Buy This 9.6% Dividend Yielder
Adnan is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
MFA Financial (NYSE: MFA) offers a high dividend yield of 9.62% and has attractive relative valuations. The company operates as a hybrid REIT, which owns and invests in both, Agency and non-Agency MBS. Given the prevailing macroeconomic situation, I believe MFA Financial offers a great opportunity to benefit from its elevated dividend yield.
The company and Business Mix
Incorporated in 1997, MFA started its operations as a hybrid REIT in 1998. The company is self managed and seeks to invest in residential mortgage backed securities, both Agency and non-Agency, with the objective of generating elevated returns for distribution to its shareholders primarily as dividends.
The company increased its holdings for non-Agency MBS. At the end of the second quarter, around 35% of the company’s entire MBS portfolio was composed of non-Agency securities, while during the third quarter the company increased its holdings of non-Agency securities to 41% of the entire portfolio. In contrast, Invesco Mortgage (NYSE: IVR), another hybrid mortgage REIT owns an MBS portfolio in which non-Agency MBS constitute 14%. Therefore, a higher percentage of non-Agency MBS makes MFA favorable.
The company’s Agency MBS have a weighted average coupon of 3.6% and a 3-month weighted average CPR of 21.6%, while the high yielding non-Agency MBS have a coupon 5.9% and a CPR of 15.4%. The company holds securities with an average coupon of 4.45% and a CPR of 19%. In contrast, Annaly Capital (NYSE: NLY) has an MBS portfolio with an average coupon of 4.1% with a CPR of 20%. Both the higher prepayment speed and higher average coupon are a disadvantage for Annaly under the prevailing macroeconomic situation. Therefore, comparatively MFA is better positioned.
The company’s third quarter earnings remained disappointing. The revenues and earnings for the third quarter remained below expectations. The top line of $79.3 million remained behind its consensus mean estimate of 83.8 million, while earnings of $0.19 per share fell 5% short of its expectation of $0.2.
At the end of the third quarter of this year, MFA earned interest income of $125.14 million against 130.7 million at the end of the same quarter of the current year. Much of the deterioration in interest income was a result of a 21% decline in interest income accruing from Agency MBS, partially offset by a 54% surge in interest income from non-Agency MBS. The decline in interest income from Agency MBS was a direct result of the flattening of the yield curve due to Fed various programs including (Operation Twist, QE3 and now QE4). The increase in interest income from non-Agency MBS was partly due to an increase in the non-Agency MBS holdings of the company.
Interest expense increased 18% from a year ago to $45.8 million. Much of the increase in interest expense was blamed by the increase in the cost of funds (repurchase agreements). The lower interest income and higher interest expense led to a 13.7% decline in net interest income compared to the prior year. Other income increased 68% on a surge in unrealized net gains and net interest income from Linked Transactions. Operating expenses remained flat when compared to a year ago, leading to a bottom line that fell 6.8% compared to the bottom line of the same quarter of the previous year.
The stock offers an elevated dividend yield of 9.62% with a cash dividend coverage ratio of 10.8%, reflecting the fact that the company generates sufficient cash from operations on an annual basis to continue its dividend distribution. The company announced a dividend distribution of $0.2 per common share for the fourth quarter of the current year.
The stock trades at an 8% discount to its third quarter book value, compared to 5% discount for Invesco Mortgage. On the other hand Agency mortgage REITs like Annaly Capital, American Capital Agency and Armour Residential trade at 12%, 8% and 17% discounts, respectively.
I have a bullish stance on MFA as it has attractive valuations, a diversified MBS portfolio with higher percentage of non-Agency MBS and lower prepayment speeds. Among my other top picks within the Agency mortgage REITs are American Capital Agency and Armour Residential as both prepayment protected MBS portfolios offering elevated dividends yields.
equityfinancials has no positions in the stocks mentioned above. The Motley Fool owns shares of Annaly Capital Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!