reference pool experience delinquencies exceeding specified thresholds.
 
Designation
 
The Company generally intends to hold its MBS until maturity; however, from time to time, it may sell any of its securities as part of the overall management of its business.  As a result, all of the Company’s MBS are designated as “available-for-sale” (“AFS”) and, accordingly, are carried at their fair value with unrealized gains and losses excluded from earnings (except when an OTTI is recognized, as discussed below) and reported in Accumulated other comprehensive income/(loss) (“AOCI”), a component of Stockholders’ Equity.
 
Upon the sale of an AFS security, any unrealized gain or loss is reclassified out of AOCI to earnings as a realized gain or loss using the specific identification method.

The Company has elected the fair value option for certain of its CRT securities as it considers this method of accounting to more appropriately reflect the risk sharing structure of these securities. Such securities are carried at their fair value with changes in fair value included in earnings for the period and reported in Other Income, net on the Company’s consolidated statements of operations.
 
Revenue Recognition, Premium Amortization and Discount Accretion
 
Interest income on securities is accrued based on the outstanding principal balance and their contractual terms. Premiums and discounts associated with Agency MBS and Non-Agency MBS assessed as high credit quality at the time of purchase are amortized into interest income over the life of such securities using the effective yield method. Adjustments to premium amortization are made for actual prepayment activity.
 
Interest income on the Non-Agency MBS that were purchased at a discount to par value and/or are considered to be of less than high credit quality is recognized based on the security’s effective interest rate which is the security’s internal rate of return (“IRR”). The IRR is determined using management’s estimate of the projected cash flows for each security, which are based on the Company’s observation of current information and events and include assumptions related to fluctuations in interest rates, prepayment speeds and the timing and amount of credit losses. On at least a quarterly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and its judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the IRR/ interest income recognized on these securities or in the recognition of OTTIs.  (See Note 3)
 
Based on the projected cash flows from the Company’s Non-Agency MBS purchased at a discount to par value, a portion of the purchase discount may be designated as non-accretable purchase discount (“Credit Reserve”), which effectively mitigates the Company’s risk of loss on the mortgages collateralizing such MBS and is not expected to be accreted into interest income.  The amount designated as Credit Reserve may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors.  If the performance of a security with a Credit Reserve is more favorable than forecasted, a portion of the amount designated as Credit Reserve may be reallocated to accretable discount and recognized into interest income over time.  Conversely, if the performance of a security with a Credit Reserve is less favorable than forecasted, the amount designated as Credit Reserve may be increased, or impairment charges and write-downs of such securities to a new cost basis could result.
 

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

Determination of Fair Value for MBS and CRT Securities
 
In determining the fair value of the Company’s MBS and CRT securities, management considers a number of observable market data points, including prices obtained from pricing services, brokers and repurchase agreement counterparties, dialogue with market participants, as well as management’s observations of market activity.  (See Note 14)
 
Impairments/OTTI

When the fair value of an AFS security is less than its amortized cost at the balance sheet date, the security is considered impaired.  The Company assesses its impaired securities on at least a quarterly basis and designates such impairments as either “temporary” or “other-than-temporary.”  If the Company intends to sell an impaired security, or it is more likely than not that it will be required to sell the impaired security before its anticipated recovery, then the Company must recognize an OTTI through charges to earnings equal to the entire difference between the investment’s amortized cost and its fair value at the balance sheet date.  If the Company does not expect to sell an other-than-temporarily impaired security, only the portion of the OTTI related to credit losses is recognized through charges to earnings with the remainder recognized through AOCI on the consolidated balance sheets.  Impairments recognized through other comprehensive income/(loss) (“OCI”) do not impact earnings.  Following the recognition of an OTTI through earnings, a new cost basis is established for the security and may not be adjusted for subsequent recoveries in fair value through earnings.  However, OTTIs recognized through charges to earnings may be accreted back to the amortized cost basis of the security on a prospective basis through interest income.  The determination as to whether an OTTI exists and, if so, the amount of credit impairment recognized in earnings is subjective, as such determinations are based on factual information available at the time of assessment as well as the Company’s estimates of the future performance and cash flow projections.  As a result, the timing and amount of OTTIs constitute material estimates that are susceptible to significant change.  (See Note 3)

Non-Agency MBS that are assessed to be of less than high credit quality and on which impairments are recognized have experienced, or are expected to experience, credit-related adverse cash flow changes.  The Company’s estimate of cash flows for its Non-Agency MBS is based on its review of the underlying mortgage loans securing the MBS.  The Company considers information available about the past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, year of origination, loan-to-value ratios (“LTVs”), geographic concentrations, as well as reports by credit rating agencies, such as Moody’s Investors Services, Inc. (“Moody’s”), Standard & Poor’s Financial Services LLC (“S&P”) or Fitch Ratings, Inc. (collectively “Rating Agencies”), general market assessments, and dialogue with market participants.  As a result, significant judgment is used in the Company’s analysis to determine the expected cash flows for its Non-Agency MBS.  In determining the OTTI related to credit losses for securities that were purchased at significant discounts to par and/or are considered to be of less than high credit quality, the Company compares the present value of the remaining cash flows expected to be collected at the purchase date (or last date previously revised) against the present value of the cash flows expected to be collected at the current financial reporting date.  The discount rate used to calculate the present value of expected future cash flows is the current yield used for income recognition purposes.  Impairment assessment for Non-Agency MBS and CRT securities that were purchased at prices close to par and/or are otherwise considered to be of high credit quality involves comparing the present value of the remaining cash flows expected to be collected against the amortized cost of the security at the assessment date.  The discount rate used to calculate the present value of the expected future cash flows is based on the instrument’s IRR.
 
Balance Sheet Presentation
 
The Company’s MBS and CRT Securities pledged as collateral against repurchase agreements and Swaps are included on the consolidated balance sheets with the fair value of the securities pledged disclosed parenthetically.  Purchases and sales of securities are recorded on the trade date. 

