Form: 10-Q

Quarterly report pursuant to Section 13 or 15(d)

May 4, 2017

Documents

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, 2017
 
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
 
(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
 
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.  Yes o  No x
 
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
 
372,840,969 shares of the registrant’s common stock, $0.01 par value, were outstanding as of April 27, 2017.
 

Table of Contents

MFA FINANCIAL, INC.

TABLE OF CONTENTS
 
 
Page
 
 
PART I
FINANCIAL INFORMATION
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

Table of Contents



MFA FINANCIAL, INC.
CONSOLIDATED BALANCE SHEET




 (In Thousands Except Per Share Amounts)
 
March 31,
2017
 
December 31,
2016
 
 
(Unaudited)
 
 
Assets:
 
 

 
 

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

 
 

Agency MBS, at fair value ($3,361,376 and $3,540,401 pledged as collateral, respectively)
 
$
3,494,614

 
$
3,738,497

Non-Agency MBS, at fair value ($4,446,745 and $4,978,199 pledged as collateral, respectively)
 
5,468,178

 
5,651,412

Non-Agency MBS transferred to consolidated variable interest entities (“VIEs”), at fair value (1)
 
—

 
174,404

CRT securities, at fair value ($446,231 and $357,488 pledged as collateral, respectively)
 
498,067

 
404,850

Securities obtained and pledged as collateral, at fair value
 
371,333

 
510,767

Residential whole loans, at carrying value ($418,372 and $427,880 pledged as collateral, respectively)
 
573,715

 
590,540

Residential whole loans, at fair value ($745,044 and $734,331 pledged as collateral, respectively)
 
775,152

 
814,682

Cash and cash equivalents
 
421,572

 
260,112

Restricted cash
 
10,980

 
58,463

Other assets
 
286,495

 
280,295

Total Assets
 
$
11,900,106

 
$
12,484,022

 
 
 
 
 
Liabilities:
 
 

 
 

Repurchase agreements and other advances
 
$
8,137,102

 
$
8,687,268

Obligation to return securities obtained as collateral, at fair value
 
510,733

 
510,767

8% Senior Notes due 2042 (“Senior Notes”)
 
96,743

 
96,733

Other liabilities
 
99,581

 
155,352

Total Liabilities
 
$
8,844,159

 
$
9,450,120

 
 
 
 
 
Commitments and contingencies (See Note 11)
 


 


 
 
 
 
 
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; 372,819 and 371,854 shares issued
and outstanding, respectively
 
3,728

 
3,719

Additional paid-in capital, in excess of par
 
3,030,603

 
3,029,062

Accumulated deficit
 
(573,127
)
 
(572,641
)
Accumulated other comprehensive income
 
594,663

 
573,682

Total Stockholders’ Equity
 
$
3,055,947

 
$
3,033,902

Total Liabilities and Stockholders’ Equity
 
$
11,900,106

 
$
12,484,022

 

(1)
Non-Agency MBS transferred to consolidated VIEs at December 31, 2016 represented assets of the consolidated VIEs that can be used only to settle the obligations of each respective VIE.

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

1
Table of Contents

MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
 
Three Months Ended 
 March 31,
(In Thousands, Except Per Share Amounts)
 
2017
 
2016
Interest Income:
 
 

 
 

Agency MBS
 
$
17,894

 
$
23,997

Non-Agency MBS
 
80,163

 
80,305

Non-Agency MBS transferred to consolidated VIEs
 
2,080

 
5,847

CRT securities
 
6,376

 
2,692

Residential whole loans held at carrying value
 
8,690

 
4,436

Other interest-earning investments
 
1,699

 
—

Cash and cash equivalent investments
 
355

 
140

Interest Income
 
$
117,257

 
$
117,417

 
 
 
 
 
Interest Expense:
 
 

 
 

Repurchase agreements and other advances
 
$
48,339

 
$
45,395

Senior Notes and other interest expense
 
2,010

 
2,205

Interest Expense
 
$
50,349

 
$
47,600

 
 
 
 
 
Net Interest Income
 
$
66,908

 
$
69,817

 
 
 
 
 
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
 
$
13,773

 
$
12,348

Net gain on sales of MBS and U.S. Treasury securities
 
9,708

 
9,745

Other, net
 
4,512

 
619

Other Income, net
 
$
27,993

 
$
22,712

 
 
 
 
 
Operating and Other Expense:
 
 

 
 

Compensation and benefits
 
$
7,793

 
$
7,407

Other general and administrative expense
 
4,225

 
3,918

Loan servicing and other related operating expenses
 
4,409

 
3,134

Operating and Other Expense
 
$
16,427

 
$
14,459

 
 
 
 
 
Net Income
 
$
78,060

 
$
78,070

Less Preferred Stock Dividends
 
3,750

 
3,750

Net Income Available to Common Stock and Participating Securities
 
$
74,310

 
$
74,320

 
 
 
 
 
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)
 
2017
 
2016
Net income
 
$
78,060

 
$
78,070

Other Comprehensive Income/(Loss):
 
 
 
 
Unrealized (loss)/gain on Agency MBS, net
 
(8,052
)
 
13,226

Unrealized gain/(loss) on Non-Agency MBS, net
 
27,521

 
(58,840
)
Reclassification adjustment for MBS sales included in net income
 
(9,971
)
 
(10,485
)
Reclassification adjustment for other-than-temporary impairments included in net income
 
(414
)
 
—

Derivative hedging instrument fair value changes, net
 
11,897

 
(49,342
)
Other Comprehensive Income/(Loss)
 
20,981

 
(105,441
)
Comprehensive income/(loss) before preferred stock dividends
 
$
99,041

 
$
(27,371
)
Dividends declared on preferred stock
 
(3,750
)
 
(3,750
)
Comprehensive Income/(Loss) Available to Common Stock and Participating Securities
 
$
95,291

 
$
(31,121
)
 
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, 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 instrument 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


 
 
Three Months Ended March 31, 2016
(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, 2015
 
8,000

 
$
80

 
370,584

 
$
3,706

 
$
3,019,956

 
$
(572,332
)
 
$
515,851

 
$
2,967,261

Net income
 
—

 
—

 
—

 
—

 
—

 
78,070

 
—

 
78,070

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

 
—

 
589

 
4

 
302

 
—

 
—

 
306

Repurchase of shares of common stock (1)
 
—

 
—

 
(196
)
 
—

 
(1,324
)
 
—

 
—

 
(1,324
)
Equity based compensation expense
 
—

 
—

 
—

 
—

 
1,130

 
—

 
—

 
1,130

Accrued dividends attributable to stock-based awards
 
—

 
—

 
—

 
—

 
(173
)
 
—

 
—

 
(173
)
Dividends declared on common stock
 
—

 
—

 
—

 
—

 
—

 
(74,215
)
 
—

 
(74,215
)
Dividends declared on preferred stock
 
—

 
—

 
—

 
—

 
—

 
(3,750
)
 
—

 
(3,750
)
Dividends attributable to dividend equivalents
 
—

 
—

 
—

 
—

 
—

 
(218
)
 
—

 
(218
)
Change in unrealized losses on MBS, net
 
—

 
—

 
—

 
—

 
—

 
—

 
(56,099
)
 
(56,099
)
Derivative hedging instruments fair value changes, net
 
—

 
—

 
—

 
—

 
—

 
—

 
(49,342
)
 
(49,342
)
Balance at March 31, 2016
 
8,000

 
$
80

 
370,977

 
$
3,710

 
$
3,019,891

 
$
(572,445
)
 
$
410,410

 
$
2,861,646


(1)  For the three months ended March 31, 2017 and 2016, includes approximately $3.9 million (492,447 shares) and $1.3 million (196,333 shares), respectively surrendered for tax purposes related to equity-based compensation awards.

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Table of Contents

MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2017
 
2016
Cash Flows From Operating Activities:
 
 

 
 

Net income
 
$
78,060

 
$
78,070

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

 
 

Gain on sales of MBS and U.S. Treasury securities
 
(9,708
)
 
(9,745
)
Gain on sales of real estate owned
 
(875
)
 
(509
)
Other-than-temporary impairment charges
 
414

 
—

Accretion of purchase discounts on MBS and CRT securities and residential whole loans
 
(23,682
)
 
(22,083
)
Amortization of purchase premiums on MBS and CRT securities
 
8,029

 
8,143

Depreciation and amortization on real estate, fixed assets and other assets
 
210

 
272

Equity-based compensation expense
 
1,106

 
1,134

Unrealized gain on residential whole loans at fair value
 
(2,948
)
 
(6,226
)
Decrease/(increase) in other assets
 
5,241

 
(6,259
)
Decrease in other liabilities
 
(12,392
)
 
(3,798
)
Net cash provided by operating activities
 
$
43,455

 
$
38,999

 
 
 
 
 
Cash Flows From Investing Activities:
 
 

 
 

Principal payments on MBS and CRT securities and other investments
 
$
762,747

 
$
807,349

Proceeds from sales of MBS and U.S. Treasury securities
 
160,697

 
32,034

Purchases of MBS and CRT securities and other investments
 
(244,582
)
 
(375,404
)
Purchases of residential whole loans and capitalized advances
 
(5,027
)
 
(165,510
)
Principal payments on residential whole loans
 
35,453

 
21,666

Proceeds from sales of real estate owned
 
10,438

 
6,157

Redemption of Federal Home Loan Bank stock
 
10,422

 
10,475

Additions to leasehold improvements, furniture and fixtures
 
(133
)
 
(56
)
Net cash provided by investing activities
 
$
730,015

 
$
336,711

 
 
 
 
 
Cash Flows From Financing Activities:
 
 
 
 
Principal payments on repurchase agreements and other advances
 
(20,513,712
)
 
$
(19,776,510
)
Proceeds from borrowings under repurchase agreements and other advances
 
19,963,451

 
19,532,131

Principal payments on securitized debt
 
—

 
(10,133
)
Payments made for margin calls on repurchase agreements and interest rate swap agreements (“Swaps”)
 
(24,846
)
 
(117,800
)
Proceeds from reverse margin calls on repurchase agreements and Swaps
 
37,517

 
55,700

Proceeds from issuances of common stock
 
3,952

 
306

Dividends paid on preferred stock
 
(3,750
)
 
(3,750
)
Dividends paid on common stock and dividend equivalents
 
(74,622
)
 
(74,425
)
Net cash used in financing activities
 
$
(612,010
)
 
$
(394,481
)
Net increase/(decrease) in cash and cash equivalents
 
$
161,460

 
$
(18,771
)
Cash and cash equivalents at beginning of period
 
$
260,112

 
$
165,007

Cash and cash equivalents at end of period
 
$
421,572

 
$
146,236

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

 
$
(5,175
)
Transfer from residential whole loans to real estate owned
 
$
31,098

 
$
22,280

Dividends and dividend equivalents declared and unpaid
 
$
74,830

 
$
74,583

 
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, 2017



 
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 Notes 2(o) and 12)
 
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, 2016.  In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31, 2017 and results of operations for all periods presented have been made.  The results of operations for the three months ended March 31, 2017 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 and CRT securities (See Notes 3 and 15), income recognition and valuation of residential whole loans (See Notes 4 and 15), valuation of derivative instruments (See Notes 5(c) and 15) 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(o))  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 certain trusts established related to the acquisition of residential whole loans. Certain prior period amounts have been reclassified to conform to the current period presentation.
 

6
Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



(b)  MBS (including Non-Agency MBS transferred to consolidated VIEs) 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 statement 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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Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



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 15)
 
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, Fair Isaac Corporation (“FICO”) scores at loan origination, 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 Corporation (“S&P”) or Fitch, Inc. (collectively with Moody’s and S&P, “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, Federal Home Loan Bank advances 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. 


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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



(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 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(k) for Repurchase Agreements and Reverse Repurchase Agreements)

(d)  Residential Whole Loans

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 generally 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.

Residential Whole Loans at Carrying Value

Notwithstanding that the majority of these loans are considered to be performing substantially in accordance with their current contractual terms and conditions, the Company has 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, the Company has assessed that these loans 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. Such loans are initially recorded at fair value with no allowance for loan losses. Subsequent to acquisition, the recorded amount 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 this accounting model 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 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. A significant increase in

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



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. (See Notes 4 and 16)

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. Given the significant uncertainty associated with estimating the timing of and amount of cash flows associated with these loans that will be collected, and that the cash flows ultimately collected may be dependent on the value of the property securing the loan, the Company considers that accounting for these loans at fair value should result in a better reflection over time of the economic returns from 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. (See Notes 4 and 15)

(e)  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, 2017 or December 31, 2016.  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 $382.6 million and $208.9 million at March 31, 2017 and December 31, 2016, respectively.  (See Notes 7 and 15)
 
(f)  Restricted Cash
 
Restricted cash represents the Company’s cash held by its counterparties in connection with certain of the Company’s Swaps and/or repurchase agreements that is not available to the Company for general corporate purposes. Restricted cash may be applied against amounts due to repurchase agreement and/or Swap counterparties, or may be returned to the Company when the related collateral requirements are exceeded or at the maturity of the Swap or repurchase agreement.  The Company had aggregate restricted cash held as collateral or otherwise in connection with its Swaps and repurchase agreements of $11.0 million and $58.5 million at March 31, 2017 and December 31, 2016, respectively.  (See Notes 5(c), 6, 7 and 15)
 
(g)  Goodwill
 
At March 31, 2017 and December 31, 2016, 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, 2017, the Company had not recognized any impairment against its goodwill. Goodwill is included in Other assets on the Company’s consolidated balance sheets.

(h) 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

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NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



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))

(i)  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.
 
(j)  Resecuritization and Other Debt Issuance 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.  Other debt issuance and related costs include costs incurred by the Company in connection with issuing 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 resecuritization financings, amortization is based upon the actual repayments of the associated beneficial interests issued to third parties. 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.

(k)  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 15)
 
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

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



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(c))

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. Accrued interest payable on FHLB advances is included in Other liabilities on the Company’s consolidated balance sheet at December 31, 2016. (See Notes 6, 7 and 15)
 
(l)  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. (See Note 2(t))
 
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 has awarded dividend equivalents in connection with its equity-based awards.   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(m) and 14)
 

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



(m)  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 13)
 
(n)  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.
 
(o)  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 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 25% (or, for 2018 and subsequent taxable years, 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, 2017 and 2016, 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.


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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



 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, 2017, December 31, 2016, or March 31, 2016. The Company filed its 2015 tax return prior to September 15, 2016. The Company’s tax returns for tax years 2011 and 2013 through 2015 are open to examination.

(p)  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.

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 contract. The effect of this change is to reduce what would have otherwise been reported as fair value of the Swap. 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.

Although permitted under certain circumstances, the Company does not offset cash collateral receivables or payables against its net derivative positions for Swaps that have not been novated to a clearing house.  (See Notes 5(c), 7 and 15)

(q)  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 15)


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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



 (r)  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.
 
The Company has in prior years entered into several resecuritization transactions which resulted 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 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 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 16)

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.

(s)  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.
 
