Edgar Filing: MFA FINANCIAL, INC.

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

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		(I.R.S. Employer
incorporation or organization)		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)

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 Web site, 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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x		Accelerated filer o

Non-accelerated filer o		Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

361,278,928 shares of the registrant’s common stock, $0.01 par value, were outstanding as of April 24, 2013.

Table of Contents

TABLE OF CONTENTS

		Page

PART I
FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets as of March 31, 2013 (Unaudited) and December 31, 2012	1

	Consolidated Statements of Operations (Unaudited) for the Three Months Ended March 31, 2013 and March 31, 2012	2

	Consolidated Statements of Comprehensive Income (Unaudited) for the Three Months Ended March 31, 2013 and March 31, 2012	3

	Consolidated Statement of Changes in Stockholders’ Equity (Unaudited) for the Three Months Ended March 31, 2013	4

	Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2013 and March 31, 2012	5

	Notes to the Unaudited Consolidated Financial Statements	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	37

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	62

Item 4.	Controls and Procedures	69

PART II
OTHER INFORMATION

Item 1.	Legal Proceedings	70

Item 1A.	Risk Factors	70

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	70

Item 6.	Exhibits	70

Signatures		71

Table of Contents

MFA FINANCIAL, INC.

CONSOLIDATED BALANCE SHEETS

	March 31,			December 31,
(In Thousands, Except Per Share Amounts)	2013			2012
	(Unaudited)
Assets:
Mortgage-backed securities (“MBS”):
Agency MBS, at fair value ($6,739,499 and $6,747,299 pledged as collateral, respectively)	$	7,153,905		$	7,225,460
Non-Agency MBS, at fair value ($1,851,879 and $1,602,953 pledged as collateral, respectively)	2,795,645			2,762,006
Non-Agency MBS transferred to consolidated variable interest entities (“VIEs”) (1)	2,592,632			2,620,159
Securities obtained and pledged as collateral, at fair value	408,118			408,833
Cash and cash equivalents	601,570			401,293
Restricted cash	5,017			5,016
MBS linked transactions, net (“Linked Transactions”), at fair value	12,572			12,704
Interest receivable	42,106			44,033
Derivative hedging instruments, at fair value	324			203
Goodwill	7,189			7,189
Prepaid and other assets	33,674			30,654
Total Assets	$	13,652,752		$	13,517,550

Liabilities:
Repurchase agreements	$	8,902,827		$	8,752,472
Securitized debt (2)	542,014			646,816
Obligation to return securities obtained as collateral, at fair value	508,187			508,827
8% Senior Notes due 2042 (“Senior Notes”)	100,000			100,000
Accrued interest payable	12,867			16,104
Derivative hedging instruments, at fair value	50,839			63,034
Dividends and dividend equivalents rights (“DERs”) payable	259,607			72,222
Payable for unsettled purchases	—			33,479
Excise tax and interest payable	5,000			7,500
Accrued expenses and other liabilities	5,863			6,090
Total Liabilities	$	10,387,204		$	10,206,544

Commitments and contingencies (Note 10)

Stockholders’ Equity:
Preferred stock, $.01 par value; series A 8.50% cumulative redeemable 5,000 shares authorized; 3,840 shares issued and outstanding ($96,000 aggregate liquidation preference)	$	38		$	38
Common stock, $.01 par value; 895,000 shares authorized; 358,419 and 357,546 issued and outstanding, respectively	3,584			3,575
Additional paid-in capital, in excess of par	2,813,878			2,805,724
Accumulated deficit	(444,324		)	(260,308		)
Accumulated other comprehensive income	892,372			761,977
Total Stockholders’ Equity	$	3,265,548		$	3,311,006
Total Liabilities and Stockholders’ Equity	$	13,652,752		$	13,517,550

(1) Non-Agency MBS transferred to consolidated VIEs represent assets of the consolidated VIEs that can be used only to settle the obligations of each respective VIE.

(2) Securitized Debt represents third-party liabilities of consolidated VIEs and excludes liabilities of the VIEs acquired by the Company that eliminate in consolidation. The third-party beneficial interest holders in the VIEs have no recourse to the general credit of the Company. (See Notes 9 and 15 for further discussion.)

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

Table of Contents

MFA FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	Three Months Ended
	March 31,
(In Thousands, Except Per Share Amounts)	2013			2012
Interest Income:
Agency MBS	$	42,787		$	53,300
Non-Agency MBS	41,047			25,794
Non-Agency MBS transferred to consolidated VIEs	38,868			44,410
Cash and cash equivalent investments	36			19
Interest Income	$	122,738		$	123,523

Interest Expense:
Repurchase agreements	$	34,675		$	36,070
Securitized debt	3,476			4,057
Senior Notes	2,007			—
Total Interest Expense	$	40,158		$	40,127

Net Interest Income	$	82,580		$	83,396

Other-Than-Temporary Impairments:
Total other-than-temporary impairment losses	$	—		$	(879	)
Portion of loss reclassed from other comprehensive income	—			(41		)
Net Impairment Losses Recognized in Earnings	$	—		$	(920	)

Other Income, net:
Unrealized net gains and net interest income from Linked Transactions	$	1,536		$	7,699
Gain on sales of MBS and U.S. Treasury securities, net	1,633			2,953
Other, net	55			—
Other Income, net	$	3,224		$	10,652

Operating and Other Expense:
Compensation and benefits	$	5,273		$	5,612
Other general and administrative expense	3,180			2,803
Operating and Other Expense	$	8,453		$	8,415

Net Income	$	77,351		$	84,713
Less: Preferred Stock Dividends	2,040			2,040
Net Income Available to Common Stock and Participating Securities	$	75,311		$	82,673

Earnings per Common Share - Basic and Diluted	$	0.21		$	0.23

Dividends Declared per Share of Common Stock	$	0.72	(1)	$	0.24

(1) Includes a special dividend of $0.50 per share.