(c) MSR Related Assets

The Company has investments in financial instruments whose cash flows are considered to be largely dependent on underlying MSRs that either directly or indirectly act as collateral for the investment. These financial instruments, which are referred to as MSR related assets, are discussed in more detail below. The Company’s MSR related assets pledged as collateral against repurchase agreements are included in the consolidated balance sheets with the amounts pledged disclosed parenthetically. Purchases and sales of MSR related assets are recorded on the trade date. (See Notes 3, 6, 7 and 14)


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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

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 reported at fair value on the Company’s consolidated balance sheets with unrealized gains and losses excluded from earnings and reported in AOCI. Interest income is recognized on an accrual basis on the Company’s consolidated statements of operations. The Company’s valuation process for such notes considers a number of factors, including a comparable bond analysis performed by a third-party pricing service which involves determining a pricing spread at issuance of the term note. The pricing spread is used at each subsequent valuation date to determine an implied yield to maturity of the term note, which is then used to derive an indicative market value for the security. This indicative market value is further reviewed by the Company and may be adjusted to ensure it reflects a realistic exit price at the valuation date given the structural features of these securities. Other factors taken into consideration include indicative values provided by repurchase agreement counterparties, estimated changes in fair value of the related underlying MSR collateral and the financial performance of the ultimate parent or sponsoring entity of the issuer, which has provided a guarantee that is intended to provide for payment of interest and principal to the holders of the term notes should cash flows generated by the related underlying MSR collateral be insufficient.

Corporate Loan

The Company has entered into a loan agreement with an entity that originates loans and owns the related MSRs. Under the terms of the loan agreement, the Company has committed to lend $130.0 million of which approximately $124.2 million was drawn at March 31, 2018. The loan is secured by certain U.S. Government, Agency and private-label MSRs, as well as other unencumbered assets owned by the borrower. The term loan is recorded on the Company’s consolidated balance sheets at the drawn amount, on which interest income is recognized on an accrual basis on the Company’s consolidated statements of operations. Commitment fees received on the undrawn amount are deferred and recognized as interest income over the remaining loan term at the time of draw. At the end of the commitment period, any remaining deferred commitment fees will be recorded as Other Income on the Company’s consolidated statements of operations. The Company evaluates the recoverability of the loan on a quarterly basis by considering various factors, including the current status of the loan, changes in fair value of the MSRs that secure the loan and the recent financial performance of the borrower.

(d)  Residential Whole Loans (including Residential Whole Loans transferred to consolidated VIEs)

Residential whole loans included in the Company’s consolidated balance sheets are comprised of pools of fixed and adjustable rate residential mortgage loans acquired through consolidated trusts in secondary market transactions, with the majority at discounted purchase prices. The accounting model utilized by the Company is determined at the time each loan package is initially acquired and is generally based on the delinquency status of the majority of the underlying borrowers in the package at acquisition. The accounting model described below under “Residential Whole Loans at Carrying Value” is typically utilized by the Company for loans where the underlying borrower has a delinquency status of less than 60 days at the acquisition date. The accounting model described below under “Residential Whole Loans at Fair Value” is typically utilized by the Company for loans where the underlying borrower has a delinquency status of 60 days or more at the acquisition date. The accounting model initially applied is not subsequently changed.

The Company’s residential whole loans pledged as collateral against repurchase agreements are included in the consolidated balance sheets with amounts pledged disclosed parenthetically.  Purchases and sales of residential whole loans are recorded on the trade date, with amounts recorded reflecting management’s current estimate of assets that will be acquired or disposed at the closing of the transaction. This estimate is subject to revision at the closing of the transaction, pending the outcome of due diligence performed prior to closing. Recorded amounts of residential whole loans for which the closing of the purchase transaction is yet to occur are not eligible to be pledged as collateral against any repurchase agreement financing until the closing of the purchase transaction. (See Notes 4, 6, 7, 14 and 15)


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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

Residential Whole Loans at Carrying Value

The Company has generally elected to account for these loans as credit impaired as they were acquired at discounted prices that reflect, in part, the impaired credit history of the borrower. Substantially all of the borrowers have previously experienced payment delinquencies and the amount owed on the mortgage loan may exceed the value of the property pledged as collateral. Consequently, these loans generally have a higher likelihood of default than newly originated mortgage loans with LTVs of 80% or less to creditworthy borrowers. The Company believes that amounts paid to acquire these loans represent fair market value at the date of acquisition. Loans considered credit impaired are initially recorded at the purchase price with no allowance for loan losses. Subsequent to acquisition, the recorded amount for these loans reflects the original investment amount, plus accretion of interest income, less principal and interest cash flows received. These loans are presented on the Company’s consolidated balance sheets at carrying value, which reflects the recorded amount reduced by any allowance for loan losses established subsequent to acquisition.

Under the application of the accounting model for credit impaired loans, the Company may aggregate into pools loans acquired in the same fiscal quarter that are assessed as having similar risk characteristics. For each pool established, or on an individual loans basis for loans not aggregated into pools, the Company estimates at acquisition, and periodically on at least a quarterly basis, the principal and interest cash flows expected to be collected. The difference between the cash flows expected to be collected and the carrying amount of the loans is referred to as the “accretable yield.” This amount is accreted as interest income over the life of the loans using an effective interest rate (level yield) methodology. Interest income recorded each period reflects the amount of accretable yield recognized and not the coupon interest payments received on the underlying loans. The difference between contractually required principal and interest payments and the cash flows expected to be collected is referred to as the “non-accretable difference,” and includes estimates of both the effect of prepayments and expected credit losses over the life of the underlying loans.

A decrease in expected cash flows in subsequent periods may indicate impairment at the pool and/or individual loan level, thus requiring the establishment of an allowance for loan losses by a charge to the provision for loan losses. The allowance for loan losses generally represents the present value of cash flows expected at acquisition, adjusted for any increases due to changes in estimated cash flows, that are subsequently no longer expected to be received at the relevant measurement date. Under the accounting model applied to credit impaired loans, a significant increase in expected cash flows in subsequent periods first reduces any previously recognized allowance for loan losses and then will result in a recalculation in the amount of accretable yield. The adjustment of accretable yield due to a significant increase in expected cash flows is accounted for prospectively as a change in estimate and results in reclassification from nonaccretable difference to accretable yield.