(t)  New Accounting Standards and Interpretations
 
Accounting Standards Adopted in 2017

Compensation - Stock Compensation - Improvements to Employee Share-Based Payment Accounting

In March 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). The amendments of this ASU require all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. ASU 2016-09 also allows an employer to repurchase more of an employee’s shares than it could prior to adoption of this ASU for tax withholding purposes without triggering liability accounting and to make a policy election to account for forfeitures as they occur. ASU 2016-09 was effective for the Company for annual periods, and interim periods within those annual periods, beginning after December 15, 2016. The Company’s adoption of ASU 2016-09 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, 2017



3.                   MBS and CRT Securities
 
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”); (iii) mortgages that have interest rates that reset more frequently (collectively, “ARM-MBS”); and (iv) 15 year and longer-term fixed rate mortgages. In addition, the Company also holds MBS that are structured with a contractual coupon step-up feature where the coupon increases up to 300 basis points at 36 months from issuance or sooner (“3 Year Step-up securities”). The majority of the Company’s 3 Year Step-up securities are backed by securitized re-performing and non-performing loans and the cash flows of the bond may not reflect the contractual cash flows of the underlying collateral. 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 (including Non-Agency MBS transferred to consolidated VIEs):  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. While the coupon payments are paid by Fannie Mae or Freddie Mac on a monthly basis, the payment of principal is dependent on the performance of loans in a reference pool of MBS securitized by Fannie Mae or Freddie Mac. As principal on loans in the reference pool are paid, principal payments on the securities are made and the principal balances of the securities are reduced. Consequently, CRT securities mirror the payment and prepayment behavior of the mortgage loans in the reference pool. 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. 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 significant 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, 2017



The following tables present certain information about the Company’s MBS and CRT securities at March 31, 2017 and December 31, 2016:
 
March 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
 
$
2,686,996

 
$
101,284

 
$
(49
)
 
$
—

 
$
2,788,231

 
$
2,808,236

 
$
39,653

 
$
(19,648
)
 
$
20,005

Freddie Mac
 
661,114

 
25,447

 
—

 
—

 
687,614

 
678,899

 
3,770

 
(12,485
)
 
(8,715
)
Ginnie Mae
 
7,231

 
130

 
—

 
—

 
7,361

 
7,479

 
118

 
—

 
118

Total Agency MBS
 
3,355,341

 
126,861

 
(49
)
 
—

 
3,483,206

 
3,494,614

 
43,541

 
(32,133
)
 
11,408

Non-Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Expected to Recover Par (3)(4)
 
2,640,311

 
57

 
(23,788
)
 
—

 
2,616,580

 
2,643,478

 
27,882

 
(984
)
 
26,898

Expected to Recover Less than Par (3)
 
3,145,353

 
—

 
(245,937
)
 
(653,337
)
 
2,246,079

 
2,824,700

 
579,929

 
(1,308
)
 
578,621

Total Non-Agency MBS (5)
 
5,785,664

 
57

 
(269,725
)
 
(653,337
)
 
4,862,659

 
5,468,178

 
607,811

 
(2,292
)
 
605,519

Total MBS
 
9,141,005

 
126,918

 
(269,774
)
 
(653,337
)
 
8,345,865

 
8,962,792

 
651,352

 
(34,425
)
 
616,927

CRT securities (6)
 
467,886

 
4,159

 
(4,875
)
 
—

 
467,170

 
498,067

 
30,975

 
(78
)
 
30,897

Total MBS and CRT securities
 
$
9,608,891

 
$
131,077

 
$
(274,649
)
 
$
(653,337
)
 
$
8,813,035

 
$
9,460,859

 
$
682,327

 
$
(34,503
)
 
$
647,824


December 31, 2016
(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
 
$
2,879,807

 
$
108,310

 
$
(51
)
 
$
—

 
$
2,988,066

 
$
3,014,464

 
$
45,706

 
$
(19,308
)
 
$
26,398

Freddie Mac
 
693,945

 
26,736

 
—

 
—

 
723,285

 
716,209

 
4,809

 
(11,885
)
 
(7,076
)
Ginnie Mae
 
7,550

 
136

 
—

 
—

 
7,686

 
7,824

 
138

 
—

 
138

Total Agency MBS
 
3,581,302

 
135,182

 
(51
)
 
—

 
3,719,037

 
3,738,497

 
50,653

 
(31,193
)
 
19,460

Non-Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Expected to Recover Par (3)(4)
 
2,847,398

 
57

 
(24,273
)
 
—

 
2,823,182

 
2,847,291

 
26,477

 
(2,368
)
 
24,109

Expected to Recover Less than Par (3)
 
3,359,200

 
—

 
(253,918
)
 
(694,241
)
 
2,411,041

 
2,978,525

 
570,318

 
(2,834
)
 
567,484

Total Non-Agency MBS (5)
 
6,206,598

 
57

 
(278,191
)
 
(694,241
)
 
5,234,223

 
5,825,816

 
596,795

 
(5,202
)
 
591,593

Total MBS
 
9,787,900

 
135,239

 
(278,242
)
 
(694,241
)
 
8,953,260

 
9,564,313

 
647,448

 
(36,395
)
 
611,053

CRT securities (6)
 
384,993

 
3,312

 
(5,557
)
 
—

 
382,748

 
404,850

 
22,105

 
(3
)
 
22,102

Total MBS and CRT securities
 
$
10,172,893

 
$
138,551

 
$
(283,799
)
 
$
(694,241
)
 
$
9,336,008

 
$
9,969,163

 
$
669,553

 
$
(36,398
)
 
$
633,155

 
(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, 2017 reflect Credit Reserve of $636.2 million and OTTI of $17.1 million.  Amounts disclosed at December 31, 2016 reflect Credit Reserve of $675.6 million and OTTI of $18.6 million.
(2)
Includes principal payments receivable of $1.1 million and $2.6 million at March 31, 2017 and December 31, 2016, 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 3 Year Step-up securities, which at March 31, 2017 had a $2.5 billion Principal/Current face, $2.4 billion amortized cost and $2.5 billion fair value. At December 31, 2016, 3Year Step-up securities had a $2.7 billion Principal/Current face, $2.7 billion amortized cost and $2.7 billion fair value.
(5)
At March 31, 2017 and December 31, 2016, the Company expected to recover approximately 89% and 89%, respectively, of the then-current face amount of Non-Agency MBS.
(6)
Amounts disclosed at March 31, 2017 includes CRT securities with a fair value of $362.1 million for which the fair value option has been elected. Such securities had gross unrealized gains of approximately $18.4 million at March 31, 2017. Amounts disclosed at December 31, 2016 includes CRT securities with a fair value of $271.2 million for which the fair value option has been elected. Such securities had gross unrealized gains of approximately $12.7 million and net unrealized losses of approximately $3,000 at December 31, 2016.
 


17
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017




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, 2017:
 
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
 
$
385,791

 
$
2,985

 
82

 
$
862,234

 
$
16,663

 
154

 
$
1,248,025

 
$
19,648

Freddie Mac
 
268,644

 
5,259

 
48

 
237,012

 
7,226

 
65

 
505,656

 
12,485

Total Agency MBS
 
654,435

 
8,244

 
130

 
1,099,246

 
23,889

 
219

 
1,753,681

 
32,133

Non-Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Expected to Recover Par (1)
 
207,251

 
399

 
4

 
126,702

 
585

 
12

 
333,953

 
984

Expected to Recover Less than Par (1)
 
3,504

 
80

 
2

 
50,019

 
1,228

 
9

 
53,523

 
1,308

Total Non-Agency MBS
 
210,755

 
479

 
6

 
176,721

 
1,813

 
21

 
387,476

 
2,292

Total MBS
 
865,190

 
8,723

 
136

 
1,275,967

 
25,702

 
240

 
2,141,157

 
34,425

CRT securities (2)
 
24,950

 
78

 
1

 
—

 
—

 
—

 
24,950

 
78

Total MBS and CRT securities
 
$
890,140

 
$
8,801

 
137

 
$
1,275,967

 
$
25,702

 
240

 
$
2,166,107

 
$
34,503


(1)
Based on management’s current estimates of future principal cash flows expected to be received.  
(2)
Amounts disclosed at March 31, 2017 includes CRT securities with a fair value of $25.0 million for which the fair value option has been elected. Such securities have unrealized losses of $78,000 at March 31, 2017.

At March 31, 2017, 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 $32.1 million at March 31, 2017.  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, 2017 any unrealized losses on its Agency MBS were temporary.

Gross unrealized losses on the Company’s Non-Agency MBS were $2.3 million at March 31, 2017. 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 recognized credit-related OTTI losses through earnings related to its Non-Agency MBS of $414,000 during three months ended March 31, 2017. The Company did not recognize any credit-related OTTI losses through earnings related to its investments during the three months ended March 31, 2016.

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

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



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, 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 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, 2017 and 2016:
 
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2017
 
2016
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)
 
2017
 
2016
Credit loss component of OTTI at beginning of period
 
$
37,305

 
$
36,820

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
 
$
37,719

 
$
36,820



19
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



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, 2017 and 2016:

 
 
Three Months Ended 
 March 31, 2017
 
Three Months Ended 
 March 31, 2016
(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
 
$
(694,241
)
 
$
(278,191
)
 
$
(787,541
)
 
$
(312,182
)
Accretion of discount
 
—

 
21,616

 
—

 
21,406

Realized credit losses
 
12,324

 
—

 
18,050

 
—

Purchases
 
—

 
—

 
(4,294
)
 
1,606

Sales
 
19,741

 
(3,897
)
 
12,020

 
12,040

Net impairment losses recognized in earnings
 
(414
)
 
—

 
—

 
—

Transfers/release of credit reserve
 
9,253

 
(9,253
)
 
4,201

 
(4,201
)
Balance at end of period
 
$
(653,337
)
 
$
(269,725
)
 
$
(757,564
)
 
$
(281,331
)

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

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, 2017 and 2016:
 
 
Three Months Ended March 31,
(In Thousands)
2017
 
2016
AOCI from AFS securities:
 
 

 
 

Unrealized gain on AFS securities at beginning of period
 
$
620,403

 
$
585,250

Unrealized (loss)/gain on Agency MBS, net
 
(8,052
)
 
13,226

Unrealized gain/(loss) on Non-Agency MBS, net
 
27,521

 
(58,840
)
Reclassification adjustment for MBS sales included in net income
 
(9,971
)
 
(10,485
)
Reclassification adjustment for OTTI included in net income
 
(414
)
 
—

Change in AOCI from AFS securities
 
9,084

 
(56,099
)
Balance at end of period
 
$
629,487

 
$
529,151

 
Sales of MBS
 
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.  During the three months ended March 31, 2016, the Company sold certain Non-Agency MBS for $32.0 million and realizing gross gains of $9.7 million. The Company has no continuing involvement with any of the sold MBS.


20
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



 Interest Income on MBS and CRT Securities
 
The following table presents the components of interest income on the Company’s MBS and CRT securities for the three months ended March 31, 2017 and 2016: 
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Agency MBS
 
 
 
 
Coupon interest
 
$
26,212

 
$
32,132

Effective yield adjustment (1)
 
(8,318
)
 
(8,135
)
Interest income
 
$
17,894

 
$
23,997

 
 
 
 
 
Legacy Non-Agency MBS
 
 
 
 
Coupon interest
 
$
34,662

 
$
40,309

Effective yield adjustment (2)
 
21,442

 
19,913

Interest income
 
$
56,104

 
$
60,222

 
 
 
 
 
3 Year Step-up securities
 
 
 
 
Coupon interest
 
$
25,965

 
$
24,370

Effective yield adjustment (1)
 
174

 
1,560

Interest income
 
$
26,139

 
$
25,930

 
 
 
 
 
CRT securities
 
 
 
 
Coupon interest
 
$
5,257

 
$
2,356

Effective yield adjustment (2)
 
1,119

 
336

Interest income
 
$
6,376

 
$
2,692

 
(1)  Includes amortization of premium paid net of accretion of purchase discount.  For Agency MBS and 3 Year Step-up securities, 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.

4.    Residential Whole Loans

Included on the Company’s consolidated balance sheets at March 31, 2017 and December 31, 2016 are approximately $1.3 billion and $1.4 billion, respectively, of residential whole loans arising from the Company’s 100% equity interest in certificates issued by certain trusts established to acquire the loans. Based on its evaluation of these interests and other factors, the Company has determined that the trusts are required to be consolidated for financial reporting purposes.

Residential Whole Loans at Carrying Value

Residential whole loans at carrying value totaled approximately $573.7 million and $590.5 million at March 31, 2017 and December 31, 2016, 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 3,150 and 3,226 Residential whole loans held at carrying value at March 31, 2017 and December 31, 2016, respectively.

As of March 31, 2017 the Company had established an allowance for loan losses of approximately $769,000 on its residential whole loan pools held at carrying value. For the three months ended March 31, 2017 and 2016, a net reversal of provision for loan losses of approximately $221,000 and $37,000 was recorded, respectively, which is included in Operating and Other expense on the Company’s consolidated statement of operations.


21
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



The following table presents the activity in the Company’s allowance for loan losses on its residential whole loan pools at carrying value for the three months ended March 31, 2017 and 2016:

 (In Thousands)
 
Three Months Ended March 31,
 
 
2017

2016
Balance at the beginning of period
 
$
990

 
$
1,165

Reversal of provisions for loan losses
 
(221
)
 
(37
)
Balance at the end of period
 
$
769

 
$
1,128


The following table presents information regarding estimates of the contractually required payments, the cash flows expected to be collected, and the estimated fair value of the residential whole loans held at carrying value acquired by the Company for the three months ended March 31, 2017 and 2016:

 (In Thousands)
 
Three Months Ended March 31,
 
 
2017
 
2016
Contractually required principal and interest
 
$
—

 
$
199,092

Contractual cash flows not expected to be collected (non-accretable yield)
 
—

 
(28,663
)
Expected cash flows to be collected
 
—

 
170,429

Interest component of expected cash flows (accretable yield)
 
—

 
(58,509
)
Fair value at the date of acquisition
 
$
—

 
$
111,920


The following table presents accretable yield activity for the Company’s residential whole loans held at carrying value for the three months ended March 31, 2017 and 2016:

 (In Thousands)
 
Three Months Ended March 31,
 
 
2017
 
2016
Balance at beginning of period
 
$
334,379

 
$
175,271

  Additions
 
—

 
58,509

  Accretion
 
(8,690
)
 
(4,436
)
  Reclassifications (to)/from non-accretable difference, net
 
(138
)
 
64

Balance at end of period
 
$
325,551

 
$
229,408


Accretable yield for 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 change. Therefore, the amount of accretable income recorded during the three months ended March 31, 2017 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.


22
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



The following table presents information regarding the Company’s residential whole loans held at fair value at March 31, 2017 and December 31, 2016:
 (Dollars in Thousands)
 
March 31, 2017
 
December 31, 2016
Outstanding principal balance
 
$
907,312

 
$
966,276

Aggregate fair value
 
$
775,152

 
$
814,682

Number of loans
 
3,558

 
3,812


During the three months ended March 31, 2017 and 2016, the Company recorded net gains on residential whole loans held at fair value of $13.8 million and $12.3 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, 2017 and 2016:
 (In Thousands)
 
Three Months Ended March 31,
 
 
2017
 
2016
Coupon payments and other income received
 
$
8,173

 
$
4,401

Net unrealized gains
 
2,948

 
6,226

Net gain on payoff/liquidation of loans
 
868

 
1,254

Net gain on transfer to REO
 
1,784

 
467

    Total
 
$
13,773

 
$
12,348



5.    Other Assets

The following table presents the components of the Company’s Other assets at March 31, 2017 and December 31, 2016:

(In Thousands)
 
March 31, 2017
 
December 31, 2016
REO
 
$
98,708

 
$
80,503

Corporate loan
 
93,002

 
85,800

Interest receivable
 
27,465

 
27,795

Swaps, at fair value
 
119

 
233

Goodwill
 
7,189

 
7,189

Prepaid and other assets
 
60,012

 
78,775

Total Other Assets
 
$
286,495

 
$
280,295


(a) Real Estate Owned

At March 31, 2017, the Company had 542 REO properties with an aggregate carrying value of $98.7 million. At December 31, 2016, the Company had 447 REO properties with an aggregate carrying value of $80.5 million.
 
During the three months ended March 31, 2017 and 2016, the Company reclassified 179 and 138 mortgage loans to REO at an aggregate estimated fair value less estimated selling costs of $31.1 million and $22.3 million, respectively, at the time of transfer. Such transfers occur when the Company takes possession of the property by foreclosing on the borrower or completes a “deed-in-lieu of foreclosure” transaction.

At March 31, 2017, $97.7 million of residential real estate property was held by the Company that was acquired either through a completed foreclosure proceeding or from completion of a deed-in-lieu of foreclosure or similar legal agreement. In addition, formal foreclosure proceedings were in process with respect to $29.2 million of residential whole loans held at carrying value and $467.9 million of residential whole loans held at fair value at March 31, 2017.