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

Table of Contents

MFA FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

	Three Months Ended
	March 31,
(In Thousands)	2013			2012

Net income	$	77,351		$	84,713
Other Comprehensive Income:
Unrealized loss on Agency MBS, net	(27,291		)	(3,158		)
Unrealized gain on Non-Agency MBS, net	146,730			262,602
Reclassification adjustment for MBS sales included in net income	(1,360		)	(2,901		)
Reclassification adjustment for other-than-temporary impairments included in net income	—			920
Unrealized gain on derivative hedging instruments, net	12,316			12,091
Other Comprehensive Income	130,395			269,554
Comprehensive income before preferred stock dividends	$	207,746		$	354,267
Dividends declared on preferred stock	(2,040		)	(2,040		)
Comprehensive Income Available to Common Stock and Participating Securities	$	205,706		$	352,227

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

Table of Contents

MFA FINANCIAL, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

	Three Months Ended
	March 31, 2013
(In Thousands, Except Per Share Amounts)	Dollars			Shares

Preferred Stock, Series A 8.50% Cumulative Redeemable - Liquidation Preference $25.00 per Share:
Balance at March 31, 2013 and December 31, 2012	$	38		3,840

Common Stock, Par Value $.01:
Balance at December 31, 2012	3,575			357,546
Issuance of common stock (1)	9			883
Repurchase of shares of common stock (1)	—			(10	)
Balance at March 31, 2013	3,584			358,419

Additional Paid-in Capital, in excess of Par:
Balance at December 31, 2012	2,805,724
Issuance of common stock, net of expenses (1)	7,359
Equity-based compensation expense	885
Repurchase of shares of common stock (1)	(90		)
Balance at March 31, 2013	2,813,878

Accumulated Deficit:
Balance at December 31, 2012	(260,308		)
Net income	77,351
Dividends declared on common stock	(258,404		)
Dividends declared on preferred stock	(2,040		)
Dividends attributable to DERs	(923		)
Balance at March 31, 2013	(444,324		)

Accumulated Other Comprehensive Income:
Balance at December 31, 2012	761,977
Change in unrealized gains on MBS, net	118,079
Change in unrealized losses on derivative hedging instruments, net	12,316
Balance at March 31, 2013	892,372

Total Stockholders’ Equity at March 31, 2013	$	3,265,548

(1) For the three months ended March 31, 2013, includes approximately $90,000 (9,607 shares) surrendered for tax purposes related to equity-based compensation awards.

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

Table of Contents

MFA FINANCIAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Three Months Ended
	March 31,
(In Thousands)	2013			2012

Cash Flows From Operating Activities:
Net income	$	77,351		$	84,713
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sales of MBS and U.S. Treasury securities	(1,633		)	(2,953		)
Other-than-temporary impairment charges	—			920
Accretion of purchase discounts on MBS	(12,058		)	(9,418		)
Amortization of purchase premiums on MBS	14,793			10,782
Depreciation and amortization on fixed assets and other assets	1,097			427
Equity-based compensation expense	885			1,101
Unrealized gains and other on Linked Transactions	(1,136		)	(6,245		)
Decrease in interest receivable	1,891			244
(Increase)/decrease in prepaid and other assets	(4,088		)	1,844
Decrease in accrued expenses and other liabilities, and excise tax and interest	(2,699		)	(3,886		)
(Decrease)/increase in accrued interest payable on financial instruments	(3,237		)	2,404
Net cash provided by operating activities	$	71,166		$	79,933

Cash Flows From Investing Activities:
Principal payments on MBS	$	711,901		$	558,516
Proceeds from sale of MBS and U.S. Treasury securities	206,203			71,103
Purchases of MBS	(569,006		)	(737,950		)
Additions to leasehold improvements, furniture and fixtures	(54		)	(130		)
Net cash provided by/(used in) investing activities	$	349,044		$	(108,461	)

Cash Flows From Financing Activities:
Principal payments on repurchase agreements	$	(18,024,857	)	$	(14,744,454	)
Proceeds from borrowings under repurchase agreements	18,175,212			14,840,227
Proceeds from issuance of securitized debt	—			186,691
Principal payments on securitized debt	(104,802		)	(94,789		)
Payments made on obligation to return securities obtained as collateral	(200,050		)	—
Payments made for resecuritization related costs	—			(1,763		)
Cash disbursements on financial instruments underlying Linked Transactions	(57,977		)	(299,173		)
Cash received from financial instruments underlying Linked Transactions	59,245			218,269
Payments made for margin calls on repurchase agreements and interest rate swaps (“Swaps”)	—			(1,590		)
Proceeds from reverse margin calls on repurchase agreements and Swaps	—			4,090
Proceeds from issuances of common stock	7,278			451
Dividends paid on preferred stock	(2,040		)	(2,040		)
Dividends paid on common stock and DERs	(71,942		)	(96,792		)
Net cash (used in)/provided by financing activities	$	(219,933	)	$	9,127
Net increase/(decrease) in cash and cash equivalents	$	200,277		$	(19,401	)
Cash and cash equivalents at beginning of period	$	401,293		$	394,022
Cash and cash equivalents at end of period	$	601,570		$	374,621

Non-cash Investing and Financing Activities:
MBS recorded upon de-linking of Linked Transactions	$	—		$	122,826
Net increase in securities obtained as collateral/obligation to return securities obtained as collateral	$	200,099		$	197,339
Dividends and DERs declared and unpaid	$	259,607		$	86,778

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

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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 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. (See Note 11)

2. Summary of Significant Accounting Policies

(a) Basis of Presentation and Consolidation

The interim unaudited 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 financial statements are adequate to make the information presented not misleading. The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31, 2013 and results of operations for all periods presented have been made. The results of operations for the three months ended March 31, 2013 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 be worse than anticipated in 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 Agency and Non-Agency MBS (Note 3), valuation of Agency and Non-Agency MBS (Notes 3 and 14), derivative hedging instruments (Notes 5 and 14) and income recognition on certain Non-Agency MBS purchased at a discount (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 (Note 2 (m)). Actual results could differ from those estimates.