Residential Whole Loans at Fair Value

Certain of the Company’s residential whole loans are presented at fair value on its consolidated balance sheets as a result of a fair value election made at time of acquisition. For the majority of these loans, there is significant uncertainty associated with estimating the timing of and amount of cash flows that will be collected. Further, the cash flows ultimately collected may be dependent on the value of the property securing the loan. Consequently, the Company considers that accounting for these loans at fair value should result in a better reflection over time of the economic returns for the majority of these loans. The Company determines the fair value of its residential whole loans held at fair value after considering portfolio valuations obtained from a third-party who specializes in providing valuations of residential mortgage loans and trading activity observed in the market place. Subsequent changes in fair value are reported in current period earnings and presented in Net gain on residential whole loans held at fair value on the Company’s consolidated statements of operations.

Cash received reflecting coupon payments on residential whole loans held at fair value is not included in Interest Income, but rather is presented in Net gain on residential whole loans held at fair value on the Company’s consolidated statements of operations. Cash outflows associated with loan-related advances made by the Company on behalf of the borrower are included in the basis of the loan and are reflected in Net gain on residential whole loans held at fair value.


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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

(e)  Securities Obtained and Pledged as Collateral/Obligation to Return Securities Obtained as Collateral
 
The Company has obtained securities as collateral under collateralized financing arrangements in connection with its financing strategy for Non-Agency MBS.  Securities obtained as collateral in connection with these transactions are recorded on the Company’s consolidated balance sheets as an asset along with a liability representing the obligation to return the collateral obtained, at fair value.  While beneficial ownership of securities obtained remains with the counterparty, the Company has the right to transfer the collateral obtained or to pledge it as part of a subsequent collateralized financing transaction.  (See Note 2(l) for Repurchase Agreements and Reverse Repurchase Agreements)

(f)  Cash and Cash Equivalents
 
Cash and cash equivalents include cash on deposit with financial institutions and investments in money market funds, all of which have original maturities of three months or less.  Cash and cash equivalents may also include cash pledged as collateral to the Company by its repurchase agreement counterparties as a result of reverse margin calls (i.e., margin calls made by the Company).  At March 31, 2018 and December 31, 2017, the Company had cash and cash equivalents of $214.7 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 or any other government agency, were $164.0 million and $354.0 million at March 31, 2018 and December 31, 2017, respectively.  (See Notes 7 and 14)
 
(g)  Restricted Cash
 
Restricted cash represents the Company’s cash held by its counterparties in connection with certain of the Company’s repurchase agreements that is not available to the Company for general corporate purposes. Restricted cash may be applied against amounts due to repurchase agreement counterparties, or may be returned to the Company when the related collateral requirements are exceeded or at the maturity of the repurchase agreement.  The Company had aggregate restricted cash held as collateral or otherwise in connection with its repurchase agreements of $7.1 million and $13.3 million at March 31, 2018 and December 31, 2017, respectively.  (See Notes 5(b), 6, 7 and 14)
 
(h)  Goodwill
 
At March 31, 2018 and December 31, 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 is tested for impairment at least annually, or more frequently under certain circumstances, at the entity level.  Through March 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.

(i) Real Estate Owned (“REO”)
 
REO represents real estate acquired by the Company, including through foreclosure, deed in lieu of foreclosure, or purchased in connection with the acquisition of residential whole loans. REO acquired through foreclosure or deed in lieu of foreclosure is initially recorded at fair value less estimated selling costs. REO acquired in connection with the acquisition of residential whole loans is initially recorded at its purchase price. Subsequent to acquisition, REO is reported, at each reporting date, at the lower of the current carrying amount or fair value less estimated selling costs and for presentation purposes is included in Other assets on the Company’s consolidated balance sheets. Changes in fair value that result in an adjustment to the reported amount of an REO property that has a fair value at or below its carrying amount are reported in Other Income, net on the Company’s consolidated statements of operations. (See Note 5(a))

(j)  Depreciation
 
Leasehold Improvements and Other Depreciable Assets
 
Depreciation is computed on the straight-line method over the estimated useful life of the related assets or, in the case of leasehold improvements, over the shorter of the useful life or the lease term.  Furniture, fixtures, computers and related hardware have estimated useful lives ranging from five to eight years at the time of purchase.
 

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

(k)  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.

(l)  Repurchase Agreements and Other Advances
 
Repurchase Agreements

The Company finances the holdings of a significant portion of its residential mortgage assets with repurchase agreements.  Under repurchase agreements, the Company sells securities to a lender and agrees to repurchase the same securities in the future for a price that is higher than the original sale price.  The difference between the sale price that the Company receives and the repurchase price that the Company pays represents interest paid to the lender.  Although legally structured as sale and repurchase transactions, the Company accounts for repurchase agreements as secured borrowings. Under its repurchase agreements, the Company pledges its securities as collateral to secure the borrowing, which is equal in value to a specified percentage of the fair value of the pledged collateral, while the Company retains beneficial ownership of the pledged collateral.  At the maturity of a repurchase financing, unless the repurchase financing is renewed with the same counterparty, the Company is required to repay the loan including any accrued interest and concurrently receives back its pledged collateral from the lender.  With the consent of the lender, the Company may renew a repurchase financing at the then prevailing financing terms.  Margin calls, whereby a lender requires that the Company pledge additional securities or cash as collateral to secure borrowings under its repurchase financing with such lender, are routinely experienced by the Company when the value of the MBS pledged as collateral declines as a result of principal amortization and prepayments or due to changes in market interest rates, spreads or other market conditions.  The Company also may make margin calls on counterparties when collateral values increase.
 