23
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



During the three months ended March 31, 2017 and 2016, the Company sold 84 and 50 REO properties for consideration of $12.7 million and $6.2 million, realizing net gains of approximately $875,000 and $509,000, respectively. These amounts are included in Other, net on the Company’s consolidated statements of operations. In addition, following an updated assessment of liquidation amounts expected to be realized that was performed on all REO held at the end of the first quarters of 2017 and 2016, downward adjustments of approximately $1.8 million and $1.8 million were recorded to reflect certain REO properties at the lower of cost or estimated fair value as of March 31, 2017 and 2016, respectively.

The following table presents the activity in the Company’s REO for the three months ended March 31, 2017 and 2016:
(In Thousands)
 
Three Months Ended March 31,
 
 
2017
 
2016
Balance at beginning of period
 
$
80,503

 
$
28,026

Adjustments to record at lower of cost or fair value
 
(1,823
)
 
(1,777
)
Transfer from residential whole loans (1)
 
31,098

 
22,280

Purchases and capital improvements
 
774

 
410

Disposals
 
(11,844
)
 
(5,648
)
Balance at end of period
 
$
98,708

 
$
43,291


(1)  Includes net gain recorded on transfer of approximately $1.3 million and $441,000, respectively, for the three months ended March 31, 2017 and 2016.

(b) Corporate Loan

The Company has entered into a loan agreement with an entity that originates loans and owns mortgage servicing rights (“MSRs”). The loan is secured by certain 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 $93.9 million was drawn at March 31, 2017. At March 31, 2017, the coupon paid by the borrower on the drawn amount is 7.50%, the remaining term associated with the loan is 3.3 years and remaining commitment period on any undrawn amount is 1.2 years. During the commitment period, the Company receives a commitment fee of 1% of the undrawn amount.
The term loan is recorded on the Company’s balance sheet at the drawn amount, with interest income recognized on an accrual basis. Commitment fees received are deferred and recognized as interest income over 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. 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. At March 31, 2017 no allowance for loan loss was recorded in relation to this loan.


24
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



(c) Derivative Instruments
 
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. The following table presents the fair value of the Company’s derivative instruments and their balance sheet location at March 31, 2017 and December 31, 2016:
 
 
 
 
 
 
 
March 31, 2017
 
December 31, 2016
Derivative Instrument
 
Designation 
 
Balance Sheet Location
 
Notional Amount
 
Fair Value
 
Notional Amount
 
Fair Value
(In Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Non-cleared legacy Swaps (1)
 
Hedging
 
Assets
 
$
300,000

 
$
119

 
$
350,000

 
$
233

Cleared Swaps (2)
 
Hedging
 
Liabilities
 
$
2,550,000

 
$
—

 
$
2,550,000

 
$
(46,954
)
 
(1)  Non-cleared legacy Swaps include Swaps executed and settled bilaterally with counterparties without the use of an organized exchange or central clearing house.
(2) Cleared Swaps include Swaps executed bilaterally with a counterparty in the over-the-counter market but then novated to a central clearing house, whereby the central clearing house becomes the counterparty to both of the original counterparties. Beginning in January 2017, variation margin payments on the Company’s cleared Swaps 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 contract. The effect of this change is to reduce what would have otherwise been reported as fair value of the Swap.
 
Swaps
 
Consistent with market practice, the Company has agreements with its Swap counterparties on contracts that are not required to be novated to a central clearing house 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.  In addition, Swaps novated to and cleared by a central clearing house are subject to initial margin requirements. Certain derivative contracts provide for cross collateralization with repurchase agreements with the same counterparty.
 
A number of the Company’s Swap 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 Swap contracts, the counterparty to such agreement may have the option to terminate all of its outstanding Swap contracts with the Company and, if applicable, any close-out amount due to the counterparty upon termination of the Swap contracts would be immediately payable by the Company.  The Company was in compliance with all of its financial covenants through March 31, 2017. 
 
The following table presents the assets pledged as collateral against the Company’s Swap contracts at March 31, 2017 and December 31, 2016:
 
(In Thousands)
 
March 31, 2017
 
December 31, 2016
Agency MBS, at fair value
 
$
31,125

 
$
32,468

Restricted cash
 
4,756

 
53,849

Total assets pledged against Swaps
 
$
35,881

 
$
86,317

 
The Company’s derivative hedging instruments, or a portion thereof, could become ineffective in the future if the associated repurchase agreements that such derivatives hedge fail to exist or fail to have terms that match those of the derivatives that hedge such borrowings.  At March 31, 2017, all of the Company’s derivatives were deemed effective for hedging purposes and no derivatives were terminated during the three months ended March 31, 2017 and 2016.
 
The Company’s Swaps designated as hedging transactions have the effect of modifying the repricing characteristics of the Company’s repurchase agreements and cash flows for such liabilities.  To date, no cost has been incurred at the inception of a Swap (except for certain transaction fees related to entering into Swaps cleared though a central clearing house), pursuant to which the Company agrees to pay a fixed rate of interest and receive a variable interest rate, generally based on one-month or three-

25
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



month London Interbank Offered Rate (“LIBOR”), on the notional amount of the Swap. The Company did not recognize any change in the value of its existing Swaps designated as hedges through earnings as a result of hedge ineffectiveness during the three months ended March 31, 2017 and 2016.
 
At March 31, 2017, the Company had Swaps designated in hedging relationships with an aggregate notional amount of $2.9 billion and extended 32 months on average with a maximum term of approximately 77 months. 

The following table presents certain information with respect to the Company’s Swap activity during the three months ended March 31, 2017:

(Dollars in Thousands)
 
Three Months Ended 
 March 31, 2017
New Swaps:
 
 
Number of new Swaps
 
—

Aggregate notional amount
 
$
—

Swaps amortized/expired:
 
 
Aggregate notional amount
 
$
50,000

Weighted average fixed-pay rate
 
0.67
%

The following table presents information about the Company’s Swaps at March 31, 2017 and December 31, 2016:
 
 
 
 
March 31, 2017
 
December 31, 2016
 
 Notional Amount
 
Weighted Average Fixed-Pay
Interest Rate
 
Weighted Average Variable
Interest Rate (2) 
Notional Amount 
 
Weighted Average Fixed-Pay
Interest Rate
 
 Weighted Average Variable
Interest Rate (2)
 
 
Maturity (1)
 
(Dollars in Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
Within 30 days
 
$
—

 
—
%
 
—
%
 
$
—

 
—
%
 
—
%
 
Over 30 days to 3 months
 
300,000

 
0.57

 
0.84

 
50,000

 
0.67

 
0.64

 
Over 3 months to 6 months
 
—

 
—

 
—

 
300,000

 
0.57

 
0.66

 
Over 6 months to 12 months
 
—

 
—

 
—

 
—

 
—

 
—

 
Over 12 months to 24 months
 
650,000

 
1.53

 
0.93

 
550,000

 
1.49

 
0.71

 
Over 24 months to 36 months
 
100,000

 
1.71

 
0.98

 
200,000

 
1.71

 
0.76

 
Over 36 months to 48 months
 
1,600,000

 
2.22

 
0.96

 
1,500,000

 
2.22

 
0.74

 
Over 48 months to 60 months
 
100,000

 
2.21

 
0.98

 
200,000

 
2.20

 
0.75

 
Over 60 months to 72 months
 
—

 
—

 
—

 
—

 
—

 
—

 
Over 72 months to 84 months (3)
 
100,000

 
2.75

 
0.98

 
100,000

 
2.75

 
0.74

 
Total Swaps
 
$
2,850,000

 
1.89
%
 
0.94
%
 
$
2,900,000

 
1.87
%
 
0.72
%

(1)  Each maturity category reflects contractual amortization and/or maturity of notional amounts.
(2)  Reflects the benchmark variable rate due from the counterparty at the date presented, which rate adjusts monthly or quarterly based on one-month or three-month LIBOR, respectively.
(3) Reflects one Swap with a maturity date of July 2023.
 

26
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



The following table presents the net impact of the Company’s derivative hedging instruments on its interest expense and the weighted average interest rate paid and received for such Swaps for the three months ended March 31, 2017 and 2016:
 
 
 
Three Months Ended 
 March 31,
(Dollars in Thousands)
 
2017
 
2016
Interest expense attributable to Swaps
 
$
7,809

 
$
10,650

Weighted average Swap rate paid
 
1.88
%
 
1.82
%
Weighted average Swap rate received
 
0.79
%
 
0.42
%
 
Impact of Derivative Hedging Instruments on AOCI
 
The following table presents the impact of the Company’s derivative hedging instruments on its AOCI for the three months ended March 31, 2017 and 2016:
 
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2017
 
2016
AOCI from derivative hedging instruments:
 
 
 
 
Balance at beginning of period
 
$
(46,721
)
 
$
(69,399
)
Net gain/(loss) on Swaps
 
11,897

 
(49,342
)
Balance at end of period
 
$
(34,824
)
 
$
(118,741
)



6.      Repurchase Agreements and Other Advances
 
Repurchase Agreements

The Company’s repurchase agreements are accounted for as secured borrowings and bear interest that is generally LIBOR-based.  (See Notes 2(k) and 7)  At March 31, 2017, the Company’s borrowings under repurchase agreements had a weighted average remaining term-to-interest rate reset of 17 days and an effective repricing period of 12 months, including the impact of related Swaps.  At December 31, 2016, the Company’s borrowings under repurchase agreements had a weighted average remaining term-to-interest rate reset of 19 days and an effective repricing period of 12 months, including the impact of related Swaps.

27
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



 
The following table presents information with respect to the Company’s borrowings under repurchase agreements and associated assets pledged as collateral at March 31, 2017 and December 31, 2016:
(Dollars in Thousands)
 
March 31,
2017
 
December 31,
2016
Repurchase agreement borrowings secured by Agency MBS
 
$
3,093,737

 
$
3,095,020

Fair value of Agency MBS pledged as collateral under repurchase agreements
 
$
3,330,251

 
$
3,280,689

Weighted average haircut on Agency MBS (1)
 
4.56
%
 
4.67
%
Repurchase agreement borrowings secured by Legacy Non-Agency MBS
 
$
1,573,545

 
$
1,690,937

Fair value of Legacy Non-Agency MBS pledged as collateral under repurchase agreements (2)
 
$
2,070,626

 
$
2,317,708

Weighted average haircut on Legacy Non-Agency MBS (1)
 
22.44
%
 
24.01
%
Repurchase agreement borrowings secured by 3 Year Step-up securities
 
$
1,875,157

 
$
2,035,531

Fair value of 3 Year Step-up securities pledged as collateral under repurchase agreements
 
$
2,376,119

 
$
2,574,691

Weighted average haircut on 3 Year Step-up securities (1)
 
21.52
%
 
21.70
%
Repurchase agreements secured by U.S. Treasuries
 
$
366,475

 
$
504,572

Fair value of U.S. Treasuries pledged as collateral under repurchase agreements
 
$
371,333

 
$
510,767

Weighted average haircut on U.S. Treasuries (1)
 
1.73
%
 
1.60
%
Repurchase agreements secured by CRT securities 
 
$
345,482

 
$
271,205

Fair value of CRT securities pledged as collateral under repurchase agreements
 
$
446,231

 
$
357,488

Weighted average haircut on CRT securities (1)
 
22.36
%
 
23.22
%
Repurchase agreements secured by residential whole loans (3)
 
$
836,203

 
$
832,060

Fair value of residential whole loans pledged as collateral under repurchase agreements
 
$
1,178,562

 
$
1,175,088

Weighted average haircut on residential whole loans (1)
 
25.16
%
 
25.03
%
Repurchase agreements secured by other investments
 
$
46,944

 
$
43,333

Fair value of other investments pledged as collateral under repurchase agreements
 
$
93,002

 
$
85,800

Weighted average haircut on other investments (1)
 
50.00
%
 
50.00
%
 
(1)
Haircut represents the percentage amount by which the collateral value is contractually required to exceed the loan amount.
(2) At December 31, 2016 includes $172.4 million of Legacy Non-Agency MBS acquired from consolidated VIEs that are eliminated from the Company’s consolidated balance sheets.
(3) Excludes $441,000 and $210,000 of unamortized debt issuance costs at March 31, 2017 and December 31, 2016, respectively.

The following table presents repricing information about the Company’s borrowings under repurchase agreements, which does not reflect the impact of associated derivative hedging instruments, at March 31, 2017 and December 31, 2016:

 
 
March 31, 2017
 
December 31, 2016
 Balance 
 
Weighted Average Interest Rate
Balance
 
Weighted Average Interest Rate
Time Until Interest Rate Reset
(Dollars in Thousands)
 
 
 
 
 
 
 
 
Within 30 days
 
$
7,502,995

 
1.86
%
 
$
7,284,062

 
1.77
%
Over 30 days to 3 months
 
634,548

 
2.41

 
1,188,416

 
1.91

Total repurchase agreements
 
8,137,543

 
1.91
%
 
8,472,478

 
1.48
%
Less debt issuance costs
 
441

 
 
 
210

 
 
Total repurchase agreements less debt
  issuance costs
 
$
8,137,102

 
 
 
$
8,472,268

 
 


28
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



The following table presents contractual maturity information about the Company’s borrowings under repurchase agreements, all of which are accounted for as secured borrowings, at March 31, 2017, and does not reflect the impact of derivative contracts that hedge such repurchase agreements:

 
 
March 31, 2017
Contractual Maturity
 
Overnight
 
Within 30 Days
 
Over 30 Days to 3 Months
 
Over 3 Months to 12 Months
 
Over 12 months
 
Total
(Dollars in Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
Agency MBS
 
$
—

 
$
3,093,737

 
$
—

 
$
—

 
$
—

 
$
3,093,737

Legacy Non-Agency MBS
 
—

 
926,866

 
336,316

 
310,363

 
—

 
1,573,545

3 Year Step-up securities
 
—

 
894,904

 
304,141

 
676,112

 
—

 
1,875,157

U.S. Treasuries
 
—

 
366,475

 
—

 
—

 
—

 
366,475

CRT securities
 
—

 
327,674

 
17,808

 
—

 
—

 
345,482

Residential whole loans
 
—

 
—

 
—

 
805,595

 
30,608

 
836,203

Other investments
 
—

 
46,944

 
—

 
—

 
—

 
46,944

Total (1)
 
$
—

 
$
5,656,600

 
$
658,265

 
$
1,792,070

 
$
30,608

 
$
8,137,543

 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted Average Interest Rate
 
—
%
 
1.56
%
 
2.41
%
 
2.80
%
 
3.36
%
 
1.91
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross amount of recognized liabilities for repurchase agreements in Note 8
 
$
8,137,543

Amounts related to repurchase agreements not included in offsetting disclosure in Note 8
 
$
—


(1)
Excludes $441,000 of unamortized debt issuance costs at March 31, 2017.


29
Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



The Company had repurchase agreements with 31 counterparties at both March 31, 2017 and December 31, 2016, respectively.  The following table presents information with respect to each counterparty under repurchase agreements for which the Company had greater than 5% of stockholders’ equity at risk in the aggregate at March 31, 2017:
 
 
 
March 31, 2017
 
 
Counterparty
Rating (1)
 
Amount 
at Risk (2)
 
Weighted 
Average Months 
to Maturity for
Repurchase Agreements
 
Percent of
Stockholders’ Equity
Counterparty
 
 
 
 
(Dollars in Thousands)
 
 
 
 
 
 
 
 
Wells Fargo (3)
 
AA-/Aa2/AA
 
$
262,489

 
6
 
8.6
%
Credit Suisse (4)
 
BBB+/Aa2/A-
 
244,263

 
6
 
8.0

RBC (5)
 
AA-/Aa3/AA
 
241,521

 
1
 
7.9

Goldman Sachs
 
BBB+/A3/A
 
210,562

 
1
 
6.9

UBS (6)
 
A+/A1/A+
 
167,321

 
14
 
5.5


(1)
As rated at March 31, 2017 by S&P, Moody’s and Fitch, Inc., respectively.  The counterparty rating presented is the lowest published for these entities.
(2)
The amount at risk reflects the difference between (a) the amount loaned to the Company through repurchase agreements, including interest payable, and (b) the cash and the fair value of the securities pledged by the Company as collateral, including accrued interest receivable on such securities.
(3)
Includes $248.7 million at risk with Wells Fargo Bank, NA and $13.8 million at risk with Wells Fargo Securities LLC.
(4)
Includes $196.7 million at risk with Credit Suisse AG, Cayman Islands and $47.5 million at risk with Credit Suisse. Counterparty ratings are not published for Credit Suisse AG, Cayman Islands.
(5)
Includes $226.8 million at risk with RBC Barbados, $9.3 million at risk with Royal Bank of Canada and $5.4 million at risk with RBC Capital
Markets LLC. Counterparty ratings are not published for RBC Barbados and RBC Capital Markets LLC.
(6) Includes Non-Agency MBS pledged as collateral with contemporaneous repurchase and reverse repurchase agreements.