The consolidated financial statements of the Company include the accounts of all subsidiaries; significant intercompany accounts and transactions have been eliminated.

(b) Agency and Non-Agency MBS (including Non-Agency MBS transferred to a consolidated VIE)

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 Fannie Mae or Freddie Mac, or any agency of the U.S. Government, such as Ginnie Mae (collectively, “Agency MBS”), and residential MBS that are not guaranteed by any U.S. Government agency or any federally chartered corporation (“Non-Agency MBS”), as described in Note 3.

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” 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 investment security, any unrealized gain or loss is reclassified out of AOCI to earnings as a realized gain or loss using the specific identification method.

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 rated AA and higher 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.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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. The effective interest rate is based on 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 yield/interest income recognized on these securities or in the recognition of OTTIs. (See Note 3)

Based on the projected cash flows from the Company’s Non-Agency MBS purchased at a discount to par value, a portion of the purchase discount may be designated as non-accretable purchase discount (“Credit Reserve”), which effectively mitigates the Company’s risk of loss on the mortgages collateralizing such MBS and is not expected to be accreted into interest income. The amount designated as Credit Reserve may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors. If the performance of a security with a Credit Reserve is more favorable than forecasted, a portion of the amount designated as Credit Reserve may be reallocated to accretable discount and recognized into interest income over time. Conversely, if the performance of a security with a Credit Reserve is less favorable than forecasted, the amount designated as Credit Reserve may be increased, or impairment charges and write-downs of such securities to a new cost basis could result.

Determination of MBS Fair Value

In determining the fair value of the Company’s MBS, 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 investment 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 sheet. 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 purchased at significant discounts to par/and are otherwise assessed to be of less than high credit quality 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, Fair Isaac Corporation (“FICO”) scores at loan origination, year of origination, loan-to-value ratios, geographic concentrations, as well as reports by credit rating agencies, such as Moody’s Investors Services, Inc. (“Moody’s”), Standard & Poor’s Corporation (“S&P”), or Fitch, Inc. (collectively, “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

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

flows is the current yield used for income recognition purposes. Impairment assessment for Non-Agency MBS that were purchased at prices close to par and are 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 effective interest rate.

Balance Sheet Presentation

The Company’s MBS pledged as collateral against repurchase agreements and Swaps are included in MBS on the consolidated balance sheet with the fair value of the MBS pledged disclosed parenthetically. Purchases and sales of securities are recorded on the trade date. However, if on the purchase settlement date, a repurchase agreement is used to finance the purchase of an MBS with the same counterparty and such transactions are determined to be linked, then the MBS and linked repurchase borrowing will be reported on the same settlement date as Linked Transactions. (See Notes 2(n) and 5)

(c) 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 sheet 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 sell the collateral obtained or to pledge it as part of a subsequent collateralized financing transaction. (See Note 2(i) for Repurchase Agreements and Reverse Repurchase Agreements)

(d) Cash and Cash Equivalents

Cash and cash equivalents include cash on deposit with financial institutions and investments in money market funds, all of which have original maturities of three months or less. Cash and cash equivalents may also include cash pledged as collateral to the Company by its repurchase agreement and/or Swap counterparties as a result of reverse margin calls (i.e., margin calls made by the Company). The Company did not hold any cash pledged by its counterparties at March 31, 2013 or December 31, 2012. At March 31, 2013 and December 31, 2012, all of the Company’s cash investments were comprised of 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. (See Notes 7 and 14)

(e) Restricted Cash

Restricted cash represents the Company’s cash held by its counterparties as collateral against the Company’s Swaps and/or repurchase agreements. Restricted cash, which earns interest, is not available to the Company for general corporate purposes, but may be applied against amounts due to counterparties to the Company’s repurchase agreements and/or Swaps, or returned to the Company when the collateral requirements are exceeded or at the maturity of the Swap or repurchase agreement. The Company had aggregate restricted cash held as collateral against its Swaps of $5.0 million at March 31, 2013 and December 31, 2012, respectively. (See Notes 5, 6, 7 and 14)

(f) Goodwill

At March 31, 2013 and December 31, 2012, 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, 2013, the Company had not recognized any impairment against its goodwill.

(g) 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.

(h) Resecuritization and Senior Notes Related Costs

Resecuritization related costs are costs associated with the issuance of beneficial interests by consolidated VIEs and incurred by the Company in connection with various resecuritization transactions completed by the Company. Senior Notes related costs are costs incurred by the Company in connection with the issuance of its Senior Notes in April, 2012. 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 sheet in prepaid and

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

other assets. These deferred charges are amortized as an adjustment to interest expense using the effective interest method, based upon the actual repayments of the associated beneficial interests issued to third parties and over the stated legal maturity of the Senior Notes.

(i) Repurchase Agreements and Reverse Repurchase Agreements

The Company finances the acquisition of a significant portion of its MBS 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, with the exception of certain repurchase agreements accounted for as components of Linked Transactions. (See Note 2(n) below.) 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 2(n), 5, 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 sheet. 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 sheet and disclosed as “Obligation to return securities obtained as collateral.” (See Note 2(c))

(j) Equity-Based Compensation

Compensation expense for equity based awards is recognized ratably over the vesting period of such awards, based upon the fair value of such awards at the grant date. With respect to awards granted in 2009 and prior years, the Company has applied a zero forfeiture rate for these awards, as they were granted to a limited number of employees, and historical forfeitures have been minimal. Forfeitures, or an indication that forfeitures are expected to occur, may result in a revised forfeiture rate and would be accounted for prospectively as a change in estimate.