The Company’s repurchase financings typically have terms ranging from one month to six months at inception, but may also have longer or shorter terms.  Should a counterparty decide not to renew a repurchase financing at maturity, the Company must either refinance elsewhere or be in a position to satisfy the obligation.  If, during the term of a repurchase financing, a lender should default on its obligation, the Company might experience difficulty recovering its pledged assets which could result in an unsecured claim against the lender for the difference between the amount loaned to the Company plus interest due to the counterparty and the fair value of the collateral pledged by the Company to such lender, including accrued interest receivable or such collateral.  (See Notes 6, 7 and 14)
 
In addition to the repurchase agreement financing arrangements discussed above, as part of its financing strategy for Non-Agency MBS, the Company has entered into contemporaneous repurchase and reverse repurchase agreements with a single counterparty.  Under a typical reverse repurchase agreement, the Company buys securities from a borrower for cash and agrees to sell the same securities in the future for a price that is higher than the original purchase price.  The difference between the purchase price the Company originally paid and the sale price represents interest received from the borrower.  In contrast, the contemporaneous repurchase and reverse repurchase transactions effectively resulted in the Company pledging Non-Agency MBS as collateral to the counterparty in connection with the repurchase agreement financing and obtaining U.S. Treasury securities as collateral from the same counterparty in connection with the reverse repurchase agreement.  No net cash was exchanged between the Company and counterparty at the inception of the transactions.  Securities obtained and pledged as collateral are recorded as an asset on the Company’s consolidated balance sheets.  Interest income is recorded on the reverse repurchase agreement and interest expense is recorded on the repurchase agreement on an accrual basis.  Both the Company and the counterparty have the right to make daily margin calls based on changes in the value of the collateral obtained and/or pledged.  The Company’s liability to the counterparty in connection with this financing arrangement is recorded on the Company’s consolidated balance sheets and disclosed as “Obligation to return securities obtained as collateral, at fair value.”  (See Note 2(e))

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018


Federal Home Loan Bank (“FHLB”) Advances

In January 2016, the Federal Housing Finance Agency (the “FHFA”) released its final rule amending its regulation on FHLB membership, which, among other things, provided termination rules for then current captive insurance members. As a result of such regulation, the Company’s wholly-owned subsidiary, MFA Insurance, Inc. (“MFA Insurance”) was required to repay all of its outstanding FHLB advances by February 19, 2017 and its FHLB membership was terminated on such date. FHLB advances were secured financing transactions and were carried at their contractual amounts. (See Note 6)
 
(m)  Equity-Based Compensation
 
Compensation expense for equity-based awards that are subject to vesting conditions, is recognized ratably over the vesting period of such awards, based upon the fair value of such awards at the grant date.  For certain awards granted prior to January 1, 2017, compensation expense recognized included the impact of estimated forfeitures, with any changes in estimated forfeiture rates accounted for as a change in estimate. Upon adoption of new accounting guidance that was effective for the Company on January 1, 2017, the Company made a policy election to account for forfeitures as they occur.
 
From 2011 through 2013, the Company granted certain restricted stock units (“RSUs”) that vested annually over a one or three-year period, provided that certain criteria were met, which were based on a formula tied to the Company’s achievement of average total stockholder return during that three-year period.  Starting in 2014, the Company has made annual grants of RSUs certain of which cliff vest after a three-year period and others of which cliff vest after a three-year period, subject to the achievement of certain performance criteria based on a formula tied to the Company’s achievement of average total stockholder return during that three-year period. The features in these awards related to the attainment of total stockholder return over a specified period constitute a “market condition” which impacts the amount of compensation expense recognized for these awards.  Specifically, the uncertainty regarding the achievement of the market condition was reflected in the grant date fair valuation of the RSUs, which is recognized as compensation expense over the relevant vesting period.  The amount of compensation expense recognized is not dependent on whether the market condition was or will be achieved.
 
The Company 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 of the Company’s Board of Directors (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 do not or are not expected to vest and grantees are not required to return payments of dividends or dividend equivalents to the Company.  (See Notes 2(n) and 13)
 
(n)  Earnings per Common Share (“EPS”)
 
Basic EPS is computed using the two-class method, which includes the weighted-average number of shares of common stock outstanding during the period and an estimate of other securities that participate in dividends, such as the Company’s unvested restricted stock and RSUs that have non-forfeitable rights to dividends and dividend equivalents attached to/associated with RSUs and vested stock options to arrive at total common equivalent shares.  In applying the two-class method, earnings are allocated to both shares of common stock and estimated securities that participate in dividends based on their respective weighted-average shares outstanding for the period.  For the diluted EPS calculation, common equivalent shares are further adjusted for the effect of dilutive unexercised stock options and RSUs outstanding that are unvested and have dividends that are subject to forfeiture using the treasury stock method.  Under the treasury stock method, common equivalent shares are calculated assuming that all dilutive common stock equivalents are exercised and the proceeds, along with future compensation expenses associated with such instruments, are used to repurchase shares of the Company’s outstanding common stock at the average market price during the reported period.  (See Note 12)
 

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

(o)  Comprehensive Income/(Loss)
 
The Company’s comprehensive income/(loss) available to common stock and participating securities includes net income, the change in net unrealized gains/(losses) on its AFS securities and derivative hedging instruments, (to the extent that such changes are not recorded in earnings), adjusted by realized net gains/(losses) reclassified out of AOCI for sold AFS securities and is reduced by dividends declared on the Company’s preferred stock and issuance costs of redeemed preferred stock.
 
(p)  U.S. Federal Income Taxes

The Company has elected to be taxed as a REIT under the provisions of the Internal Revenue Code of 1986, as amended, (the “Code”) and the corresponding provisions of state law.  The Company expects to operate in a manner that will enable it to satisfy the various requirements to maintain its status as a REIT for federal income tax purposes. In order to maintain its status as a REIT, the Company must, among other things, distribute at least 90% of its REIT taxable income (excluding net long-term capital gains) to stockholders in the timeframe permitted by the Code.  As long as the Company maintains its status as a REIT, the Company will not be subject to regular federal income tax to the extent that it distributes 100% of its REIT taxable income (including net long-term capital gains) to its stockholders within the permitted timeframe.  Should this not occur, the Company would be subject to federal taxes at prevailing corporate tax rates on the difference between its REIT taxable income and the amounts deemed to be distributed for that tax year.  As the Company’s objective is to distribute 100% of its REIT taxable income to its stockholders within the permitted timeframe, no provision for current or deferred income taxes has been made in the accompanying consolidated financial statements.  Should the Company incur a liability for corporate income tax, such amounts would be recorded as REIT income tax expense on the Company’s consolidated statements of operations. Furthermore, if the Company fails to distribute during each calendar year, or by the end of January following the calendar year in the case of distributions with declaration and record dates falling in the last three months of the calendar year, at least the sum of (i) 85% its REIT ordinary income for such year, (ii) 95% of its REIT capital gain income for such year, and (iii) any undistributed taxable income from prior periods, the Company would be subject to a 4% nondeductible excise tax on the excess of the required distribution over the amounts actually distributed. To the extent that the Company incurs interest, penalties or related excise taxes in connection with its tax obligations, including as a result of its assessment of uncertain tax positions, such amounts will be included in Operating and Other Expense on the Company’s consolidated statements of operations.