FHLB Advances

In January 2016, 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, 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. At December 31, 2016, MFA Insurance had $215.0 million in outstanding long-term secured FHLB advances with a weighted average borrowing rate of 0.78%. Interest payable on outstanding FHLB advances at December 31, 2016 totaled approximately $42,000 and was included in Other liabilities on the Company’s consolidated balance sheets.

7.      Collateral Positions
 
The Company pledges securities or cash as collateral to its counterparties pursuant to its borrowings under repurchase agreements, certain of its Swap contracts that are not centrally cleared that are in an unrealized loss position and for initial margin payments on centrally cleared Swaps, and it receives securities or cash as collateral pursuant to financing provided under reverse repurchase agreements and certain of its Swap contracts that are not centrally cleared that are in an unrealized gain position.  The Company exchanges collateral with its counterparties based on changes in the fair value, notional amount and term of the associated repurchase agreements and Swap contracts, as applicable.  In connection with these margining practices, either the Company or its counterparty may be required to pledge cash or securities as collateral.  When the Company’s pledged collateral exceeds the required margin, the Company may initiate a reverse margin call, at which time the counterparty may either return the excess collateral or provide collateral to the Company in the form of cash or equivalent securities.


30
Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



The following table summarizes the fair value of the Company’s collateral positions, which includes collateral pledged and collateral held, with respect to its borrowings under repurchase agreements, reverse repurchase agreements, derivative hedging instruments and FHLB advances at March 31, 2017 and December 31, 2016: 
 
 
March 31, 2017
 
December 31, 2016
(In Thousands)
 
Assets Pledged
 
Collateral Held
 
Assets Pledged
 
Collateral Held
Derivative Hedging Instruments:
 
 

 
 

 
 

 
 

Agency MBS
 
$
31,125

 
$
—

 
$
32,468

 
$
—

Cash (1)
 
4,756

 
—

 
53,849

 
—

 
 
35,881

 
—

 
86,317

 
—

Repurchase Agreement Borrowings:
 
 
 
 

 
 

 
 

Agency MBS
 
3,330,251

 
—

 
3,280,689

 
—

Legacy Non-Agency MBS (2)(3)
 
2,070,626

 
—

 
2,317,708

 
—

3 Year Step-up securities
 
2,376,119

 
—

 
2,574,691

 
—

U.S. Treasury securities
 
371,333

 
—

 
510,767

 
—

CRT securities
 
446,231

 
—

 
357,488

 
—

Residential whole loans
 
1,178,562

 
—

 
1,175,088

 
—

Other investments
 
93,002

 
—

 
85,800

 
—

Cash (1)
 
6,224

 
—

 
4,614

 
—

 
 
9,872,348

 
—

 
10,306,845

 
—

 
 
 
 
 
 
 
 
 
FHLB Advances:
 
 
 
 
 
 
 
 
Agency MBS
 
—

 
—

 
227,244

 
—

 
 
—

 
—

 
227,244

 
—

 
 
 
 
 
 
 
 
 
Reverse Repurchase Agreements:
 
 

 
 

 
 

 
 

U.S. Treasury securities
 
—

 
510,733

 
—

 
510,767

 
 
—

 
510,733

 
—

 
510,767

Total
 
$
9,908,229

 
$
510,733

 
$
10,620,406

 
$
510,767

 
(1)  Cash pledged as collateral is reported as “Restricted cash” on the Company’s consolidated balance sheets.
(2)  At December 31, 2016 includes $172.4 million of Legacy Non-Agency MBS acquired in connection with resecuritization transactions from consolidated VIEs that are eliminated from the Company’s consolidated balance sheets.
(3)  In addition, at March 31, 2017 and December 31, 2016, $687.8 million and $688.2 million of Legacy Non-Agency MBS, respectively, are pledged as collateral in connection with contemporaneous repurchase and reverse repurchase agreements entered into with a single counterparty.


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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



The following table presents detailed information about the Company’s assets pledged as collateral pursuant to its borrowings under repurchase agreements and derivative hedging instruments at March 31, 2017:
 
 
March 31, 2017
 
 
Assets Pledged Under Repurchase 
Agreements
 
Assets Pledged Against Derivative
Hedging Instruments
 
Total Fair
Value of Assets Pledged and Accrued Interest
(In Thousands)
 
Fair Value
 
Amortized
Cost
 
Accrued 
Interest on
Pledged 
Assets
 
Fair Value/ 
Carrying 
Value
 
Amortized
Cost
 
Accrued Interest on 
Pledged 
Assets
 
Agency MBS
 
$
3,330,251

 
$
3,318,013

 
$
8,344

 
$
31,125

 
$
31,917

 
$
64

 
$
3,369,784

Legacy Non-Agency MBS (1)
 
2,070,626

 
1,668,418

 
7,726

 
—

 
—

 
—

 
2,078,352

3 Year Step-up securities
 
2,376,119

 
2,371,887

 
1,536

 
—

 
—

 
—

 
2,377,655

U.S. Treasuries
 
371,333

 
374,081

 
—

 
—

 
—

 
—

 
371,333

CRT securities
 
446,231

 
417,091

 
279

 
—

 
—

 
—

 
446,510

Residential whole loans (2)
 
1,178,562

 
1,163,416

 
3,861

 
—

 
—

 
—

 
1,182,423

Other investments
 
93,002

 
93,002

 
572

 
—

 
—

 
—

 
93,574

Cash (3)
 
6,224

 
6,224

 
—

 
4,756

 
4,756

 
—

 
10,980

Total
 
$
9,872,348

 
$
9,412,132

 
$
22,318

 
$
35,881

 
$
36,673

 
$
64

 
$
9,930,611


(1)
In addition, at March 31, 2017, $687.8 million of Legacy Non-Agency MBS are pledged as collateral in connection with contemporaneous repurchase and reverse repurchase agreements entered into with a single counterparty.
(2)
Includes residential whole loans held at carrying value with an aggregate fair value of $433.5 million and aggregate amortized cost of $418.4 million and residential whole loans held at fair value with an aggregate fair value and amortized cost of $745.0 million.
(3)
Cash pledged as collateral is reported as “Restricted cash” on the Company’s consolidated balance sheets.

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



8.    Offsetting Assets and Liabilities
 
The following tables present information about certain assets and liabilities that are subject to master netting arrangements (or similar agreements) and may potentially be offset on the Company’s consolidated balance sheets at March 31, 2017 and December 31, 2016:
 
Offsetting of Financial Assets and Derivative Assets
 
 
Gross Amounts of Recognized Assets
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Amounts of Assets Presented in the Consolidated Balance Sheets
 
Gross Amounts Not Offset in 
the Consolidated Balance Sheets
 
 Net Amount
(In Thousands) 
Financial
Instruments
 
Cash 
Collateral 
Received
March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Swaps, at fair value
 
$
119

 
$
—

 
$
119

 
$
(119
)
 
$
—

 
$
—

Total
 
$
119

 
$
—

 
$
119

 
$
(119
)
 
$
—

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Swaps, at fair value
 
$
233

 
$
—

 
$
233

 
$
(233
)
 
$
—

 
$
—

Total
 
$
233

 
$
—

 
$
233

 
$
(233
)
 
$
—

 
$
—

 
Offsetting of Financial Liabilities and Derivative Liabilities 
 
 
Gross Amounts of Recognized Liabilities
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Amounts of Liabilities Presented in the Consolidated Balance Sheets
 
Gross Amounts Not Offset in the 
Consolidated Balance Sheets
 
Net Amount 
(In Thousands)
Financial 
Instruments (1)
 
Cash 
Collateral 
Pledged (1)
March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Swaps, at fair value (2)
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Repurchase agreements and other advances (3)(4)
 
8,137,543

 
—

 
8,137,543

 
(8,131,319
)
 
(6,224
)
 
—

Total
 
$
8,137,543

 
$
—

 
$
8,137,543

 
$
(8,131,319
)
 
$
(6,224
)
 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Swaps, at fair value (2)
 
$
46,954

 
$
—

 
$
46,954

 
$
—

 
$
(46,954
)
 
$
—

Repurchase agreements and other advances (3)(4)
 
8,687,478

 
—

 
8,687,478

 
(8,682,864
)
 
(4,614
)
 
—

Total
 
$
8,734,432

 
$
—

 
$
8,734,432

 
$
(8,682,864
)
 
$
(51,568
)
 
$
—

 
(1) Amounts disclosed in the Financial Instruments column of the table above represent collateral pledged that is available to be offset against liability balances associated with repurchase agreements and other advances, and derivative transactions.  Amounts disclosed in the Cash Collateral Pledged column of the table above represent amounts pledged as collateral against derivative transactions and repurchase agreements, and exclude excess collateral of $4.8 million and $6.9 million at March 31, 2017 and December 31, 2016, respectively.
(2) The fair value of securities pledged against the Company’s Swaps was $31.1 million and $32.5 million at March 31, 2017 and December 31, 2016, respectively. Beginning in January 2017, variation margin payments on the Company’s cleared Swaps 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 contract. The effect of this change is to reduce what would have otherwise been reported as fair value of the Swap.
(3) The fair value of financial instruments pledged against the Company’s repurchase agreements and other advances was $9.9 billion and $10.5 billion at March 31, 2017 and December 31, 2016, respectively.
(4) Excludes $441,000 and $210,000 of unamortized debt issuance costs at March 31, 2017 and December 31, 2016, respectively.
 

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



Nature of Setoff Rights
 
In the Company’s consolidated balance sheets, all balances associated with the repurchase agreement and Swap transactions that are not centrally cleared are presented on a gross basis.
 
Certain of the Company’s repurchase agreement and derivative transactions are governed by underlying agreements that generally provide for a right of setoff in the event of default or in the event of a bankruptcy of either party to the transaction.  For one repurchase agreement counterparty, the underlying agreements provide for an unconditional right of setoff.  

9.     Senior Notes
 
On April 11, 2012, the Company issued $100.0 million in aggregate principal amount of its Senior Notes in an underwritten public offering.  The total net proceeds to the Company from the offering of the Senior Notes were approximately $96.6 million, after deducting offering expenses and the underwriting discount.  The Senior Notes bear interest at a fixed rate of 8.00% per year, paid quarterly in arrears on January 15, April 15, July 15 and October 15 of each year and will mature on April 15, 2042.  The Senior Notes have an effective interest rate, including the impact of amortization to interest expense of debt issuance costs, of 8.31%. The Company may redeem the Senior Notes, in whole or in part, at any time on or after April 15, 2017, at a redemption price equal to 100% of the principal amount redeemed plus accrued and unpaid interest to, but not excluding, the redemption date.

The Senior Notes are the Company’s senior unsecured obligations and are subordinate to all of the Company’s secured indebtedness, which includes the Company’s repurchase agreements, obligation to return securities obtained as collateral and other financing arrangements, to the extent of the value of the collateral securing such indebtedness.
 
10. Other Liabilities

The following table presents the components of the Company’s Other liabilities at March 31, 2017 and December 31, 2016:

(In Thousands)
 
March 31, 2017
 
December 31, 2016
Accrued interest payable
 
$
13,648

 
$
14,129

Swaps, at fair value (1)
 
—

 
46,954

Dividends and dividend equivalents payable
 
74,830

 
74,657

Accrued expenses and other liabilities
 
11,103

 
19,612

Total Other Liabilities
 
$
99,581

 
$
155,352


(1)
Beginning in January 2017, variation margin payments on the Company’s cleared Swaps 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 contract. The effect of this change is to reduce what would have otherwise been reported as fair value of the Swap.


11.    Commitments and Contingencies
 
Lease Commitments
 
The Company pays monthly rent pursuant to two operating leases.  The lease term for the Company’s headquarters in New York, New York extends through May 31, 2020.  The lease provides for aggregate cash payments ranging over time of approximately $2.5 million per year, paid on a monthly basis, exclusive of escalation charges.  In addition, as part of this lease agreement, the Company has provided the landlord a $785,000 irrevocable standby letter of credit fully collateralized by cash.  The letter of credit may be drawn upon by the landlord in the event that the Company defaults under certain terms of the lease.  In addition, the Company has a lease through December 31, 2021 for its off-site back-up facility located in Rockville Centre, New York, which provides for, among other things, lease payments totaling $32,000, annually.


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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



Corporate Loan

The Company has entered into a loan agreement with an entity that originates loans and owns MSRs. The loan is secured by certain 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 $93.9 million was drawn at March 31, 2017.


12.    Stockholders’ Equity
 
(a) Preferred Stock
 
Issuance of 7.50% Series B Cumulative Redeemable Preferred Stock (“Series B Preferred Stock”)

On April 15, 2013, the Company completed the issuance of 8.0 million shares of its Series B Preferred Stock with a par value of $0.01 per share, and a liquidation preference of $25.00 per share plus accrued and unpaid dividends, in an underwritten public offering. The Company’s Series B Preferred Stock is entitled to receive a dividend at a rate of 7.50% per year on the $25.00 liquidation preference before the Company’s common stock is paid any dividends and is senior to the Company’s common stock with respect to distributions upon liquidation, dissolution or winding up. Dividends on the Series B Preferred Stock are payable quarterly in arrears on or about March 31, June 30, September 30 and December 31 of each year. The Series B Preferred Stock is redeemable at $25.00 per share plus accrued and unpaid dividends (whether or not authorized or declared) exclusively at the Company’s option commencing on April 15, 2018 (subject to the Company’s right, under limited circumstances, to redeem the Series B Preferred Stock prior to that date in order to preserve its qualification as a REIT) and upon certain specified change in control transactions in which the Company’s common stock and the acquiring or surviving entity common securities would not be listed on the New York Stock Exchange (the “NYSE”), the NYSE MKT or NASDAQ, or any successor exchange.
The Series B Preferred Stock generally does not have any voting rights, subject to an exception in the event the Company fails to pay dividends on such stock for six or more quarterly periods (whether or not consecutive).  Under such circumstances, the Series B Preferred Stock will be entitled to vote to elect two additional directors to the Company’s Board of Directors (the “Board”), until all unpaid dividends have been paid or declared and set apart for payment.  In addition, certain material and adverse changes to the terms of the Series B Preferred Stock cannot be made without the affirmative vote of holders of at least 66 2/3% of the outstanding shares of Series B Preferred Stock.
The following table presents cash dividends declared by the Company on its Series B Preferred Stock from January 1, 2017 through March 31, 2017:

Declaration Date
Record Date
Payment Date
Dividend Per Share
February 17, 2017
March 6, 2017
March 31, 2017
$
0.46875


(b)  Dividends on Common Stock
 
The following table presents cash dividends declared by the Company on its common stock from January 1, 2017 through March 31, 2017:
 
Declaration Date (1)
Record Date
Payment Date
Dividend Per Share
March 8, 2017
March 29, 2017
April 28, 2017
$
0.20

(1)
 
(1)  At March 31, 2017, the Company had accrued dividends and dividend equivalents payable of $74.8 million related to the common stock dividend declared on March 8, 2017.
 