During 2010, the Company granted certain restricted stock units (“RSUs”) that vest after either two or four years of service and provided that certain criteria are met, which are based on a formula that includes changes in the Company’s closing stock price over a two- or four-year period and dividends declared on the Company’s common stock during those periods. During 2011 and 2012, the Company granted certain RSUs that vest annually over a one

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

or three-year period, provided that certain criteria are met, which are based on a formula that includes changes in the Company’s closing stock price over the annual vesting period and dividends declared on the Company’s common stock during those periods. Such criteria constitute a “market condition” which impacts the amount of compensation expense recognized for these awards. Specifically, the uncertainty regarding whether the market condition will be achieved is reflected in the grant date fair valuation of the RSUs, which in addition to estimates regarding the amount of RSUs expected to be forfeited during the associated service period, determines the amount of compensation expense that is recognized. Compensation expense is not reversed should the market condition not be achieved, while differences in actual forfeiture experience relative to estimated forfeitures will result in adjustments to the timing and amount of compensation expense recognized.

The Company has awarded DERs that may be attached to or awarded separately from other equity based awards. Compensation expense for separately awarded DERs is based on the grant date fair value of such awards and is recognized over the vesting period. Payments pursuant to these DERs are charged to stockholders’ equity. Payments pursuant to DERs that are attached to equity based awards are charged to stockholders’ equity to the extent that the attached equity awards are expected to vest. Compensation expense is recognized for payments made for DERs 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 DERs to the Company. (See Notes 2(k) and 13)

(k) 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 other securities that participate in dividends, such as the Company’s unvested restricted stock and RSUs that have non-forfeitable rights to dividends and DERs 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 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)

(l) 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 MBS and its derivative hedging instruments, currently comprised of Swaps, (to the extent that such changes are not recorded in earnings), adjusted by realized net gains/(losses) reclassified out of AOCI for MBS and is reduced by dividends declared on the Company’s preferred stock.

(m) 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. In order to maintain its status a REIT, the Company must, among other things, distribute at least 90% of its REIT taxable income to stockholders in the timeframe permitted by the Code. The Company is not subject to tax to the extent that it distributes 100% of its REIT taxable income 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. 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 shall be included within Operating and other expense on the Company’s consolidated statements of operations.

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, 2013, December 31, 2012, or March 31, 2012. The Company’s tax returns for tax years 2009 through 2011 are open to examination. The Company expects to file its 2012 tax return prior to September 15, 2013.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(n) Derivative Financial Instruments

Hedging Activity

As part of the Company’s interest rate risk management, it periodically hedges a portion of its interest rate risk using derivative financial instruments, currently comprised of Swaps. Hedge accounting is used to account for these instruments.

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. The Company assesses, both at inception of a hedge and on a quarterly basis thereafter, whether or not the hedge is “highly effective.”

The Company discontinues hedge accounting on a prospective basis and recognizes changes in the 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.

Although permitted under certain circumstances, the Company does not offset cash collateral receivables or payables against its net derivative positions. (See Notes 5, 7 and 14)

Swaps

Swaps are carried on the Company’s balance sheet at fair value, as assets, if their fair value is positive, or as liabilities, if their fair value is negative. Changes in the fair value of the Company’s Swaps 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 through earnings as a result of hedge ineffectiveness.

Non-Hedging Activity/Linked Transactions

It is presumed that the initial transfer of a financial asset (i.e., the purchase of an MBS by the Company) and contemporaneous repurchase financing of such MBS with the same counterparty are considered part of the same arrangement, or a “linked transaction,” unless certain criteria are met. The two components of a linked transaction (MBS purchase and repurchase financing) are not reported separately but are evaluated on a combined basis and reported as a forward (derivative) contract and are presented as “Linked Transactions” on the Company’s consolidated balance sheet. Changes in the fair value of the assets and liabilities underlying Linked Transactions and associated interest income and expense are reported as “unrealized net gains/(losses) and net interest income from Linked Transactions” on the Company’s consolidated statements of operations and are not included in OCI. However, if certain criteria are met, the initial transfer (i.e., the purchase of a security by the Company) and repurchase financing will not be treated as a Linked Transaction and will be evaluated and reported separately, as an MBS purchase and repurchase financing. When or if a transaction is no longer considered to be linked, the MBS and repurchase financing will be reported on a gross basis. In this case, the fair value of the MBS at the time the transactions are no longer considered linked will become the cost basis of the MBS, and the income recognition yield for such MBS will be calculated prospectively using this new cost basis. (See Notes 5 and 14)

(o) 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. (See Note 14)

Although permitted under GAAP to measure many financial instruments and certain other items at fair value, the Company has not elected the fair value option for any of its assets or liabilities. If the fair value option is elected, unrealized gains and losses on such items for which fair value is elected would be recognized in earnings at each subsequent reporting date. 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.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

(p) Variable Interest Entities

An entity is referred to as a VIE if it meets at least one of the following criteria: (1) the entity has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support of other parties; or (2) 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 (3) have disproportional voting rights and the entity’s activities are conducted on behalf of the investor that has disproportionally few voting rights.

The Company consolidates a VIE when it has both the power to direct the activities that most significantly impact the economic performance of the VIE and a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE. The Company is required to reconsider its evaluation of whether to consolidate a VIE each reporting period, based upon changes in the facts and circumstances pertaining to the VIE.

The Company has entered into resecuritization transactions which result in the Company consolidating the VIEs that were created to facilitate the transactions and to which the underlying assets in connection with the resecuritizations were transferred. In determining the accounting treatment to be applied to these resecuritization transactions, the Company evaluated whether the entities used to facilitate these transactions were VIEs and, if so, whether they should be consolidated. Based on its evaluation, the Company concluded that the VIEs should be consolidated. If the Company had determined that consolidation was not required, it would have then assessed whether the transfer of the underlying assets would qualify as a sale or should be accounted for as secured financings under GAAP.

Prior to the completion of its initial resecuritization transaction in October 2010, the Company had not transferred assets to VIEs or Qualifying Special Purpose Entities (“QSPEs”) and other than acquiring MBS issued by such entities, had no other involvement with VIEs or QSPEs. (See Note 15)

(q) New and Proposed Accounting Standards and Interpretations

Accounting Standards Adopted in 2013

Balance Sheet

In December 2011, the FASB issued ASU 2011-11, Disclosures about Offsetting Assets and Liabilities, (“ASU 2011-11”) regarding disclosures concerning the offsetting of assets and liabilities. Under ASU 2011-11, an entity is required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. The scope includes derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. This disclosure is intended to support further the convergence of U.S. GAAP and International Financial Reporting Standards requirements. ASU 2011-11 was effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods.