In addition, the Company has elected to treat certain of its subsidiaries as a TRS. In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. Generally, a domestic TRS is subject to U.S. federal, state and local corporate income taxes. Since a portion of the Company’s business may be conducted through one or more TRS, its income earned by TRS may be subject to corporate income taxation. To maintain the Company’s REIT election, no more than 20% of the value of a REIT’s assets at the end of each calendar quarter may consist of stock or securities in TRS. For purposes of the determination of U.S. federal and state income taxes, the Company’s subsidiaries that elected to be treated as a TRS record current or deferred income taxes based on differences (both permanent and timing) between the determination of their taxable income and net income under GAAP. No deferred tax benefit was recorded by the Company for the three months ended March 31, 2018 and 2017, as a valuation allowance for the full amount of the associated deferred tax asset was recognized as its recovery is not considered more likely than not.

 Based on its analysis of any potential uncertain tax positions, the Company concluded that it does not have any material uncertain tax positions that meet the relevant recognition or measurement criteria as of March 31, 2018, December 31, 2017, or March 31, 2017. The Company filed its 2016 tax return prior to October 16, 2017. The Company’s tax returns for tax years 2014 through 2016 are open to examination.

(q)  Derivative Financial Instruments
 
The Company may use a variety of derivative instruments to economically hedge a portion of its exposure to market risks, including interest rate risk and prepayment risk. The objective of the Company’s risk management strategy is to reduce fluctuations in net book value over a range of interest rate scenarios. In particular, the Company attempts to mitigate the risk of the cost of its variable rate liabilities increasing during a period of rising interest rates. The Company’s derivative instruments are currently comprised of Swaps, which are designated as cash flow hedges against the interest rate risk associated with its borrowings.

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018


Swaps
 
The Company documents its risk-management policies, including objectives and strategies, as they relate to its hedging activities and the relationship between the hedging instrument and the hedged liability for all Swaps designated as hedging transactions.  The Company assesses, both at inception of a hedge and on a quarterly basis thereafter, whether or not the hedge is “highly effective.”
 
Swaps are carried on the Company’s consolidated balance sheets at fair value, in Other assets, if their fair value is positive, or in Other liabilities, if their fair value is negative.  Beginning in January 2017, variation margin payments on the Company’s Swaps that have been novated to a clearing house are treated as a legal settlement of the exposure under the Swap contract. 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. As of March 31, 2018, 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.

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(b), 7 and 14)

(r)  Fair Value Measurements and the Fair Value Option for Financial Assets and Financial Liabilities
 
The Company’s presentation of fair value for its financial assets and liabilities is determined within a framework that stipulates that the fair value of a financial asset or liability is an exchange price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability.  The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability.  This definition of fair value focuses on exit price and prioritizes the use of market-based inputs over entity-specific inputs when determining fair value.  In addition, the framework for measuring fair value establishes a three-level hierarchy for fair value measurements based upon the observability of inputs to the valuation of an asset or liability as of the measurement date. 

In addition to the financial instruments that it is required to report at fair value, the Company has elected the fair value option for certain of its residential whole loans and CRT securities at time of acquisition. Subsequent changes in the fair value of these loans and CRT securities are reported in Net gain on residential whole loans held at fair value and Other income, net respectively on the Company’s consolidated statements of operations.  A decision to elect the fair value option for an eligible financial instrument, which may be made on an instrument by instrument basis, is irrevocable. (See Notes 2(d), 4 and 14)

 (s)  Variable Interest Entities
 
An entity is referred to as a VIE if it meets at least one of the following criteria:  (i) the entity has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support of other parties; or (ii) as a group, the holders of the equity investment at risk lack (a) the power to direct the activities of an entity that most significantly impact the entity’s economic performance; (b) the obligation to absorb the expected losses; or (c) the right to receive the expected residual returns; or (iii) have disproportional voting rights and the entity’s activities are conducted on behalf of the investor that has disproportionately few voting rights.
 
The Company consolidates a VIE when it has both the power to direct the activities that most significantly impact the economic performance of the VIE and a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE.   The Company is required to reconsider its evaluation of whether to consolidate a VIE each reporting period, based upon changes in the facts and circumstances pertaining to the VIE.
 

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

The Company has entered into several financing transactions which resulted in the Company consolidating the VIEs that were created 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 were VIEs and that they should be consolidated.  If the Company had determined that consolidation was not required, it would have then assessed whether the transfers of the underlying assets would qualify as sale or should be accounted for as secured financings under GAAP. (See Note 15)

The Company also includes on its consolidated balance sheets certain financial assets and liabilities that are acquired/issued by trusts and/or other special purpose entities that have been evaluated as being required to be consolidated by the Company under the applicable accounting guidance.

(t)  Offering Costs Related to Issuance and Redemption of Preferred Stock

Offering costs related to issuance of preferred stock are recorded as a reduction in Additional paid-in capital, a component of Stockholders’ Equity, at the time such preferred stock is issued. On redemption of preferred stock, any excess of the fair value of the consideration transferred to the holders of the preferred stock over the carrying amount of the preferred stock in the Company’s consolidated balance sheets is included in the determination of Net Income Available to Common Stock and Participating Securities in the calculation of EPS.
 
(u)  New Accounting Standards and Interpretations
 
Accounting Standards Adopted in 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.


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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 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.