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



(c) Discount Waiver, Direct Stock Purchase and Dividend Reinvestment Plan (“DRSPP”)
 
On September 16, 2016, the Company filed a shelf registration statement on Form S-3 with the SEC under the Securities Act of 1933, as amended (the “1933 Act”), for the purpose of registering additional common stock for sale through its DRSPP.  Pursuant to Rule 462(e) of the 1933 Act, this shelf registration statement became effective automatically upon filing with the SEC and, when combined with the unused portion of the Company’s previous DRSPP shelf registration statements, registered an aggregate of 15 million shares of common stock.  The Company’s DRSPP is designed to provide existing stockholders and new investors with a convenient and economical way to purchase shares of common stock through the automatic reinvestment of dividends and/or optional cash investments.  At March 31, 2017, 14.0 million shares of common stock remained available for issuance pursuant to the DRSPP shelf registration statement.
 
During the three months ended March 31, 2017, the Company issued 514,324 shares of common stock through the DRSPP, raising net proceeds of approximately $4.0 million.  From the inception of the DRSPP in September 2003 through March 31, 2017, the Company issued 31,897,109 shares pursuant to the DRSPP, raising net proceeds of $266.9 million.
 
(d)  Stock Repurchase Program
 
As previously disclosed, in August 2005, the Company’s Board authorized a stock repurchase program (the “Repurchase Program”) to repurchase up to 4.0 million shares of its outstanding common stock.  The Board reaffirmed such authorization in May 2010.  In December 2013, the Board increased the number of shares authorized under the Repurchase Program to an aggregate of 10.0 million. Such authorization does not have an expiration date and, at present, there is no intention to modify or otherwise rescind such authorization.  Subject to applicable securities laws, repurchases of common stock under the Repurchase Program are made at times and in amounts as the Company deems appropriate, (including, in our discretion, through the use of one or more plans adopted under Rule 10b5-1 promulgated under the Securities Exchange Act of 1934, as amended (the “1934 Act”)) using available cash resources.  Shares of common stock repurchased by the Company under the Repurchase Program are cancelled and, until reissued by the Company, are deemed to be authorized but unissued shares of the Company’s common stock.  The Repurchase Program may be suspended or discontinued by the Company at any time and without prior notice. The Company did not repurchase any shares of its common stock during the three months ended March 31, 2017.  At March 31, 2017, 6,616,355 shares remained authorized for repurchase under the Repurchase Program.

(e)  Accumulated Other Comprehensive Income/(Loss)

The following table presents changes in the balances of each component of the Company’s AOCI for the three months ended March 31, 2017:
 
 
Three Months Ended 
 March 31, 2017
(In Thousands)
 
Net Unrealized
Gain/(Loss) on
AFS Securities
 
Net 
(Loss)/Gain
on Swaps
 
Total AOCI
Balance at beginning of period
 
$
620,403

 
$
(46,721
)
 
$
573,682

OCI before reclassifications
 
19,469

 
11,897

 
31,366

Amounts reclassified from AOCI (1)
 
(10,385
)
 
—

 
(10,385
)
Net OCI during the period (2)
 
9,084

 
11,897

 
20,981

Balance at end of period
 
$
629,487

 
$
(34,824
)
 
$
594,663


(1)  See separate table below for details about these reclassifications.
(2)  For further information regarding changes in OCI, see the Company’s consolidated statements of comprehensive income/(loss).
 

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017




The following table presents changes in the balances of each component of the Company’s AOCI for the three months ended March 31, 2016:
 
 
Three Months Ended 
 March 31, 2016
(In Thousands)
 
Net Unrealized
Gain/(Loss) on
AFS Securities
 
Net 
Loss
on Swaps
 
Total AOCI
Balance at beginning of period
 
$
585,250

 
$
(69,399
)
 
$
515,851

OCI before reclassifications
 
(45,614
)
 
(49,342
)
 
(94,956
)
Amounts reclassified from AOCI (1)
 
(10,485
)
 
—

 
(10,485
)
Net OCI during the period (2)
 
(56,099
)
 
(49,342
)
 
(105,441
)
Balance at end of period
 
$
529,151

 
$
(118,741
)
 
$
410,410


(1)  See separate table below for details about these reclassifications.
(2)  For further information regarding changes in OCI, see the Company’s consolidated statements of comprehensive income/(loss).
 
The following table presents information about the significant amounts reclassified out of the Company’s AOCI for the three months ended March 31, 2017:
 
 
Three Months Ended 
 March 31, 2017
 
 
Details about AOCI Components
 
Amounts Reclassified from AOCI
Affected Line Item in the Statement
Where Net Income is Presented
(In Thousands)
 
 
 
 
AFS Securities:
 
 
 
 
Realized gain on sale of securities
 
$
(9,971
)
 
Net gain on sales of MBS and U.S. Treasury securities
OTTI recognized in earnings
 
(414
)
 
Net impairment losses recognized in earnings
Total AFS Securities
 
$
(10,385
)
 
 
Total reclassifications for period
 
$
(10,385
)
 
 
 
The following table presents information about the significant amounts reclassified out of the Company’s AOCI for the three months ended March 31, 2016:
 
 
Three Months Ended 
 March 31, 2016
 
 
Details about AOCI Components
 
Amounts Reclassified from AOCI
Affected Line Item in the Statement
Where Net Income is Presented
(In Thousands)
 
 
 
 
AFS Securities:
 
 
 
 
Realized gain on sale of securities
 
$
(10,485
)
 
Net gain on sales of MBS and U.S. Treasury securities
OTTI recognized in earnings
 
—

 
Net impairment losses recognized in earnings
Total AFS Securities
 
$
(10,485
)
 
 
Total reclassifications for period
 
$
(10,485
)
 
 

At March 31, 2017 and December 31, 2016, the Company had unrealized losses recorded in AOCI of approximately $872,000 and $1.7 million, respectively, on securities for which OTTI had been recognized in earnings in prior periods.

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



13.    EPS Calculation
 
The following table presents a reconciliation of the earnings and shares used in calculating basic and diluted EPS for the three months ended March 31, 2017 and 2016:
 
 
 
Three Months Ended 
 March 31,
(In Thousands, Except Per Share Amounts)
 
2017
 
2016
Numerator:
 
 
 
 
Net income
 
$
78,060

 
$
78,070

Dividends declared on preferred stock
 
(3,750
)
 
(3,750
)
Dividends, dividend equivalents and undistributed earnings allocated to participating securities
 
(431
)
 
(395
)
Net income to common stockholders - basic and diluted
 
$
73,879

 
$
73,925

 
 
 
 
 
Denominator:
 
 
 
 
Weighted average common shares for basic and diluted earnings per share (1)
 
372,579

 
370,942

Basic and diluted earnings per share
 
$
0.20

 
$
0.20


(1)
At March 31, 2017, the Company had an aggregate of 2.3 million equity instruments outstanding that were not included in the calculation of diluted EPS for the three months ended March 31, 2017, as their inclusion would have been anti-dilutive.  These equity instruments were comprised of approximately 22,000 shares of restricted common stock with a weighted average grant date fair value of $7.12 and approximately 2.3 million RSUs (based on current estimate of expected share settlement amount) with a weighted average grant date fair value of $6.50. These equity instruments may have a dilutive impact on future EPS.  

14.    Equity Compensation, Employment Agreements and Other Benefit Plans
 
(a)  Equity Compensation Plan
 
In accordance with the terms of the Company’s Equity Compensation Plan (the “Equity Plan”), which was adopted by the Company’s stockholders on May 21, 2015 (and which amended and restated the Company’s 2010 Equity Compensation Plan), directors, officers and employees of the Company and any of its subsidiaries and other persons expected to provide significant services for the Company and any of its subsidiaries are eligible to receive grants of stock options (“Options”), restricted stock, RSUs, dividend equivalent rights and other stock-based awards under the Equity Plan.
 
Subject to certain exceptions, stock-based awards relating to a maximum of 12.0 million shares of common stock may be granted under the Equity Plan; forfeitures and/or awards that expire unexercised do not count towards this limit.  At March 31, 2017, approximately 7.1 million shares of common stock remained available for grant in connection with stock-based awards under the Equity Plan.  A participant may generally not receive stock-based awards in excess of 1.5 million shares of common stock in any one year and no award may be granted to any person who, assuming exercise of all Options and payment of all awards held by such person, would own or be deemed to own more than 9.8% of the outstanding shares of the Company’s common stock.  Unless previously terminated by the Board, awards may be granted under the Equity Plan until May 20, 2025.
 
Restricted Stock Units

Under the terms of the Equity Plan, RSUs are instruments that provide the holder with the right to receive, subject to the satisfaction of conditions set by the Compensation Committee of the Board (the “Compensation Committee”) at the time of grant, a payment of a specified value, which may be a share of the Company’s common stock, the fair market value of a share of the Company’s common stock, or such fair market value to the extent in excess of an established base value, on the applicable settlement date.  Although the Equity Plan permits the Company to issue RSUs that can settle in cash, all of the Company’s outstanding RSUs as of March 31, 2017 are designated to be settled in shares of the Company’s common stock.  The Company granted 758,750 and 615,000 RSUs during the three months ended March 31, 2017 and 2016, respectively. There were no RSUs forfeited during the three months ended March 31, 2017. During the three months ended March 31, 2016 an aggregate of 10,000 RSUs were forfeited. All RSUs outstanding at March 31, 2017 may be entitled to receive dividend equivalent payments depending on the terms and conditions of the award either in cash at the time dividends are paid by the Company, or for certain performance-based RSU awards, as a grant of stock at the time such awards are settled.  At March 31, 2017 and December 31, 2016, the Company had unrecognized

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



compensation expense of $7.8 million and $3.6 million, respectively, related to RSUs.  The unrecognized compensation expense at March 31, 2017 is expected to be recognized over a weighted average period of 2.3 years.

Restricted Stock
 
The Company did not award any shares of restricted common stock during the three months ended March 31, 2017 and 2016. At March 31, 2017 and December 31, 2016, the Company had unrecognized compensation expense of approximately $153,000 and $203,000, respectively, related to the unvested shares of restricted common stock.  The Company had accrued dividends payable of approximately $40,000 and $55,000 on unvested shares of restricted stock at March 31, 2017 and December 31, 2016, respectively.  The unrecognized compensation expense at March 31, 2017 is expected to be recognized over a weighted average period of nine months.

Dividend Equivalents
 
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 Equity Plan, and they are paid in cash or other consideration at such times and in accordance with such rules, as the Compensation Committee shall determine in its discretion.  Payments made on the Company’s outstanding dividend equivalent rights that have been granted as a separate instrument are charged to Stockholders’ Equity when common stock dividends are declared to the extent that such equivalents are expected to vest.  The Company did not make any payments in respect of such instruments during the three months ended March 31, 2017 and made payments of approximately $1,600 in respect of such separate instruments during the three months ended March 31, 2016. At March 31, 2017, there were no dividend equivalent rights outstanding, which had been awarded separately from, but in connection with, grants of RSUs made in prior years.
 
Options
 
The Company did not grant any stock options during the three months ended March 31, 2017 and 2016. At March 31, 2017, the Company had no stock options outstanding.
 
Expense Recognized for Equity-Based Compensation Instruments
 
The following table presents the Company’s expenses related to its equity-based compensation instruments for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2017
 
2016
RSUs
 
$
1,056

 
$
960

Restricted shares of common stock
 
50

 
152

Dividend equivalent rights
 
—

 
22

Total
 
$
1,106

 
$
1,134


(b)  Employment Agreements
 
At March 31, 2017, the Company had employment agreements with four of its officers, with varying terms that provide for, among other things, base salary, bonus and change-in-control payments upon the occurrence of certain triggering events.

(c)  Deferred Compensation Plans
 
The Company administers deferred compensation plans for its senior officers and non-employee directors (collectively, the “Deferred Plans”), pursuant to which participants may elect to defer up to 100% of certain cash compensation.  The Deferred Plans are designed to align participants’ interests with those of the Company’s stockholders.
 
Amounts deferred under the Deferred Plans are considered to be converted into “stock units” of the Company.  Stock units do not represent stock of the Company, but rather are a liability of the Company that changes in value as would equivalent shares

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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



of the Company’s common stock.  Deferred compensation liabilities are settled in cash at the termination of the deferral period, based on the value of the stock units at that time.  The Deferred Plans are non-qualified plans under the Employee Retirement Income Security Act of 1974 and, as such, are not funded.  Prior to the time that the deferred accounts are settled, participants are unsecured creditors of the Company.
 
The Company’s liability for stock units in the Deferred Plans is based on the market price of the Company’s common stock at the measurement date.  The following table presents the Company’s expenses related to its Deferred Plans for its non-employee directors and senior officers for the three months ended March 31, 2017 and 2016:
 
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2017
 
2016
Non-employee directors
 
$
114

 
$
49

Total
 
$
114

 
$
49

 
The following table presents the aggregate amount of income deferred by participants of the Deferred Plans through March 31, 2017 and December 31, 2016 that had not been distributed and the Company’s associated liability for such deferrals at March 31, 2017 and December 31, 2016:
 
 
 
March 31, 2017
 
December 31, 2016
(In Thousands)
Undistributed Income Deferred (1)
 
 Liability Under Deferred Plans
Undistributed Income Deferred (1)
 
 Liability Under Deferred Plans
Non-employee directors
 
$
1,208

 
$
1,519

 
$
1,066

 
$
1,263

Total
 
$
1,208

 
$
1,519

 
$
1,066

 
$
1,263


(1)  Represents the cumulative amounts that were deferred by participants through March 31, 2017 and December 31, 2016, which had not been distributed through such respective date.
 
(d)  Savings Plan
 
The Company sponsors a tax-qualified employee savings plan (the “Savings Plan”) in accordance with Section 401(k) of the Code.  Subject to certain restrictions, all of the Company’s employees are eligible to make tax-deferred contributions to the Savings Plan subject to limitations under applicable law.  Participant’s accounts are self-directed and the Company bears the costs of administering the Savings Plan.  The Company matches 100% of the first 3% of eligible compensation deferred by employees and 50% of the next 2%, subject to a maximum as provided by the Code.  The Company has elected to operate the Savings Plan under the applicable safe harbor provisions of the Code, whereby among other things, the Company must make contributions for all participating employees and all matches contributed by the Company immediately vest 100%.  For the three months ended March 31, 2017 and 2016, the Company recognized expenses for matching contributions of $87,500 and $86,000, respectively.
 
15.  Fair Value of Financial Instruments
 
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.  The three levels of valuation hierarchy are defined as follows:
 
Level 1 — Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
 
Level 2 — Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
 
Level 3 — Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
 

40
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MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



The following describes the valuation methodologies used for the Company’s financial instruments measured at fair value on a recurring basis, as well as the general classification of such instruments pursuant to the valuation hierarchy.
 
Securities Obtained and Pledged as Collateral/Obligation to Return Securities Obtained as Collateral
 
The fair value of U.S. Treasury securities obtained as collateral and the associated obligation to return securities obtained as collateral are based upon prices obtained from a third-party pricing service, which are indicative of market activity.  Securities obtained as collateral are classified as Level 1 in the fair value hierarchy.
 
MBS and CRT Securities
 
The Company determines the fair value of its Agency MBS, based upon prices obtained from third-party pricing services, which are indicative of market activity and repurchase agreement counterparties.
 
For Agency MBS, the valuation methodology of the Company’s third-party pricing services incorporate commonly used market pricing methods, trading activity observed in the marketplace and other data inputs.  The methodology also considers the underlying characteristics of each security, which are also observable inputs, including: collateral vintage, coupon, maturity date, loan age, reset date, collateral type, periodic and life cap, geography, and prepayment speeds.  Management analyzes pricing data received from third-party pricing services and compares it to other indications of fair value including data received from repurchase agreement counterparties and its own observations of trading activity observed in the marketplace.
 
In determining the fair value of its Non-Agency MBS and CRT securities, management considers a number of observable market data points, including prices obtained from pricing services and brokers as well as dialogue with market participants.  In valuing Non-Agency MBS, the Company understands that pricing services use observable inputs that include, in addition to trading activity observed in the marketplace, loan delinquency data, credit enhancement levels and vintage, which are taken into account to assign pricing factors such as spread and prepayment assumptions.  For tranches of Legacy Non-Agency MBS that are cross-collateralized, performance of all collateral groups involved in the tranche are considered.  The Company collects and considers current market intelligence on all major markets, including benchmark security evaluations and bid-lists from various sources, when available.
 