In January 2013, the FASB issued ASU 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities (“ASU 2013-01”). The main objective of this ASU is to limit the scope of the new balance sheet and offsetting disclosure requirements of ASU 2011-11 to certain derivatives (including bifurcated embedded derivatives,) repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions. The amendments of ASU 2013-01 should be applied for fiscal years beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the required disclosures retrospectively for all comparative periods presented.

The Company’s adoption of ASU 2011-11 and ASU 2013-01 beginning on January 1, 2013 did not have a material impact on the Company’s consolidated financial statements.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

Comprehensive Income

In February 2013, the FASB issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). The amendments of this ASU do not change the current requirements for reporting net income or OCI in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of AOCI by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. ASU 2013-02 was effective prospectively for the Company for reporting periods beginning after December 15, 2012. The Company’s adoption of ASU 2013-02 beginning on January 1, 2013 did not have a material impact on the Company’s consolidated financial statements.

Proposed Accounting Standards

The FASB has recently issued or discussed a number of proposed standards on such topics as investment companies and investment property entities, repurchase agreements and similar transactions, measurement of credit impairment, financial instrument measurement and classification, revenue recognition, leases, hedging and disclosures about liquidity risk and interest rate risk. Some of the proposed changes are potentially significant and could have a material impact on the Company’s reporting. The Company has not yet fully evaluated the potential impact of these proposals but will make such an evaluation as the standards are finalized.

3. MBS

The Company’s MBS are comprised of Agency MBS and Non-Agency MBS. These MBS are secured by: (i) hybrid mortgages (“Hybrids”), which have interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index; (ii) adjustable-rate mortgages (“ARMs”); (iii) mortgages that have interest rates that reset more frequently (collectively, “ARM-MBS”); and (iv) 15-year and longer-term fixed rate mortgages. MBS do not have a single maturity date, and further, the mortgage loans underlying ARM-MBS do not all reset at the same time.

The Company pledges a significant portion of its MBS as collateral against its borrowings under repurchase agreements and Swaps. Non-Agency MBS that are accounted for as components of Linked Transactions are not reflected in the tables set forth in this note, as they are accounted for as derivatives. (See Notes 5 and 7)

Agency MBS: Agency MBS are guaranteed as to principal and/or interest by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae. The payment of principal and/or interest on Ginnie Mae MBS is explicitly backed by the full faith and credit of the U.S. Government. Since the third quarter of 2008, Fannie Mae and Freddie Mac have been under the conservatorship of the Federal Housing Finance Agency, which significantly strengthened the backing for these government-sponsored entities.

Non-Agency MBS (including Non-Agency MBS transferred to consolidated VIEs): The Company’s Non-Agency MBS are secured by pools of residential mortgages, which are not guaranteed by an agency of the U.S. Government or any federally chartered corporation. Non-Agency MBS may be rated by one or more Rating Agencies or may be unrated (i.e., not assigned a rating by any Rating Agency). The rating indicates the opinion of the Rating Agency as to the creditworthiness of the investment, indicating the obligor’s ability to meet its full financial commitment on the obligation. A rating of “D” is assigned when a security has defaulted on any of its contractual terms.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

The following tables present certain information about the Company’s MBS at March 31, 2013 and December 31, 2012:

March 31, 2013

								Discount
								Designated
	Principal/				Accretable			as Credit							Gross		Gross			Net
	Current		Purchase		Purchase			Reserve			Amortized				Unrealized		Unrealized			Unrealized
(In Thousands)	Face		Premiums		Discounts			and OTTI (1)			Cost (2)		Fair Value		Gains		Losses			Gain/(Loss)
Agency MBS:
Fannie Mae	$	5,631,101	$	188,186	$	(51	)	$	—		$	5,819,236	$	5,974,186	$	157,790	$	(2,840	)	$	154,950
Freddie Mac	1,100,024		42,866		—			—			1,146,602		1,164,812		21,227		(3,017		)	18,210
Ginnie Mae	14,170		245		—			—			14,415		14,907		492		—			492
Total Agency MBS	6,745,295		231,297		(51		)	—			6,980,253		7,153,905		179,509		(5,857		)	173,652
Non-Agency MBS (3)
Rated AAA	22,658		135		(205		)	—			22,588		23,338		750		—			750
Rated A	1,008		21		—			—			1,029		988		—		(41		)	(41		)
Rated BBB	42,818		580		(1,346		)	—			42,052		43,440		2,079		(691		)	1,388
Rated BB	118,881		53		(9,028		)	(874		)	109,032		116,887		8,088		(233		)	7,855
Rated B	241,825		—		(31,771		)	(10,377		)	199,677		228,401		28,724		—			28,724
Rated CCC	1,205,624		13		(115,858		)	(188,857		)	900,922		1,063,379		163,933		(1,476		)	162,457
Rated CC	554,897		—		(36,537		)	(132,586		)	385,774		459,565		73,791		—			73,791
Rated C	733,338		—		(47,516		)	(126,533		)	559,289		639,835		80,568		(22		)	80,546
Unrated and D-rated (4)	3,392,056		—		(139,652		)	(853,725		)	2,398,679		2,812,444		413,925		(160		)	413,765
Total Non-Agency MBS	6,313,105		802		(381,913		)	(1,312,952		)	4,619,042		5,388,277		771,858		(2,623		)	769,235
Total MBS	$	13,058,400	$	232,099	$	(381,964	)	$	(1,312,952	)	$	11,599,295	$	12,542,182	$	951,367	$	(8,480	)	$	942,887