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

3.                   MBS, CRT Securities and MSR Related Assets
 
Agency and Non-Agency MBS

The Company’s MBS are comprised of Agency MBS and Non-Agency MBS which include MBS issued prior to 2008 (“Legacy Non-Agency MBS”). These MBS are secured by:  (i) hybrid mortgages (“Hybrids”), which have interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index; (ii) adjustable-rate mortgages (“ARMs”), which have interest rates that reset annually or more frequently (collectively, “ARM-MBS”); and (iii) 15 year fixed-rate mortgage 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 up to 300 basis points at 36 months from issuance or sooner. The Company pledges a significant portion of its MBS as collateral against its borrowings under repurchase agreements and Swaps.  (See Note 7)
 
Agency MBS:  Agency MBS are guaranteed as to principal and/or interest by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae.  The payment of principal and/or interest on Ginnie Mae MBS is explicitly backed by the full faith and credit of the U.S. Government.  Since the third quarter of 2008, Fannie Mae and Freddie Mac have been under the conservatorship of the Federal Housing Finance Agency, which significantly strengthened the backing for these government-sponsored entities.
 
Non-Agency MBS:  The Company’s Non-Agency MBS are primarily secured by pools of residential mortgages, which are not guaranteed by an agency of the U.S. Government or any federally chartered corporation.  Credit risk associated with Non-Agency MBS is regularly assessed as new information regarding the underlying collateral becomes available and based on updated estimates of cash flows generated by the underlying collateral.
 
CRT Securities

CRT securities are debt obligations issued by Fannie Mae and Freddie Mac. The payments of principal and interest on the CRT securities are paid by Fannie Mae or Freddie Mac, as the case may be, on a monthly basis, and are dependent on the performance of loans in a reference pool of Agency MBS securitized by the issuing entity. As an investor in a CRT security, the Company may incur a loss if losses on the mortgage loans in the reference pool exceed the credit enhancement on the underlying CRT security owned by the Company. The Company assesses the credit risk associated with CRT securities by assessing the current and expected future performance of the associated reference pool. The Company pledges a portion of its CRT securities as collateral against its borrowings under repurchase agreements.  (See Note 7)



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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

The following tables present certain information about the Company’s MBS and CRT securities at March 31, 2018 and December 31, 2017:
 
March 31, 2018
(In Thousands)
 
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)
Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
2,038,059

 
$
77,640

 
$
(36
)
 
$
—

 
$
2,115,663

 
$
2,106,021

 
$
23,283

 
$
(32,925
)
 
$
(9,642
)
Freddie Mac
 
534,008

 
20,650

 
—

 
—

 
555,262

 
535,084

 
1,455

 
(21,633
)
 
(20,178
)
Ginnie Mae
 
5,865

 
108

 
—

 
—

 
5,973

 
6,043

 
70

 
—

 
70

Total Agency MBS
 
2,577,932

 
98,398

 
(36
)
 
—

 
2,676,898

 
2,647,148

 
24,808

 
(54,558
)
 
(29,750
)
Non-Agency MBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Expected to Recover Par (3)(4)
 
1,143,670

 
48

 
(22,636
)
 
—

 
1,121,082

 
1,145,482

 
24,927

 
(527
)
 
24,400

Expected to Recover Less than Par (3)
 
2,439,186

 
—

 
(177,023
)
 
(572,580
)
 
1,689,583

 
2,252,772

 
563,349

 
(160
)
 
563,189

Total Non-Agency MBS (5)
 
3,582,856

 
48

 
(199,659
)
 
(572,580
)
 
2,810,665

 
3,398,254

 
588,276

 
(687
)
 
587,589

Total MBS
 
6,160,788

 
98,446

 
(199,695
)
 
(572,580
)
 
5,487,563

 
6,045,402

 
613,084

 
(55,245
)
 
557,839

CRT securities (6)
 
617,351

 
10,012

 
(3,049
)
 
—

 
624,314

 
679,491

 
55,441

 
(264
)
 
55,177

Total MBS and CRT securities
 
$
6,778,139

 
$
108,458

 
$
(202,744
)
 
$
(572,580
)
 
$
6,111,877

 
$
6,724,893

 
$
668,525

 
$
(55,509
)
 
$
613,016


December 31, 2017
(In Thousands)
 
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)
Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
2,170,974

 
$
82,271

 
$
(40
)
 
$
—

 
$
2,253,205

 
$
2,246,600

 
$
21,736

 
$
(28,341
)
 
$
(6,605
)
Freddie Mac
 
561,346

 
21,683

 
—

 
—

 
584,920

 
571,748

 
1,624

 
(14,796
)
 
(13,172
)
Ginnie Mae
 
6,142

 
112

 
—

 
—

 
6,254

 
6,333

 
79

 
—

 
79

Total Agency MBS
 
2,738,462

 
104,066

 
(40
)
 
—

 
2,844,379

 
2,824,681

 
23,439

 
(43,137
)
 
(19,698
)
Non-Agency MBS:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Expected to Recover Par (3)(4)
 
1,128,808

 
50

 
(22,737
)
 
—

 
1,106,121

 
1,132,205

 
26,518

 
(434
)
 
26,084

Expected to Recover Less than Par (3)
 
2,589,935

 
—

 
(192,588
)
 
(593,227
)
 
1,804,120

 
2,401,761

 
597,660

 
(19
)
 
597,641

Total Non-Agency MBS (5)
 
3,718,743

 
50

 
(215,325
)
 
(593,227
)
 
2,910,241

 
3,533,966

 
624,178

 
(453
)
 
623,725

Total MBS
 
6,457,205

 
104,116

 
(215,365
)
 
(593,227
)
 
5,754,620

 
6,358,647

 
647,617

 
(43,590
)
 
604,027

CRT securities (6)
 
602,799

 
8,887

 
(3,550
)
 
—

 
608,136

 
664,403

 
56,290

 
(23
)
 
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 March 31, 2018 reflect Credit Reserve of $558.5 million and OTTI of $14.0 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 $604,000 and $1.9 million at March 31, 2018 and December 31, 2017, respectively, which are not included in the Principal/Current Face.
(3)
Based on management’s current estimates of future principal cash flows expected to be received.
(4)
Includes RPL/NPL MBS, which at March 31, 2018 had a $935.1 million Principal/Current face, $933.2 million amortized cost and $935.2 million 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.
(5)
At March 31, 2018 and December 31, 2017, the Company expected to recover approximately 84% and 84%, respectively, of the then-current face amount of Non-Agency MBS.
(6)
Amounts disclosed at March 31, 2018 includes CRT securities with a fair value of $546.3 million for which the fair value option has been elected. Such securities had gross unrealized gains of approximately $39.8 million and gross unrealized losses of approximately $264,000 at March 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 has been elected. Such securities had gross unrealized gains of approximately $40.5 million and gross unrealized losses of approximately $23,000 at December 31, 2017.
 