The Company’s Legacy Non-Agency MBS, 3 Year Step-up securities backed by re-performing and non-performing loans and CRT securities are valued using various market data points as described above, which management considers directly or indirectly observable parameters.  Accordingly, these securities are classified as Level 2 in the fair value hierarchy. The Company’s 3 Year Step-up securities reflecting investments in term notes backed by MSR-related collateral are valued using a similar process to Non-Agency MBS and CRT Securities. However, as the valuation of these securities requires certain significant unobservable inputs, the securities are classified as Level 3 in the fair value hierarchy.

Residential Whole Loans, at Fair Value
 
The Company determines the fair value of its residential whole loans held at fair value after considering valuations obtained from a third-party who specializes in providing valuations of residential mortgage loans trading activity observed in the marketplace. The Company’s residential whole loans held at fair value are classified as Level 3 in the fair value hierarchy.

Swaps
 
The Company determines the fair value of non-centrally cleared Swaps by considering valuations obtained from a third-party pricing service. For Swaps that are cleared by a central clearing house, valuations provided by the clearing house are used. All valuations obtained are tested with internally developed models that apply readily observable market parameters.  The Company considers the creditworthiness of both the Company and its counterparties, along with collateral provisions contained in each derivative agreement, from the perspective of both the Company and its counterparties.  All of the Company’s Swaps are subject either to bilateral collateral arrangements, or for cleared Swaps, to the clearing house’s margin requirements.  Consequently, no credit valuation adjustment was made in determining the fair value of such instruments.  Beginning in January 2017, variation margin payments on the Company’s cleared Swaps 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 contract. The effect of this change is to reduce what would have otherwise been reported as fair value of the Swap. Swaps are classified as Level 2 in the fair value hierarchy.

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Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



 
The following tables present the Company’s financial instruments carried at fair value on a recurring basis as of March 31, 2017 and December 31, 2016, on the consolidated balance sheets by the valuation hierarchy, as previously described:

Fair Value at March 31, 2017
 
(In Thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
 
Agency MBS
 
$
—

 
$
3,494,614

 
$
—

 
$
3,494,614

Non-Agency MBS
 
—

 
5,185,846

 
282,332

 
5,468,178

CRT securities
 
—

 
498,067

 
—

 
498,067

Securities obtained and pledged as collateral
 
371,333

 
—

 
—

 
371,333

Residential whole loans, at fair value
 
—

 
—

 
775,152

 
775,152

Swaps
 
—

 
119

 
—

 
119

Total assets carried at fair value
 
$
371,333

 
$
9,178,646

 
$
1,057,484

 
$
10,607,463

Liabilities:
 
 

 
 

 
 

 
 

Swaps
 
$
—

 
$
—

 
$
—

 
$
—

Obligation to return securities obtained as collateral
 
510,733

 
—

 
—

 
510,733

Total liabilities carried at fair value
 
$
510,733

 
$
—

 
$
—

 
$
510,733


Fair Value at December 31, 2016
 
(In Thousands)
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 

 
 

 
 

 
 

Agency MBS
 
$
—

 
$
3,738,497

 
$
—

 
$
3,738,497

Non-Agency MBS, including MBS transferred to consolidated VIEs
 
—

 
5,825,816

 
—

 
5,825,816

CRT securities
 
—

 
404,850

 
—

 
404,850

Securities obtained and pledged as collateral
 
510,767

 
—

 
—

 
510,767

Residential whole loans, at fair value
 
—

 
—

 
814,682

 
814,682

Swaps
 
—

 
233

 
—

 
233

Total assets carried at fair value
 
$
510,767

 
$
9,969,396

 
$
814,682

 
$
11,294,845

Liabilities:
 
 

 
 

 
 

 
 

Swaps
 
$
—

 
$
46,954

 
$
—

 
$
46,954

Obligation to return securities obtained as collateral
 
510,767

 
—

 
—

 
510,767

Total liabilities carried at fair value
 
$
510,767

 
$
46,954

 
$
—

 
$
557,721


 

42
Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis

The following table presents additional information for the three months ended March 31, 2017 and 2016 about the Company’s Residential whole loans, at fair value, which are classified as Level 3 and measured at fair value on a recurring basis:

 
 
Residential Whole Loans, at Fair Value
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Balance at beginning of period
 
$
814,682

 
$
623,276

Purchases and capitalized advances
 
5,333

 
53,590

Changes in fair value recorded in Net gain on residential whole loans held at fair value
 
2,948

 
6,226

Collection of principal, net of liquidation gains/losses
 
(20,043
)
 
(14,602
)
  Repurchases
 
(306
)
 
—

  Transfer to REO
 
(27,462
)
 
(21,130
)
Balance at end of period
 
$
775,152

 
$
647,360



The following table presents additional information for the three months ended March 31, 2017 and 2016 about the Company’s investments in term notes backed by MSR-related collateral held at fair value, which are classified as Level 3 and measured at fair value on a recurring basis:

 
 
Term Notes Backed by MSR-Related Collateral
 
 
Three Months Ended March 31,
(In Thousands)
 
2017
 
2016
Balance at beginning of period
 
$
—

 
$
—

Purchases
 
150,000

 
—

  Collection of principal
 
(8,648
)
 
—

  Transfers from Level 2 to Level 3 (1)
 
140,980

 
—

Balance at end of period
 
$
282,332

 
$
—


(1) Investments in term notes backed by MSR-related collateral were transferred from Level 2 to Level 3 during the three months ended March 31, 2017 as there has been very limited secondary market trading in these securities since issuance. Transfers between levels are deemed to take place on the first day of the reporting period in which the transfer has taken place.

The Company did not transfer any assets or liabilities from one level to another during the three months ended March 31, 2016.


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Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



Fair Value Methodology for Level 3 Financial Instruments

Residential Whole Loans, at Fair Value

The following table presents a summary of quantitative information about the significant unobservable inputs used in the fair value measurement of the Company’s residential whole loans held at fair value for which it has utilized Level 3 inputs to determine fair value as of March 31, 2017 and December 31, 2016:

 
 
March 31, 2017
(Dollars in Thousands)
 
Fair Value (1)
 
Valuation Technique
 
Unobservable Input
 
Weighted Average (2)
 
Range
 
 
 
 
 
 
 
 
 
 
 
Residential whole loans, at fair value
 
$
267,878

 
Discounted cash flow
 
Discount rate
 
6.6
%
 
5.0-7.7%
 
 
 
 
 
 
Prepayment rate
 
7.8
%
 
0.0-12.3%
 
 
 
 
 
 
Default rate
 
3.2
%
 
0.0-10.1%
 
 
 
 
 
 
Loss severity
 
12.8
%
 
0.0-100.0%
 
 
 
 
 
 
 
 
 
 
 
 
 
$
507,274

 
Liquidation model
 
Discount rate
 
7.7
%
 
6.2-26.9%
 
 
 
 
 
 
Annual change in home prices
 
1.9
%
 
(5.0)-10.7%
 
 
 
 
 
 
Liquidation timeline
(in years)
 
1.5

 
0.1-4.4
 
 
 
 
 
 
Current value of underlying properties (3)
 
$
641

 
$15-$4,900
Total
 
$
775,152

 
 
 
 
 
 
 
 

 
 
December 31, 2016
(Dollars in Thousands)
 
Fair Value (1)
 
Valuation Technique
 
Unobservable Input
 
Weighted Average (2)
 
Range
 
 
 
 
 
 
 
 
 
 
 
Residential whole loans, at fair value
 
$
253,287

 
Discounted cash flow
 
Discount rate
 
6.6
%
 
5.0-7.7%
 
 
 
 
 
 
Prepayment rate
 
7.6
%
 
0.0-12.0%
 
 
 
 
 
 
Default rate
 
2.9
%
 
0.0-9.7%
 
 
 
 
 
 
Loss severity
 
13.0
%
 
0.0-77.5%
 
 
 
 
 
 
 
 
 
 
 
 
 
$
516,014

 
Liquidation model
 
Discount rate
 
7.7
%
 
6.8-26.9%
 
 
 
 
 
 
Annual change in home prices
 
1.7
%
 
(9.2)-7.7%
 
 
 
 
 
 
Liquidation timeline
(in years)
 
1.6

 
0.1-4.4
 
 
 
 
 
 
Current value of underlying properties (3)
 
$
634

 
$5-$4,900
Total
 
$
769,301

 
 
 
 
 
 
 
 

(1) Excludes approximately zero and $45.4 million of loans for which management considers the purchase price continues to reflect the fair value of such loans at March 31, 2017 and December 31, 2016, respectively.
(2) Amounts are weighted based on the fair value of the underlying loan.
(3) The simple average value of the properties underlying residential whole loans held at fair value valued via a liquidation model was approximately $340,000 and $320,000 as of March 31, 2017 and December 31, 2016, respectively.


44
Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017




The following table presents the difference between the fair value and the aggregate unpaid principal balance of the Company’s residential whole loans for which the fair value option was elected, at March 31, 2017 and December 31, 2016:

 
 
March 31, 2017
 
December 31, 2016
(In Thousands)
 
Fair Value
 
Unpaid Principal Balance
 
Difference
 
Fair Value
 
Unpaid Principal Balance
 
Difference
Residential whole loans, at fair value
 
 
 
 
 
 
 
 
 
 
 
 
Total loans
 
$
775,152

 
$
907,311

 
$
(132,159
)
 
$
814,682

 
$
966,174

 
$
(151,492
)
Loans 90 days or more past due
 
$
523,637

 
$
626,554

 
$
(102,917
)
 
$
570,025

 
$
695,282

 
$
(125,257
)

Term Notes Backed by MSR-Related Collateral

The Company’s valuation process for term notes backed by MSR-related collateral 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 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. At March 31, 2017, the implied yields used in the valuation of these securities ranged from 4.0% to 6.6%. The weighted average yield to maturity was 5.25%. 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, who 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.

Changes to the valuation methodologies used with respect to the Company’s financial instruments are reviewed by management to ensure any such changes result in appropriate exit price valuations.  The Company will refine its valuation methodologies as markets and products develop and pricing methodologies evolve.  The methods described above may produce fair value estimates that may not be indicative of net realizable value or reflective of future fair values.  Furthermore, while the Company believes its valuation methods are appropriate and consistent with those used by market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.  The Company uses inputs that are current as of the measurement date, which may include periods of market dislocation, during which price transparency may be reduced.  The Company reviews the classification of its financial instruments within the fair value hierarchy on a quarterly basis, and management may conclude that its financial instruments should be reclassified to a different level in the future.
 

45
Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



The following table presents the carrying values and estimated fair values of the Company’s financial instruments at March 31, 2017 and December 31, 2016:
 
 
 
March 31, 2017
 
December 31, 2016
Carrying
Value
 
Estimated Fair Value
Carrying
Value
 
Estimated Fair Value
(In Thousands)
Financial Assets:
 
 
 
 
 
 
 
 
Agency MBS
 
$
3,494,614

 
$
3,494,614

 
$
3,738,497

 
$
3,738,497

Non-Agency MBS, including MBS transferred to consolidated VIEs
 
5,468,178

 
5,468,178

 
5,825,816

 
5,825,816

CRT securities
 
498,067

 
498,067

 
404,850

 
404,850

Securities obtained and pledged as collateral
 
371,333

 
371,333

 
510,767

 
510,767

Residential whole loans, at carrying value
 
573,715

 
608,209

 
590,540

 
621,548

Residential whole loans, at fair value
 
775,152

 
775,152

 
814,682

 
814,682

Cash and cash equivalents
 
421,572

 
421,572

 
260,112

 
260,112

Restricted cash
 
10,980

 
10,980

 
58,463

 
58,463

Corporate loan
 
93,002

 
93,002

 
85,800

 
85,800

Swaps
 
119

 
119

 
233

 
233

Financial Liabilities (1):
 
 
 
 
 
 
 
 
Repurchase agreements
 
8,137,102

 
8,137,251

 
8,472,268

 
8,472,078

FHLB advances
 
—

 
—

 
215,000

 
215,000

Obligation to return securities obtained as collateral
 
510,733

 
510,733

 
510,767

 
510,767

Senior Notes
 
96,743

 
100,591

 
96,733

 
101,111

Swaps
 
—

 
—

 
46,954

 
46,954


(1) Carrying value of Senior Notes and certain repurchase agreements is net of associated debt issuance costs.

In addition to the methodologies used to determine the fair value of the Company’s financial assets and liabilities reported at fair value on a recurring basis discussed on pages 41-45, the following methods and assumptions were used by the Company in arriving at the fair value of the Company’s other financial instruments presented in the above table that are not reported at fair value on a recurring basis:
 
Residential Whole Loans at Carrying Value:  The Company determines the fair value of its residential whole loans held at carrying 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. The Company’s residential whole loans held at carrying value are classified as Level 3 in the fair value hierarchy.
 
Cash and Cash Equivalents and Restricted Cash:  Cash and cash equivalents and restricted cash are comprised of cash held in overnight money market investments and demand deposit accounts.  At March 31, 2017 and December 31, 2016, the Company’s money market funds were invested in securities issued by the U.S. Government, or its agencies, instrumentalities, and sponsored entities, and repurchase agreements involving the securities described above.  Given the overnight term and assessed credit risk, the Company’s investments in money market funds are determined to have a fair value equal to their carrying value.

Corporate Loan: The Company determines the fair value of this loan after considering recent past and expected future loan performance, recent financial performance of the borrower and estimates of the current value of the underlying collateral, which includes certain MSRs and other assets of the borrower that are pledged to secure the borrowing. The Company’s investment in this term loan is classified as Level 3 in the fair value hierarchy.

Repurchase Agreements:  The fair value of repurchase agreements reflects the present value of the contractual cash flows discounted at market interest rates at the valuation date for repurchase agreements with a term equivalent to the remaining term to interest rate repricing, which may be at maturity.  Such interest rates are estimated based on LIBOR rates observed in the market.  The Company’s repurchase agreements are classified as Level 2 in the fair value hierarchy.


46
Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



FHLB Advances: As previously discussed, the Company did not have any FHLB advances as of March 31, 2017. FHLB advances at December 31, 2016 reflected collateralized borrowings at variable market interest rates that reset on a monthly basis. Accordingly, the carrying amount of FHLB advances were considered to approximate fair value. The Company’s FHLB advances at December 31, 2016 were classified as Level 2 in the fair value hierarchy.
 
Senior Notes:  The fair value of the Senior Notes is determined using the end of day market price quoted on the NYSE at the reporting date.  The Company’s Senior Notes are classified as Level 1 in the fair value hierarchy.

The Company holds REO at the lower of the current carrying amount or fair value less estimated selling costs. At March 31, 2017 and December 31, 2016, the Company’s REO had an aggregate carrying value of $98.7 million and $80.5 million, and an aggregate estimated fair value of $112.7 million and $91.1 million, respectively. The Company’s REO is classified as Level 3 in the fair value hierarchy.

16.  Use of Special Purpose Entities and Variable Interest Entities
 
A Special Purpose Entity (“SPE”) is an entity designed to fulfill a specific limited need of the company that organized it.  SPEs are often used to facilitate transactions that involve securitizing financial assets or resecuritizing previously securitized financial assets.  The objective of such transactions may include obtaining non-recourse financing, obtaining liquidity or refinancing the underlying securitized financial assets on improved terms.  Securitization involves transferring assets to a SPE to convert all or a portion of those assets into cash before they would have been realized in the normal course of business, through the SPE’s issuance of debt or equity instruments.  Investors in an SPE usually have recourse only to the assets in the SPE and, depending on the overall structure of the transaction, may benefit from various forms of credit enhancement such as over-collateralization in the form of excess assets in the SPE, priority with respect to receipt of cash flows relative to holders of other debt or equity instruments issued by the SPE, or a line of credit or other form of liquidity agreement that is designed with the objective of ensuring that investors receive principal and/or interest cash flow on the investment in accordance with the terms of their investment agreement. 