December 31, 2012

								Discount
								Designated
	Principal/				Accretable			as Credit							Gross		Gross			Net
	Current		Purchase		Purchase			Reserve			Amortized				Unrealized		Unrealized			Unrealized
(In Thousands)	Face		Premiums		Discounts			and OTTI (1)			Cost (2)		Fair Value		Gains		Losses			Gain/(Loss)
Agency MBS:
Fannie Mae	$	5,977,388	$	196,686	$	(58	)	$	—		$	6,174,016	$	6,351,621	$	178,970	$	(1,365	)	$	177,605
Freddie Mac	800,854		30,447		—			—			835,724		858,560		22,925		(89		)	22,836
Ginnie Mae	14,526		251		—			—			14,777		15,279		502		—			502
Total Agency MBS	6,792,768		227,384		(58		)	—			7,024,517		7,225,460		202,397		(1,454		)	200,943
Non-Agency MBS (3)
Rated AAA	25,209		158		(219		)	—			25,148		25,905		757		—			757
Rated A	1,147		24		—			—			1,171		1,086		—		(85		)	(85		)
Rated BBB	49,301		637		(1,741		)	(378		)	47,819		48,563		1,806		(1,062		)	744
Rated BB	118,031		39		(8,892		)	(853		)	108,325		112,905		4,937		(357		)	4,580
Rated B	247,532		—		(31,133		)	(12,462		)	203,937		225,281		21,452		(108		)	21,344
Rated CCC	1,235,638		14		(107,618		)	(201,126		)	926,908		1,055,757		131,826		(2,977		)	128,849
Rated CC	579,632		—		(41,191		)	(132,061		)	406,380		468,017		61,739		(102		)	61,637
Rated C	952,984		—		(55,294		)	(166,529		)	731,161		812,523		81,850		(488		)	81,362
Unrated and D-rated (4)	3,300,086		—		(125,538		)	(867,097		)	2,307,451		2,632,128		325,796		(1,119		)	324,677
Total Non-Agency MBS	6,509,560		872		(371,626		)	(1,380,506		)	4,758,300		5,382,165		630,163		(6,298		)	623,865
Total MBS	$	13,302,328	$	228,256	$	(371,684	)	$	(1,380,506	)	$	11,782,817	$	12,607,625	$	832,560	$	(7,752	)	$	824,808

(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, 2013 reflect Credit Reserve of $1.266 billion and OTTI of $46.9 million. Amounts disclosed at December 31, 2012 reflect Credit Reserve of $1.332 billion and OTTI of $48.7 million.

(2) Includes principal payments receivable of $3.7 million and $4.4 million at March 31, 2013 and December 31, 2012, respectively, which are not included in the Principal/Current Face.

(3) Non-Agency MBS, including Non-Agency MBS transferred to consolidated VIEs, are reported based on the lowest rating issued by a Rating Agency, if more than one rating is issued on the security, at the date presented.

(4) Includes 268 Non-Agency MBS that were D-rated and had an aggregate amortized cost and fair value of $2.348 billion and $2.754 billion, respectively, at March 31, 2013 and 246 Non-Agency MBS that were D-rated and had an aggregate amortized cost and fair value of $2.252 billion and $2.573 billion, respectively, at December 31, 2012.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

Unrealized Losses on MBS and Impairments

The following table presents information about the Company’s MBS that were in an unrealized loss position at March 31, 2013:

Unrealized Loss Position For:

	Less than 12 Months					12 Months or more					Total
	Fair		Unrealized		Number of	Fair		Unrealized		Number of	Fair		Unrealized
(In Thousands)	Value		Losses		Securities	Value		Losses		Securities	Value		Losses
Agency MBS:
Fannie Mae	$	550,988	$	2,063	66	$	42,957	$	777	11	$	593,945	$	2,840
Freddie Mac	525,500		3,015		63	2,623		2		1	528,123		3,017
Total Agency MBS	1,076,488		5,078		129	45,580		779		12	1,122,068		5,857
Non-Agency MBS:
Rated A	—		—		—	989		41		2	989		41
Rated BBB	—		—		—	20,225		691		2	20,225		691
Rated BB	—		—		—	2,130		233		3	2,130		233
Rated CCC	—		—		—	23,683		1,476		4	23,683		1,476
Rated C	3,869		22		2	—		—		—	3,869		22
Unrated and other	15,190		88		1	16,563		72		2	31,753		160
Total Non-Agency MBS	19,059		110		3	63,590		2,513		13	82,649		2,623
Total MBS	$	1,095,547	$	5,188	132	$	109,170	$	3,292	25	$	1,204,717	$	8,480

At March 31, 2013, the Company did not intend to sell any of its MBS that were in an unrealized loss position, and it is “more likely than not” that the Company will not be required to sell these MBS before recovery of their amortized cost basis, which may be at their maturity. With respect to Non-Agency MBS held by consolidated VIEs, the ability of any entity to cause the sale by the VIE prior to the maturity of these Non-Agency MBS is either specifically precluded, or is limited to specified events of default, none of which have occurred to date.

Gross unrealized losses on the Company’s Agency MBS were $5.9 million at March 31, 2013. 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 their maturity, the Company considers 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, 2013 any unrealized losses on its Agency MBS were temporary.

Unrealized losses on the Company’s Non-Agency MBS (including Non-Agency MBS transferred to consolidated VIEs) were $2.6 million at March 31, 2013. 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 due to non-credit related factors. 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 MBS, which considers recent bond performance and expected future performance of the underlying collateral.

The Company did not recognize any credit-related OTTI losses through earnings during the three months ended March 31, 2013. The Company recognized credit-related OTTI losses through earnings of $920,000 on Non-Agency MBS during the three months ended March 31, 2012.