19
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018


Unrealized Losses on MBS and CRT Securities

The following table presents information about the Company’s MBS and CRT securities that were in an unrealized loss position at March 31, 2018:
 
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
(Dollars in Thousands)
Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
303,575

 
$
2,479

 
87

 
$
897,700

 
$
30,446

 
221

 
$
1,201,275

 
$
32,925

Freddie Mac
 
90,177

 
1,178

 
34

 
384,069

 
20,455

 
106

 
474,246

 
21,633

Total Agency MBS
 
393,752

 
3,657

 
121

 
1,281,769

 
50,901

 
327

 
1,675,521

 
54,558

Non-Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Expected to Recover Par (1)
 
371,688

 
378

 
6

 
12,068

 
149

 
9

 
383,756

 
527

Expected to Recover Less than Par (1)
 
24,010

 
160

 
7

 
—

 
—

 
—

 
24,010

 
160

Total Non-Agency MBS
 
395,698

 
538

 
13

 
12,068

 
149

 
9

 
407,766

 
687

Total MBS
 
789,450

 
4,195

 
134

 
1,293,837

 
51,050

 
336

 
2,083,287

 
55,245

CRT securities (2)
 
39,187

 
264

 
11

 
—

 
—

 
—

 
39,187

 
264

Total MBS and CRT securities
 
$
828,637

 
$
4,459

 
145

 
$
1,293,837

 
$
51,050

 
336

 
$
2,122,474

 
$
55,509


(1)
Based on management’s current estimates of future principal cash flows expected to be received.  
(2)
Amounts disclosed at March 31, 2018 represent CRT securities on which the fair value option has been elected.

At March 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 $54.6 million at March 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 March 31, 2018 any unrealized losses on its Agency MBS were temporary.

Gross unrealized losses on the Company’s Non-Agency MBS were $687,000 at March 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.
  
The Company did not recognize any credit-related OTTI losses through earnings related to its Non-Agency MBS during the three months ended March 31, 2018. The Company recognized credit-related OTTI losses through earnings related to its Non-Agency MBS of $414,000 during the three months ended March 31, 2017.

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

20
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

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, as well as Rating Agency reports, general market assessments, and dialogue with market participants.  Changes in the Company’s evaluation of each of these factors impacts the cash flows expected to be collected at the OTTI assessment date. For Non-Agency MBS purchased at a discount to par that were assessed for and had no OTTI recorded this period, such cash flow estimates indicated that the amount of expected losses decreased compared to the previous OTTI assessment date. These positive cash flow changes are primarily driven by recent improvements in LTVs due to loan amortization and home price appreciation, which, in turn, positively impacts the Company’s estimates of default rates and loss severities for the underlying collateral. In addition, voluntary prepayments (i.e., loans that prepay in full with no loss) have generally trended higher 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 three months ended March 31, 2018 and 2017:
 
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2018
 
2017
Total OTTI losses
 
$
—

 
$
(63
)
OTTI reclassified from OCI
 
—

 
(351
)
OTTI recognized in earnings
 
$
—

 
$
(414
)

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.
 
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2018
 
2017
Credit loss component of OTTI at beginning of period
 
$
38,337

 
$
37,305

Additions for credit related OTTI not previously recognized
 
—

 
63

Subsequent additional credit related OTTI recorded
 
—

 
351

Credit loss component of OTTI at end of period
 
$
38,337

 
$
37,719



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Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

Purchase Discounts on Non-Agency MBS
 
The following tables present 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 three months ended March 31, 2018 and 2017:

 
 
Three Months Ended 
 March 31, 2018
 
Three Months Ended 
 March 31, 2017
(In Thousands)
 
Discount
Designated as
Credit Reserve and OTTI
 
Accretable
Discount (1) 
Discount
Designated as
Credit Reserve and OTTI
 
 Accretable Discount (1)
Balance at beginning of period
 
$
(593,227
)
 
$
(215,325
)
 
$
(694,241
)
 
$
(278,191
)
Accretion of discount
 
—

 
17,216

 
—

 
21,616

Realized credit losses
 
8,447

 
—

 
12,324

 
—

Purchases
 
(535
)
 
488

 
—

 
—

Sales
 
5,592

 
5,105

 
19,741

 
(3,897
)
Net impairment losses recognized in earnings
 
—

 
—

 
(414
)
 
—

Transfers/release of credit reserve
 
7,143

 
(7,143
)
 
9,253

 
(9,253
)
Balance at end of period
 
$
(572,580
)
 
$
(199,659
)
 
$
(653,337
)
 
$
(269,725
)

(1)  Together with coupon interest, accretable purchase discount is recognized as interest income over the life of the security.

Sales of MBS
 
During the three months ended March 31, 2018, the Company sold certain Non-Agency MBS for $19.4 million, realizing gross gains of $8.8 million.  During the three months ended March 31, 2017, the Company sold certain Non-Agency MBS for $21.6 million, realizing gross gains of $10.0 million. The Company has no continuing involvement with any of the sold MBS.

MSR Related Assets

(a) Term Notes Backed by MSR Related Collateral

At March 31, 2018 and December 31, 2017, the Company had $332.0 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 March 31, 2018, these term notes had an amortized cost of $331.0 million, gross unrealized gains of $1.0 million, a weighted average yield of 5.28% and a weighted average term to maturity of 4.2 years. At December 31, 2017, the 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.

(b) Corporate Loan

The Company has entered into a loan agreement with an entity that originates loans and owns the related MSRs. The loan is secured by certain U.S. Government, Agency and private-label MSRs, as well as other unencumbered assets owned by the borrower. Under the terms of the loan agreement, the Company has committed to lend $130.0 million of which approximately $124.2 million was drawn at March 31, 2018. At March 31, 2018, the coupon paid by the borrower on the drawn amount is 8.39%, the remaining term associated with the loan is 2.3 years and remaining commitment period on any undrawn amount is three months. During the remaining commitment period of three months, the Company receives a commitment fee of 1.5%. For the three months ended March 31, 2018 and 2017, the Company recognized interest income of $2.5 million and $1.7 million including discount accretion and commitment fee income of $107,000 and $62,000, respectively.