Resecuritization Transactions
 
The Company has in prior years entered into several resecuritization transactions that resulted in the Company consolidating as VIEs the SPEs that were created to facilitate the transactions and to which the underlying assets in connection with the resecuritizations were transferred. See Note 2(r) for a discussion of the accounting policies applied to the consolidation of VIEs and transfers of financial assets in connection with resecuritization transactions.
 
The Company has engaged in resecuritization transactions primarily for the purpose of obtaining non-recourse financing on a portion of its Non-Agency MBS portfolio, as well as refinancing a portion of its Non-Agency MBS portfolio on improved terms. Notwithstanding the Company’s participation in these transactions, the risks facing the Company are largely unchanged as the Company remains economically exposed to the first loss position on the underlying MBS transferred to the VIEs.
 
The activities that can be performed by an entity created to facilitate a resecuritization transaction are generally specified in the entity’s formation documents. Those documents do not permit the entity, any beneficial interest holder in the entity, or any other party associated with the entity to cause the entity to sell or replace the assets held by the entity, or limit such ability to when specific events of default occur.
 
The Company concluded that the entities created to facilitate these resecuritization transactions are VIEs.  The Company then completed an analysis of whether each VIE created to facilitate the resecuritization transaction should be consolidated by the Company, based on consideration of its involvement in each VIE, including the design and purpose of the SPE, and whether its involvement reflected a controlling financial interest that resulted in the Company being deemed the primary beneficiary of each VIE.  In determining whether the Company would be considered the primary beneficiary, the following factors were assessed:
 
•
Whether the Company has both the power to direct the activities that most significantly impact the economic performance of the VIE;  and
•
Whether the Company has a right to receive benefits or absorb losses of the entity that could be potentially significant to the VIE.
 
Based on its evaluation of the factors discussed above, including its involvement in the purpose and design of the entity, the Company determined that it was required to consolidate each VIE created to facilitate these resecuritization transaction.

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Table of Contents
MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2017



 
During the first quarter of 2017, the Company entered into a transaction to exchange the remaining beneficial interests issued by the WFMLT 2012-RR1 (the “Trust”) and held by the Company for the underlying securities that had previously been transferred to and held by the Trust.  Following the completion of this transaction, the remaining beneficial interests were cancelled and the Trust was terminated.

For financial reporting purposes, the exchange transaction and termination of this financing structure did not result in any gain or loss to the Company as this resecuritization was accounted for as a financing transaction.  However, for purposes of determining REIT taxable income, this resecuritization transaction was originally accounted for as a sale of the underlying securities to the Trust and acquisition of beneficial interests issued by the Trust.  Because the fair value of the underlying securities received exceeded the Company’s tax basis in the remaining beneficial interests at the exchange date, the unwind of this resecuritization structure resulted in the Company recognizing taxable income currently estimated to be approximately $47.1 million or $0.13 per common share. In addition, the underlying securities originally transferred as part of this resecuritization are reported as Non-Agency MBS in the Company’s consolidated balance sheets at March 31, 2017 and interest income from the underlying securities from the date of exchange transaction through March 31, 2017 is reported as Interest income from Non-Agency MBS in the Company’s consolidated statements of operations.

As of March 31, 2017 the Company did not have any Non-Agency MBS that were resecuritized as described above. At December 31, 2016, the aggregate fair value of the Non-Agency MBS that were resecuritized as described above was $174.4 million.  These assets were included in the Company’s consolidated balance sheets and disclosed as “Non-Agency MBS transferred to consolidated VIEs, at fair value.”

Prior to the completion of the Company’s first resecuritization transaction in October 2010, the Company had not transferred assets to VIEs or QSPEs and other than acquiring MBS issued by such entities, had no other involvement with VIEs or QSPEs.

Residential Whole Loans

Included on the Company’s consolidated balance sheets as of March 31, 2017 and December 31, 2016 are a total of $1.3 billion and $1.4 billion of residential whole loans, of which approximately $573.7 million and $590.5 million are reported at carrying value and $775.2 million and $814.7 million are reported at fair value, respectively. The inclusion of these assets arises from the Company’s 100% equity interest in certain trusts established to acquire the loans. Based on its evaluation of its 100% interest in these trusts and other factors, the Company has determined that the trusts are required to be consolidated for financial reporting purposes. During the three months ended March 31, 2017 and 2016, the Company recognized interest income from residential whole loans reported at carrying value of approximately $8.7 million and $4.4 million, respectively, which is included in Interest Income on the Company’s consolidated statements of operations. In addition, the Company recognized net gains on residential whole loans held at fair value during the three months ended March 31, 2017 and 2016 of approximately $13.8 million and $12.3 million, respectively, which amounts are included in Other Income, net on the Company’s consolidated statements of operations. (See Note 4)

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Table of Contents

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
In this Quarterly Report on Form 10-Q, we refer to MFA Financial, Inc. and its subsidiaries as “the Company,” “MFA,” “we,” “us,” or “our,” unless we specifically state otherwise or the context otherwise indicates.
 
The following discussion should be read in conjunction with our financial statements and accompanying notes included in Item 1 of this Quarterly Report on Form 10-Q as well as our Annual Report on Form 10-K for the year ended December 31, 2016.

Forward Looking Statements

When used in this Quarterly Report on Form 10-Q, in future filings with the SEC or in press releases or other written or oral communications, statements which are not historical in nature, including those containing words such as “will,” “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “could,” “would,” “may” the negative of these words or similar expressions, are intended to identify “forward-looking statements” within the meaning of Section 27A of the 1933 Act and Section 21E of the 1934 Act and, as such, may involve known and unknown risks, uncertainties and assumptions.

These forward-looking statements include information about possible or assumed future results with respect to our business, financial condition, liquidity, results of operations, plans and objectives.  Statements regarding the following subjects, among others, may be forward-looking: changes in interest rates and the market value of our MBS; changes in the prepayment rates on the mortgage loans securing our MBS, an increase of which could result in a reduction of the yield on MBS in our portfolio and an increase of which could require us to reinvest the proceeds received by us as a result of such prepayments in MBS with lower coupons; credit risks underlying our assets, including changes in the default rates and management’s assumptions regarding default rates on the mortgage loans securing our Non-Agency MBS and relating to our residential whole loan portfolio; our ability to borrow to finance our assets and the terms, including the cost, maturity and other terms, of any such borrowings; implementation of or changes in government regulations or programs affecting our business; our estimates regarding taxable income the actual amount of which is dependent on a number of factors, including, but not limited to, changes in the amount of interest income and financing costs, the method elected by us to accrete the market discount on Non-Agency MBS and residential whole loans and the extent of prepayments, realized losses and changes in the composition of our Agency MBS, Non-Agency MBS and residential whole loan portfolios that may occur during the applicable tax period, including gain or loss on any MBS disposals and whole loan modification foreclosure and liquidation; the timing and amount of distributions to stockholders, which are declared and paid at the discretion of our Board and will depend on, among other things, our taxable income, our financial results and overall financial condition and liquidity, maintenance of our REIT qualification and such other factors as the Board deems relevant; our ability to maintain our qualification as a REIT for federal income tax purposes; our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended (or the Investment Company Act), including statements regarding the concept release issued by the SEC relating to interpretive issues under the Investment Company Act with respect to the status under the Investment Company Act of certain companies that are engaged in the business of acquiring mortgages and mortgage-related interests; our ability to successfully implement our strategy to grow our residential whole loan portfolio, which is dependent on, among other things, the supply of loans offered for sale in the market; expected returns on our investments in NPLs, which are affected by, among other things, the length of time required to foreclose upon, sell, liquidate or otherwise reach a resolution of the property underlying the NPL, home price values, amounts advanced to carry the asset (e.g., taxes, insurance, maintenance expenses, etc. on the underlying property) and the amount ultimately realized upon resolution of the asset; and risks associated with investing in real estate assets, including changes in business conditions and the general economy.  These and other risks, uncertainties and factors, including those described in the annual, quarterly and current reports that we file with the SEC, could cause our actual results to differ materially from those projected in any forward-looking statements we make.  All forward-looking statements are based on beliefs, assumptions and expectations of our future performance, taking into account all information currently available.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made.  New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us.  Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 
Business/General
 
We are a REIT primarily engaged in the business of investing, on a leveraged basis, in residential mortgage assets, including Agency MBS, Non-Agency MBS, residential whole loans and CRT securities.  Our principal business objective is to deliver shareholder value through the generation of distributable income and through asset performance linked to residential mortgage

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credit fundamentals. We selectively invest in residential mortgage assets with a focus on credit analysis, projected prepayment rates, interest rate sensitivity and expected return.
 
At March 31, 2017, we had total assets of approximately $11.9 billion, of which $9.0 billion, or 75.3%, represented our MBS portfolio.  At such date, our MBS portfolio was comprised of $3.5 billion of Agency MBS and $5.5 billion of Non-Agency MBS which includes $3.0 billion of Legacy Non-Agency MBS and $2.5 billion of MBS that are primarily structured with a contractual coupon step-up feature where the coupon increases up to 300 basis points at 36 months from issuance or sooner (or 3 Year Step-up securities). These 3 Year Step-up securities are primarily backed by securitized re-performing and non-performing loans. In addition, at March 31, 2017, we had approximately $1.3 billion in residential whole loans acquired through our consolidated trusts, which represented approximately 11.3% of our total assets. Our remaining investment-related assets were primarily comprised of collateral obtained in connection with reverse repurchase agreements, cash and cash equivalents (including restricted cash), CRT securities, REO, MBS-related receivables and derivative instruments.

The results of our business operations are affected by a number of factors, many of which are beyond our control, and primarily depend on, among other things, the level of our net interest income, the market value of our assets, which is driven by numerous factors, including the supply and demand for residential mortgage assets in the marketplace, the terms and availability of adequate financing, general economic and real estate conditions (both on a national and local level), the impact of government actions in the real estate and mortgage sector, and the credit performance of our credit sensitive residential mortgage assets.  Our net interest income varies primarily as a result of changes in interest rates, the slope of the yield curve (i.e., the differential between long-term and short-term interest rates), borrowing costs (i.e., our interest expense) and prepayment speeds on our MBS, the behavior of which involves various risks and uncertainties.  Interest rates and conditional prepayment rates (or CPRs) (which measure the amount of unscheduled principal prepayment on a bond as a percentage of the bond balance), vary according to the type of investment, conditions in the financial markets, competition and other factors, none of which can be predicted with any certainty.
 
With respect to our business operations, increases in interest rates, in general, may over time cause:  (i) the interest expense associated with our borrowings to increase; (ii) the value of our MBS portfolio and, correspondingly, our stockholders’ equity to decline; (iii) coupons on our ARM-MBS to reset, on a delayed basis, to higher interest rates; (iv) prepayments on our MBS to decline, thereby slowing the amortization of our MBS purchase premiums and the accretion of our purchase discounts; and (v) the value of our derivative hedging instruments and, correspondingly, our stockholders’ equity to increase.  Conversely, decreases in interest rates, in general, may over time cause:  (i) the interest expense associated with our borrowings to decrease; (ii) the value of our MBS portfolio and, correspondingly, our stockholders’ equity to increase; (iii) coupons on our ARM-MBS to reset, on a delayed basis, to lower interest rates; (iv) prepayments on our MBS to increase, thereby accelerating the amortization of our MBS purchase premiums and the accretion of our purchase discounts; and (v) the value of our derivative hedging instruments and, correspondingly, our stockholders’ equity to decrease.  In addition, our borrowing costs and credit lines are further affected by the type of collateral we pledge and general conditions in the credit market.
 
Our investments in residential mortgage assets expose us to credit risk, generally meaning that we are subject to credit losses due to the risk of delinquency, default and foreclosure on the underlying real estate collateral. We believe the discounted purchase prices paid on certain of these investments mitigate our risk of loss in the event that, as we expect on most such investments, we receive less than 100% of the par value of these investments.  Our investment process for credit sensitive assets focuses primarily on quantifying and pricing credit risk. 

As of March 31, 2017, approximately $5.4 billion, or 62.2%, of our MBS portfolio was in its contractual fixed-rate period or were fixed-rate MBS and approximately $3.3 billion, or 37.8%, was in its contractual adjustable-rate period, or were floating rate MBS with interest rates that reset monthly.  Our ARM-MBS in their contractual adjustable-rate period primarily include MBS collateralized by Hybrids for which the initial fixed-rate period has elapsed, such that the interest rate will typically adjust on an annual or semiannual basis. 
 
Premiums arise when we acquire MBS at a price in excess of the principal balance of the mortgages securing such MBS (i.e., par value).  Conversely, discounts arise when we acquire MBS at a price below the principal balance of the mortgages securing such MBS or acquire residential whole loans at a price below the principal balance of the mortgage.  Premiums paid on our MBS are amortized against interest income and accretable purchase discounts on these investments are accreted to interest income.  Purchase premiums, which are primarily carried on our Agency MBS and certain CRT securities, are amortized against interest income over the life of each security using the effective yield method, adjusted for actual prepayment activity.  An increase in the prepayment rate, as measured by the CPR, will typically accelerate the amortization of purchase premiums, thereby reducing the IRR/interest income earned on such assets. 
 

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CPR levels are impacted by, among other things, conditions in the housing market, new regulations, government and private sector initiatives, interest rates, availability of credit to home borrowers, underwriting standards and the economy in general.  In particular, CPR reflects the conditional repayment rate (or CRR), which measures voluntary prepayments of mortgages collateralizing a particular MBS, and the conditional default rate (or CDR), which measures involuntary prepayments resulting from defaults.  CPRs on Agency MBS and Legacy Non-Agency MBS may differ significantly.  For the three months ended March 31, 2017, our Agency MBS portfolio experienced a weighted average CPR of 15.1%, and our Legacy Non-Agency MBS portfolio experienced a weighted average CPR of 16.8%. Over the last consecutive eight quarters, ending with March 31, 2017, the monthly weighted average CPR on our Agency and Legacy Non-Agency MBS portfolios ranged from a high of 17.1% experienced during the month ended September 30, 2016 to a low of 11.3%, experienced during the month ended February 29, 2016, with an average CPR over such quarters of 14.9%.
 
Our method of accounting for Non-Agency MBS purchased at significant discounts to par value, requires us to make assumptions with respect to each security.  These assumptions include, but are not limited to, future interest rates, voluntary prepayment rates, default rates, mortgage modifications and loss severities.  As part of our Non-Agency MBS surveillance process, we track and compare each security’s actual performance over time to the performance expected at the time of purchase or, if we have modified our original purchase assumptions, to our revised performance expectations.  To the extent that actual performance or our expectation of future performance of our Non-Agency MBS deviates materially from our expected performance parameters, we may revise our performance expectations, such that the amount of purchase discount designated as credit discount may be increased or decreased over time.  Nevertheless, credit losses greater than those anticipated or in excess of the recorded purchase discount could occur, which could materially adversely impact our operating results.
 
It is our business strategy to hold our residential mortgage assets as long-term investments.  On at least a quarterly basis, excluding investments for which the fair value option has been elected or for which specialized loan accounting is otherwise applied, we assess our ability and intent to continue to hold each asset and, as part of this process, we monitor our MBS and CRT securities for other-than-temporary impairment.  A change in our ability and/or intent to continue to hold any of these securities that are in an unrealized loss position, or a deterioration in the underlying characteristics of these securities, could result in our recognizing future impairment charges or a loss upon the sale of any such security.  At March 31, 2017, we had net unrealized gains of $11.4 million on our Agency MBS, comprised of gross unrealized gains of $43.5 million and gross unrealized losses of $32.1 million and net unrealized gains on our Non-Agency MBS of $605.5 million, comprised of gross unrealized gains of $607.8 million and gross unrealized losses of $2.3 million. At March 31, 2017, we did not intend to sell any of our MBS or CRT securities that were in an unrealized loss position, and we believe it is more likely than not that we will not be required to sell those securities before recovery of their amortized cost basis, which may be at their maturity.
 