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 its Non-Agency MBS is based on its review of the underlying mortgage loans securing these MBS. The Company considers information available about the structure of the securitization, including structural credit enhancement, if any, and the past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, FICO scores at loan origination, year of origination, loan-to-value ratios, geographic concentrations, as well as Rating Agency reports, general market assessments, and dialogue with market participants. Significant judgment is used in both the Company’s analysis of the expected cash flows for its Non-Agency MBS and any determination of the credit component of OTTI.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

The following table presents the composition of OTTI charges recorded by the Company for the three months ended March 31, 2013 and 2012:

	Three Months Ended
	March 31,
(In Thousands)	2013		2012
Total OTTI losses	$	—	$	(879	)
OTTI reclassified from OCI	—		(41		)
OTTI recognized in earnings	$	—	$	(920	)

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)	2013		2012
Credit loss component of OTTI at beginning of period	$	36,115	$	34,915
Additions for credit related OTTI not previously recognized	—		458
Subsequent additional credit related OTTI recorded	—		462
Credit loss component of OTTI at end of period	$	36,115	$	35,835

The significant inputs considered and assumptions made at time of impairment in determining the measurement of the component of OTTI recorded in earnings for the Company’s Non-Agency MBS for the three months ended March 31, 2013 and March 31, 2012 are summarized as follows:

	Three Months Ended
	March 31,
	2013	2012
Credit enhancement (1) (2)
Weighted average (3)	—	4.40%
Range (4)	—	0.00-16.50%

Projected CPR (2) (5)
Weighted average (3)	—	10.20%
Range (4)	—	9.40-13.30%

Projected Loss Severity (2) (6)
Weighted average (3)	—	55.40%
Range (4)	—	45.90-60.00%

60+ days delinquent (2) (7)
Weighted average (3)	—	21.50%
Range (4)	—	18.20-23.80%

(1) Represents a level of protection for these securities, expressed as a percentage of total current underlying loan balance.

(2) Information provided is based on loans for all groups that provide credit enhancement for MBS with credit enhancement. If an MBS no longer has credit enhancement, information provided is based on loans for the individual group owned by the Company.

(3) Calculated by weighting the relevant input/assumptions for each individual security by current outstanding face of the security.

(4) Represents the range of inputs/assumptions based on individual securities.

(5) CPR - conditional prepayment rate.

(6) Projected loss severity represents the projected amount of loss realized on liquidated properties as a percentage of the principal balance.

(7) Includes, for each security, underlying loans 60 or more days delinquent, foreclosed loans and other real estate owned.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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, 2013 and March 31, 2012:

	Three Months Ended						Three Months Ended
	March 31, 2013						March 31, 2012
	Discount						Discount
	Designated as						Designated as
	Credit Reserve			Accretable			Credit Reserve			Accretable
(In Thousands)	and OTTI (1)			Discount (1) (2)			and OTTI (3)			Discount (2)(3)

Balance at beginning of period	$	(1,380,506	)	$	(371,626	)	$	(1,228,766	)	$	(250,479	)
Accretion of discount	—			12,051			—			9,410
Realized credit losses	50,307			—			22,394			—
Purchases	(23,535		)	11,229			(108,449		)	(7,433		)
Sales	6,283			932			—			—
Reclass discount for OTTI	—			—			684			(684		)
Net impairment losses recognized in earnings	—			—			(920		)	—
Unlinking of Linked Transactions	—			—			(38,579		)	(6,078		)
Transfers/release of credit reserve	34,499			(34,499		)	8,918			(8,918		)
Balance at end of period	$	(1,312,952	)	$	(381,913	)	$	(1,344,718	)	$	(264,182	)

(1) In addition, the Company reallocated $13,000 of purchase discount designated as Credit Reserve to accretable purchase discount on Non-Agency MBS underlying Linked Transactions during the three months ended March 31, 2013.

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

(3) The Company reallocated $629,000 of purchase discount designated as accretable purchase discount to Credit Reserve on Non-Agency MBS underlying Linked Transactions during the three months ended March 31, 2012.

Impact of MBS on AOCI

The following table presents the impact of the Company’s MBS on its AOCI for the three months ended March 31, 2013 and 2012:

	Three Months Ended
	March 31,
(In Thousands)	2013			2012
AOCI from MBS:
Unrealized gain on MBS at beginning of period	$	824,808		$	55,491
Unrealized loss on Agency MBS, net	(27,291		)	(3,158		)
Unrealized gain on Non-Agency MBS, net	146,730			262,602
Reclassification adjustment for MBS sales included in net income	(1,360		)	(2,901		)
Reclassification adjustment for OTTI included in net income	—			920
Change in AOCI from MBS	$	118,079		$	257,463
Balance at end of period	$	942,887		$	312,954

Sales of MBS

During the first three months of 2013, the Company sold certain Non-Agency MBS for $6.1 million, realizing gross gains of $1.7 million. During the first three months of 2012, the Company sold certain Agency MBS for $71.1 million, realizing gross gains of $3.0 million. The Company has no continuing involvement with any of the sold MBS.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

MBS Interest Income

The following table presents the components of interest income on the Company’s Agency MBS for the three months ended March 31, 2013 and 2012:

	Three Months Ended March 31,
(In Thousands)	2013			2012
Coupon interest	$	57,504		$	64,008
Effective yield adjustment (1)	(14,717		)	(10,708		)
Agency MBS interest income	$	42,787		$	53,300

(1) Includes amortization of premium paid net of accretion of purchase discount. For Agency MBS, interest income is recorded at an effective yield, which reflects net premium amortization based on actual prepayment activity.

The following table presents components of interest income for the Company’s Non-Agency MBS (including MBS transferred to consolidated VIEs) for the three months ended March 31, 2013 and 2012:

	Three Months Ended March 31,
(In Thousands)	2013		2012
Coupon interest	$	67,933	$	60,860
Effective yield adjustment (1)	11,982		9,344
Non-Agency MBS interest income	$	79,915	$	70,204

(1) The effective yield adjustment is the difference between the net income calculated using the net yield, which is based on management’s estimates of future cash flows for Non-Agency MBS, less the current coupon yield.