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

Impact of AFS Securities on AOCI
 
The following table presents the impact of the Company’s AFS securities on its AOCI for the three months ended March 31, 2018 and 2017:
 
 
Three Months Ended March 31,
(In Thousands)
2018
 
2017
AOCI from AFS securities:
 
 

 
 

Unrealized gain on AFS securities at beginning of period
 
$
620,648

 
$
620,403

Unrealized loss on Agency MBS, net
 
(10,052
)
 
(8,052
)
Unrealized (loss)/gain on Non-Agency MBS, net
 
(27,488
)
 
27,521

Reclassification adjustment for MBS sales included in net income
 
(8,623
)
 
(9,971
)
Reclassification adjustment for OTTI included in net income
 
—

 
(414
)
Change in AOCI from AFS securities
 
(46,163
)
 
9,084

Balance at end of period
 
$
574,485

 
$
629,487

 
Interest Income on MBS, CRT Securities and MSR Related Assets
 
The following table presents the components of interest income on the Company’s MBS, CRT securities and MSR related assets for the three months ended March 31, 2018 and 2017: 
 
 
Three Months Ended March 31,
(In Thousands)
 
2018
 
2017
Agency MBS
 
 
 
 
Coupon interest
 
$
20,958

 
$
26,212

Effective yield adjustment (1)
 
(5,665
)
 
(8,318
)
Interest income
 
$
15,293

 
$
17,894

 
 
 
 
 
Legacy Non-Agency MBS
 
 
 
 
Coupon interest
 
$
28,835

 
$
34,662

Effective yield adjustment (2)
 
17,201

 
21,442

Interest income
 
$
46,036

 
$
56,104

 
 
 
 
 
RPL/NPL MBS
 
 
 
 
Coupon interest
 
$
10,053

 
$
22,929

Effective yield adjustment (1)
 
13

 
175

Interest income
 
$
10,066

 
$
23,104

 
 
 
 
 
CRT securities
 
 
 
 
Coupon interest
 
$
8,374

 
$
5,257

Effective yield adjustment (2)
 
1,122

 
1,119

Interest income
 
$
9,496

 
$
6,376

 
 
 
 
 
MSR related assets
 
 
 
 
Coupon interest
 
$
7,517

 
$
4,672

Effective yield adjustment (1)
 
106

 
62

Interest income
 
$
7,623

 
$
4,734

 
(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.


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Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

4.    Residential Whole Loans

Included on the Company’s consolidated balance sheets at March 31, 2018 and December 31, 2017 are approximately $2.7 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.

Residential Whole Loans, at Carrying Value

Residential whole loans, at carrying value totaled approximately $1.1 billion and $908.5 million at March 31, 2018 and December 31, 2017, respectively. The carrying value reflects the original investment amount, plus accretion of interest income, less principal and interest cash flows received. The carrying value is reduced by any allowance for loan losses established subsequent to acquisition. The Company had approximately 5,400 and 4,800 Residential whole loans held at carrying value at March 31, 2018 and December 31, 2017, respectively.

As of March 31, 2018, the Company had established an allowance for loan losses of approximately $380,000 on its residential whole loan pools held at carrying value. For the three months ended March 31, 2018, a net provision for loan losses of approximately $50,000 was recorded, which is included in Operating and Other expense on the Company’s consolidated statements of operations. For the three months ended March 31, 2017, the Company recorded a net reversal of provision for loan losses of approximately $221,000.

The following table presents the activity in the Company’s allowance for loan losses on its residential whole loan pools held at carrying value for the three months ended March 31, 2018 and 2017:

 (In Thousands)
 
Three Months Ended March 31,
 
 
2018

2017
Balance at the beginning of period
 
$
330

 
$
990

Provisions/(reversal of provisions) for loan losses
 
50

 
(221
)
Balance at the end of period
 
$
380

 
$
769


The Company did not acquire any purchase credit impaired residential whole loans held at carrying value during the three months ended March 31, 2018 and 2017.

The following table presents accretable yield activity for the Company’s purchase credit impaired residential whole loans held at carrying value for the three months ended March 31, 2018 and 2017:

 (In Thousands)
 
Three Months Ended March 31,
 
 
2018
 
2017
Balance at beginning of period
 
$
421,872

 
$
334,379

  Accretion
 
(11,031
)
 
(8,690
)
Liquidations and other
 
(2,170
)
 
—

  Reclassifications from/(to) non-accretable difference, net
 
4,733

 
(138
)
Balance at end of period
 
$
413,404

 
$
325,551


Accretable yield for purchase 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

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2018

change. Therefore, the amount of accretable income recorded during the three months ended March 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 held at fair value on the Company’s consolidated statements of operations.

The following table presents information regarding the Company’s residential whole loans held at fair value at March 31, 2018 and December 31, 2017:
 (Dollars in Thousands)
 
March 31, 2018
 
December 31, 2017
Outstanding principal balance
 
$
1,769,454

 
$
1,562,373

Aggregate fair value
 
$
1,555,620

 
$
1,325,115

Number of loans
 
7,085

 
6,514


During the three months ended March 31, 2018 and 2017 the Company recorded net gains on residential whole loans held at fair value of $38.5 million and $13.8 million, respectively.

The following table presents the components of Net gain on residential whole loans held at fair value for the three months ended March 31, 2018 and 2017:
 (In Thousands)
 
Three Months Ended March 31,
 
 
2018
 
2017
Coupon payments and other income received
 
$
15,397

 
$
8,173

Net unrealized gains
 
13,747

 
2,948

Net gain on payoff/liquidation of loans
 
2,908

 
868

Net gain on transfers to REO
 
6,446

 
1,784

    Total
 
$
38,498

 
$
13,773



5.    Other Assets

The following table presents the components of the Company’s Other assets at March 31, 2018 and December 31, 2017: