MFA Financial Finds Promise in Nonperforming Mortgages

WASHINGTON — MFA Financial has carved out an impressive niche for itself by buying reperforming and nonperforming residential mortgages and securities.

The real estate investment trust has $900 million invested in these loans and $2.5 billion invested in step-up securities backed by such credits.

The New York-based institution argues it takes experience and the ability to do its own analysis to make it work, since the loans are not typically rated.

"You have to rely on your own credit work," William Gorin, MFA's chief executive, said during a Keefe, Bruyette & Woods conference here.

One drawback is that these step-up securities are structured as debt, so a mortgage REIT can only hold a limited amount.

On a step-up bond, the coupon rate increases over a set number of years.

If the loan pool still exists after three years, the coupon steps up by 300 basis points.

"So 400 basis points becomes 700 basis points," Gorin said. "If you are comfortable with the underlying loan collateral, which we are, we think the structure is very compelling."

Last year, $28 billion of these step-up securities were issued. So far, $7 billion have been issued this year.

MFA executives expect it is going to take a long time for the rating agencies to become comfortable in analyzing these step-up securities that are being issued by investment firms and hedge funds. And the lack of a rating excludes a lot of potential buyers.

The nonperforming mortgages are purchased from Fannie Mae, Freddie Mac, the Department of Housing and Urban Development and banks.

Prior to the mortgage crisis, MFA Financial mainly focused on investing in Fannie and Freddie mortgage-backed securities. As of March 31, the REIT held $4.5 billion in agency MBS.

"The agencies were the most liquid securities and with leverage they were generating 9% to 11%" return on equity, Gorin said. "But in times of stress, we made a transition to more credit-sensitive assets. We have done that in a big way."

Not everyone is headed in that direction. American Capital Agency Corp. remains focused on the Fannie-Freddie agency market.

"While we have been an agency-only REIT, we remain very comfortable with that business model," said Gary Kain, president, chief executive and chief information officer of the Bethesda, Md., mortgage REIT.

Speaking at the KBW conference this week, Kain noted that management took a defensive position in 2015 and reduced its leverage. "Valuations were stretched and we were concerned about interest rate risk as well," he said.

But now he is "pretty confident" that conditions are improving.

"With spreads materially wider than they were before — mortgages are more attractive," he said.

There is also an "understanding on the part of market participants that longer term rates are unlikely to move up dramatically from here."

Kain appeared to express support for the common securities platform that Fannie and Freddie are building under the direction of their regulator, the Federal Housing Finance Agency.

Merging Fannie MBS and the Freddie Participation Certificates into a "single security is something that will increase the liquidity of the market over time," Kain said.

"We think that is a good thing over the long run. In the intermediate or short-medium term, it is not a game-changer or that big of an issue from a return issue."

Meanwhile, the FHFA's decision to roll back REIT access to Federal Home Loan Bank advances diminished American Capital's plans to diversify its portfolio by purchasing nonagency mortgage-backeds.

"Without FHLB financing, to own triple-A securities and fund it in the wholesale market, is not very compelling," Kain said.