4. Interest Receivable

The following table presents the Company’s interest receivable by investment category at March 31, 2013

and December 31, 2012:

	March 31,		December 31,
(In Thousands)	2013		2012
MBS interest receivable:
Fannie Mae	$	16,157	$	17,597
Freddie Mac	3,246		2,696
Ginnie Mae	23		24
Non-Agency MBS	22,658		23,707
Total MBS interest receivable	42,084		44,024
Money market and other investments	22		9
Total interest receivable	$	42,106	$	44,033

5. Derivatives

The Company’s derivatives are comprised of Swaps, which are designated as cash flow hedges against the interest rate risk associated with its borrowings, and Linked Transactions, which are not designated as hedging instruments. The following table presents the fair value of the Company’s derivative instruments and their balance sheet location at March 31, 2013 and December 31, 2012:

		Balance Sheet	March 31,			December 31,
Derivative Instrument	Designation	Location	2013			2012
(In Thousands)
Swaps, at fair value ($100.0 million notional at March 31, 2013)	Hedging	Assets	$	324		$	203
Linked Transactions, at fair value	Non-Hedging	Assets	$	12,572		$	12,704
Swaps, at fair value ($2.414 billion notional at March 31, 2013)	Hedging	Liabilities	$	(50,839	)	$	(63,034	)

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

Linked Transactions

The Company’s Linked Transactions are evaluated on a combined basis, reported as forward (derivative) instruments and presented as assets on the Company’s consolidated balance sheet at fair value. The fair value of Linked Transactions reflect the value of the underlying Non-Agency MBS, linked repurchase agreement borrowings and accrued interest receivable/payable on such instruments. The Company’s Linked Transactions are not designated as hedging instruments and, as a result, the change in the fair value and net interest income from Linked Transactions is reported in other income on the Company’s consolidated statements of operations.

The following tables present certain information about the Non-Agency MBS and repurchase agreements underlying the Company’s Linked Transactions at March 31, 2013 and December 31, 2012:

Linked Transactions at March 31, 2013

Linked Repurchase Agreements					Linked MBS
			Weighted									Weighted
			Average									Average
Maturity or Repricing	Balance		Interest Rate		Non-Agency MBS	Fair Value		Amortized Cost		Par/Current Face		Coupon Rate
(Dollars in Thousands)					(Dollars in Thousands)
Within 30 days	$	23,236	1.67	%	Rated AA	$	12,654	$	11,578	$	11,937	5.00	%
>30 days to 90 days	10,900		1.45		Rated A	3,019		2,431		3,178		0.75
Total	$	34,136	1.60	%	Rated BBB	8,270		7,121		8,680		2.53
					Rated BB	7,162		6,540		7,234		2.70
					Rated D	15,478		13,894		18,606		5.82
					Total	$	46,583	$	41,564	$	49,635	4.27	%

Linked Transactions at December 31, 2012

Linked Repurchase Agreements					Linked MBS
			Weighted									Weighted
			Average									Average
Maturity or Repricing	Balance		Interest Rate		Non-Agency MBS	Fair Value		Amortized Cost		Par/Current Face		Coupon Rate
(Dollars in Thousands)					(Dollars in Thousands)
Within 30 days	$	13,672	1.57	%	Rated AA	$	13,588	$	12,817	$	13,192	5.00	%
>30 days to 90 days	21,599		1.66		Rated A	3,075		2,548		3,342		0.76
Total	$	35,271	1.63	%	Rated BBB	8,299		7,226		8,847		2.55
					Rated BB	7,365		6,854		7,593		2.75
					Rated D	15,501		14,372		19,303		5.80
					Total	$	47,828	$	43,817	$	52,277	4.28	%

At March 31, 2013, Linked Transactions also included $175,000 of associated accrued interest receivable and $50,000 of accrued interest payable. At December 31, 2012, Linked Transactions also included $185,000 of associated accrued interest receivable and $38,000 of accrued interest payable.

Table of Contents

MFA FINANCIAL, INC.

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

The following table presents certain information about the components of the unrealized net gains and net interest income from Linked Transactions included in the Company’s consolidated statements of operations for the three months ended March 31, 2013 and 2012:

Components of Unrealized Net Gains and Net Interest Income from Linked Transactions	Three Months Ended March 31,
(In Thousands)	2013			2012
Interest income attributable to MBS underlying Linked Transactions	$	668		$	2,288
Interest expense attributable to linked repurchase agreement borrowings underlying Linked Transactions	(140		)	(504		)
Change in fair value of Linked Transactions included in earnings	1,008			5,915
Unrealized net gains and net interest income from Linked Transactions	$	1,536		$	7,699

Derivative Hedging Instruments

Consistent with market practice, the Company has agreements with its Swap counterparties that provide for the posting of collateral based on the fair values of its derivative contracts. Through this margining process, either the Company or its derivative counterparty may be required to pledge cash or securities as collateral. Collateral requirements vary by counterparty and change over time based on the market value, notional amount and remaining term of the derivative contract. Certain derivative contracts provide for cross collateralization with repurchase agreements with the same counterparty.

A number of the Company’s derivative contracts include financial covenants, which, if breached, could cause an event of default or early termination event to occur under such agreements. Such financial covenants include minimum net worth requirements and maximum debt-to-equity ratios. If the Company were to cause an event of default or trigger an early termination event pursuant to one of its derivative contracts, the counterparty to such agreement may have the option to terminate all of its outstanding derivative contracts with the Company and, if applicable, any close-out amount due to the counterparty upon termination of the derivative contracts would be immediately payable by the Company. The Company was in compliance with all of its financial covenants through March 31, 2013. At March 31, 2013, the aggregate fair value of assets needed to immediately settle derivative contracts that were in a liability position to the Company, if so required, was approximately $53.1 million, including accrued interest payable of approximately $2.2 million.

The following table presents the assets pledged as collateral against the Company’s derivative contracts at March 31, 2013 and December 31, 2012:

(In Thousands)	March 31, 2013		December 31, 2012
Agency MBS, at fair value	$	57,119	$	68,915
Restricted cash	5,017		5,016
Total assets pledged against derivative contracts	$	62,136	$