We rely primarily on borrowings under repurchase agreements to finance our residential mortgage assets.  Our residential mortgage investments have longer-term contractual maturities than our borrowings under repurchase agreements.  Even though the majority of our investments have interest rates that adjust over time based on short-term changes in corresponding interest rate indices (typically following an initial fixed-rate period for our Hybrids), the interest rates we pay on our borrowings will typically change at a faster pace than the interest rates we earn on our investments.  In order to reduce this interest rate risk exposure, we may enter into derivative instruments, which at March 31, 2017 were comprised of Swaps.
 
Our Swap derivative instruments are designated as cash-flow hedges against a portion of our current and forecasted LIBOR-based repurchase agreements.  Our Swaps do not extend the maturities of our repurchase agreements; they do, however, lock in a fixed rate of interest over their term for the notional amount of the Swap corresponding to the hedged item.  During the three months ended March 31, 2017, we did not enter into any new Swaps and had Swaps with an aggregate notional amount of $50.0 million and a weighted average fixed-pay rate of 0.67% amortize and/or expire. At March 31, 2017, we had Swaps designated in hedging relationships with an aggregate notional amount of $2.9 billion with a weighted average fixed-pay rate of 1.89% and a weighted average variable interest rate received of 0.94%.

Recent Market Conditions and Our Strategy
 
During the first quarter of 2017, we continued to invest in residential mortgage assets, primarily 3 Year Step-up securities and CRT securities.  At March 31, 2017, our MBS portfolio was approximately $9.0 billion compared to $9.6 billion at December 31, 2016. At March 31, 2017, our total investment in residential whole loans was $1.3 billion compared to $1.4 billion at December 31, 2016. We did not acquire any Agency MBS, Legacy Non-Agency MBS, or residential whole loans during the first quarter of 2017.

At March 31, 2017, $5.5 billion, or 61.0% of our MBS portfolio, was invested in Non-Agency MBS.  During the three months ended March 31, 2017, the fair value of our Non-Agency MBS holdings decreased by $357.6 million. The primary components of the change during the quarter in these Non-Agency MBS include $524.5 million of principal repayments and other principal

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reductions and the sale of Non-Agency MBS with a fair value of $21.6 million partially offset by $150.0 million of purchases (at a weighted average purchase price of 100.0%), and an increase reflecting Non-Agency MBS price changes of $38.5 million.

At March 31, 2017, $3.5 billion, or 39.0% of our MBS portfolio, was invested in Agency MBS.  During the three months ended March 31, 2017, the fair value of our Agency MBS decreased by $243.9 million. This was due to $227.5 million of principal repayments, $8.3 million of premium amortization and an $8.1 million decrease in net unrealized gains.

In this low interest rate environment, we continue to invest in more credit sensitive, less interest sensitive residential mortgage assets. At March 31, 2017, our total recorded investment in residential whole loans was $1.3 billion. Of this amount, $573.7 million is presented as residential whole loans at carrying value and $775.2 million as residential whole loans at fair value in our consolidated balance sheets. For the three months ended March 31, 2017, we recognized approximately $8.7 million of income on residential whole loans held at carrying value in Interest Income on our consolidated statements of operations, representing an effective yield of 5.95% (excluding servicing costs). In addition, we recorded a net gain on residential whole loans held at fair value of $13.8 million in Other Income, net in our consolidated statements of operations for the three months ended March 31, 2017.

During the three months ended March 31, 2017 we purchased $87.4 million of CRT securities, which are debt obligations issued by Fannie Mae and Freddie Mac. At March 31, 2017, our investments in these securities totaled $498.1 million.

We currently expect to continue to seek more credit sensitive, less interest rate sensitive residential mortgage assets during the remainder of 2017, including residential whole loans, Non-Agency MBS and CRT securities. In order to achieve our current investment strategy, interest rate sensitive Agency MBS may continue to pay down without reinvestment in this asset class. While the Federal Reserve increased the Fed Funds rate in both December 2016 and March 2017, yields on credit sensitive assets remained flat as investors priced in more optimistic credit assumptions. During the first quarter of 2017, we did not reinvest all of our portfolio runoff due to credit asset pricing and our strategy of allowing Agency MBS runoff. However, we are seeing ample supply of credit sensitive whole loans which we believe will lead to sizable investment opportunities in 2017.

Our book value per common share was $7.66 as of March 31, 2017. Book value per common share increased from $7.62 as of December 31, 2016 due primarily to the impact of fair value changes of Legacy Non-Agency MBS, CRT securities and Swaps, partially offset by a decline in fair value changes on our Agency MBS and the impact of discount accretion income on Legacy Non-Agency MBS that was recognized and declared as dividends during the quarter.
 
At the end of the first quarter of 2017, the average coupon on mortgages underlying our Agency MBS was higher compared to the end of the first quarter of 2016, due to upward resets on Hybrid and ARM-MBS within the portfolio.  As a result, the coupon yield on our Agency MBS portfolio increased to 2.90% for the three months ended March 31, 2017, from 2.78% for the three months ended March 31, 2016.  The net Agency MBS yield decreased to 1.98% for the three months ended March 31, 2017, from 2.07% for the three months ended March 31, 2016 primarily due to an increase in premium amortization as a result of higher CPRs for the three months ended March 31, 2017 compared to the three months ended March 31, 2016. The net yield for our Legacy Non-Agency MBS portfolio was 8.90% for the three months ended March 31, 2017 compared to 7.61% for the three months ended March 31, 2016.  The increase in the net yield on our Legacy Non-Agency MBS portfolio reflects the impact of the cash proceeds received during 2016 in connection with the settlement of litigation related to certain Countrywide and Citigroup sponsored residential mortgage backed securitization trusts, the improved performance of loans underlying the Legacy Non-Agency MBS portfolio, which has resulted in credit reserve releases, in the current and prior year and the impact of redemptions during 2017 of certain securities that had been previously purchased at a discount. The net yield for our 3 Year Step-up securities portfolio was 4.02% for the three months ended March 31, 2017 compared to 3.97% for the three months ended March 31, 2016. 
 
We believe that our $653.3 million Credit Reserve and OTTI appropriately factors in remaining uncertainties regarding underlying mortgage performance and the potential impact on future cash flows for our existing Legacy Non-Agency MBS portfolio.  In addition, while the majority of our Legacy Non-Agency MBS will not return their full face value due to loan defaults, we believe that they will deliver attractive loss adjusted yields due to our discounted amortized cost of 72% of face value at March 31, 2017. Home price appreciation and underlying mortgage loan amortization have decreased the LTV for many of the mortgages underlying our Legacy Non-Agency portfolio. Home price appreciation during the past few years has generally been driven by a combination of limited housing supply, low mortgage rates and demographic-driven U.S. household formation. Lower LTVs lessen the likelihood of defaults and simultaneously decrease loss severities. Further, during 2016 and the three months ended March 31, 2017, we have also observed faster voluntary prepayment (i.e., prepayment of loans in full with no loss) speeds than originally projected. The yields on our Legacy Non-Agency MBS that were purchased at a discount are generally positively impacted if prepayment rates on these securities exceed our prepayment assumptions. Based on these current conditions, we have reduced estimated future losses within our Legacy Non-Agency portfolio. As a result, during the three months ended March 31, 2017, $9.3 million was transferred from Credit Reserve to accretable discount.  This increase in accretable discount is expected

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to increase the interest income realized over the remaining life of our Legacy Non-Agency MBS. The remaining average contractual life of such assets is approximately 19 years, but based on scheduled loan amortization and prepayments (both voluntary and involuntary), loan balances will decline substantially over time. Consequently, we believe that the majority of the impact on interest income from the reduction in Credit Reserve will occur over the next ten years.
 
At March 31, 2017, we have access to various sources of liquidity which we estimate to be in excess of $903.8 million. This amount includes (i) $421.6 million of cash and cash equivalents; (ii) $212.4 million in estimated financing available from unpledged Agency MBS and from other Agency MBS collateral that is currently pledged in excess of contractual requirements; and (iii) $269.8 million in estimated financing available from unpledged Non-Agency MBS. Our sources of liquidity do not include restricted cash. We believe that we are positioned to continue to take advantage of investment opportunities within the residential mortgage marketplace. 
 
Repurchase agreement funding for our residential mortgage investments continues to be available to us from multiple counterparties during the first quarter of 2017.  Typically, repurchase agreement funding involving credit-sensitive investments is available at terms requiring higher collateralization and higher interest rates, than for repurchase agreement funding involving Agency MBS.  In July 2015, our wholly-owned subsidiary, MFA Insurance, became a member of the Federal Home Loan Bank of Des Moines, further diversifying our potential sources of funding for residential mortgage investments. However, in January 2016, the Federal Housing Finance Agency (or 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, MFA Insurance was required to repay all outstanding advances by February 19, 2017, and its FHLB membership was terminated on such date. At March 31, 2017, our debt consisted of borrowings under repurchase agreements with 31 counterparties, Senior Notes outstanding and obligation to return securities obtained as collateral, resulting in a debt-to-equity multiple of 2.9 times.  (See table on page 69 under Results of Operations that presents our quarterly leverage multiples since March 31, 2016.)

Information About Our Assets

The tables below present certain information about our asset allocation at March 31, 2017:
 
ASSET ALLOCATION
 
 
Agency MBS
 
Legacy
Non-Agency MBS
 
3 Year Step-up Securities (1)
 
Credit Risk Transfer Securities
 
Residential Whole Loans, at Carrying Value (2)
 
Residential Whole Loans, at Fair Value
 
Other,
net (3)
 
Total
(Dollars in Millions)
 
 

 
 

 
 
 
 
 
 
 
 

 
 

 
 

Fair Value/Carrying Value
 
$
3,495

 
$
3,015

 
$
2,453

 
$
498

 
$
574

 
$
775

 
$
480

 
$
11,290

Less Repurchase Agreements
 
(3,094
)
 
(1,940
)
 
(1,875
)
 
(345
)
 
(328
)
 
(508
)
 
(47
)
 
(8,137
)
Less Senior Notes
 
—

 
—

 
—

 
—

 
—

 
—

 
(97
)
 
(97
)
Net Equity Allocated
 
$
401

 
$
1,075

 
$
578

 
$
153

 
$
246

 
$
267

 
$
336

 
$
3,056

Debt/Net Equity Ratio (4)
 
7.7
x
 
1.8
x
 
3.2
x
 
2.3
x
 
1.3
x
 
1.9
x
 
 
 
2.9
x

(1)
3 Year Step-up securities are MBS that are backed primarily by securitized re-performing and non-performing loans. The securities are structured such that the coupon increases up to 300 basis points at 36 months from issuance or sooner. Included with the balance of Non-Agency MBS reported on our consolidated balance sheets.
(2)
The carrying value of such loans reflects the purchase price, accretion of income, cash received and provision for loan losses since acquisition. At March 31, 2017, the fair value of such loans is estimated to be approximately $608.2 million.
(3)
Includes cash and cash equivalents and restricted cash, securities obtained and pledged as collateral, other assets, obligation to return securities obtained as collateral and other liabilities.     
(4)
Represents the sum of borrowings under repurchase agreements as a multiple of net equity allocated.  The numerator of our Total Debt/Net Equity Ratio also includes the obligation to return securities obtained as collateral of $510.7 million and Senior Notes.


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Agency MBS
 
The following table presents certain information regarding the composition of our Agency MBS portfolio as of March 31, 2017 and December 31, 2016:
 
March 31, 2017
(Dollars in Thousands)
 
Current
Face
 
Weighted
Average
Purchase
Price
 
Weighted
Average
Market
Price
 
Fair
Value (1)
 
Weighted
Average
Loan Age
(Months) (2)
 
Weighted
Average
Coupon (2)
 
3 Month
Average
CPR
15-Year Fixed Rate:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Low Loan Balance (3)
 
$
1,113,427

 
104.3
%
 
102.7
%
 
$
1,143,742

 
58

 
2.96
%
 
9.8
%
HARP (4)
 
109,133

 
104.8

 
102.7

 
112,124

 
57

 
2.95

 
13.8

Other (Post June 2009) (5)
 
99,749

 
104.0

 
105.6

 
105,325

 
78

 
4.14

 
12.3

Other (Pre June 2009) (6)
 
394

 
104.9

 
105.8

 
416

 
94

 
4.50

 
42.2

Total 15-Year Fixed Rate
 
$
1,322,703

 
104.3
%
 
102.9
%
 
$
1,361,607

 
60

 
3.05
%
 
10.4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hybrid:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Other (Post June 2009) (5)
 
$
1,273,235

 
104.4
%
 
104.7
%
 
$
1,333,450

 
70

 
3.04
%
 
19.5
%
Other (Pre June 2009) (6)
 
667,768

 
101.7

 
105.4

 
703,918

 
123

 
3.14

 
16.5

Total Hybrid
 
$
1,941,003

 
103.5
%
 
105.0
%
 
$
2,037,368

 
89

 
3.08
%
 
18.5
%
CMO/Other
 
$
91,635

 
102.5
%
 
103.2
%
 
$
94,587

 
189

 
2.84
%
 
10.9
%
Total Portfolio
 
$
3,355,341

 
103.8
%
 
104.1
%
 
$
3,493,562

 
80

 
3.06
%
 
15.1
%

December 31, 2016

(Dollars in Thousands)
 
Current
Face
 
Weighted
Average
Purchase
Price
 
Weighted
Average
Market
Price
 
Fair
Value (1)
 
Weighted
Average
Loan Age
(Months) (2)
 
Weighted
Average
Coupon (2)
 
3 Month
Average
CPR
15-Year Fixed Rate:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Low Loan Balance (3)
 
$
1,170,788

 
104.3
%
 
103.0
%
 
$
1,206,174

 
55

 
2.97
%
 
11.2
%
HARP (4)
 
116,790

 
104.7

 
103.0

 
120,290

 
54

 
2.96

 
12.1

Other (Post June 2009) (5)
 
106,343

 
104.0

 
105.7

 
112,400

 
75

 
4.14

 
14.3

Other (Pre June 2009) (6)
 
564

 
104.9

 
105.9

 
597

 
91

 
4.50

 
28.8

Total 15-Year Fixed Rate
 
$
1,394,485

 
104.3
%
 
103.2
%
 
$
1,439,461

 
57

 
3.06
%
 
11.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hybrid:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Other (Post June 2009) (5)
 
$
1,370,019

 
104.4
%
 
104.8
%
 
$
1,436,184

 
67

 
2.99
%
 
19.9
%
Other (Pre June 2009) (6)
 
720,419

 
101.7

 
105.6

 
761,052

 
120

 
3.03

 
17.0

Total Hybrid
 
$
2,090,438

 
103.5
%
 
105.1
%
 
$
2,197,236

 
86

 
3.01
%
 
18.9
%
CMO/Other
 
$
96,379

 
102.5
%
 
102.9
%
 
$
99,196

 
187

 
2.81
%
 
14.7
%
Total Portfolio
 
$
3,581,302

 
103.8
%
 
104.3
%
 
$
3,735,893

 
77

 
3.02
%
 
15.9
%

(1)  Does not include principal payments receivable of $1.1 million and $2.6 million at March 31, 2017 and December 31, 2016, respectively.
(2)  Weighted average is based on MBS current face at March 31, 2017 and December 31, 2016, respectively.
(3)  Low loan balance represents MBS collateralized by mortgages with an original loan balance of less than or equal to $175,000.
(4)  Home Affordable Refinance Program (or HARP) MBS are backed by refinanced loans with LTVs greater than or equal to 80% at origination.
(5)  MBS issued in June 2009 or later. Majority of underlying loans are ineligible to refinance through the HARP program.
(6)  MBS issued before June 2009.
 

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The following table presents certain information regarding our 15-year fixed-rate Agency MBS as of March 31, 2017 and December 31, 2016:
 
March 31, 2017

Coupon
 
Current
Face
 
Weighted
Average
Purchase
Price
 
Weighted
Average
Market
Price
 
Fair
Value (1)
 
Weighted
Average
Loan Age
(Months) (2)
 
Weighted
Average
Loan Rate
 
Low Loan
Balance
and/or
HARP (3)
 
3 Month
Average
CPR
(Dollars in Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-Year Fixed Rate:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

2.5%
 
$
671,727

 
104.0
%
 
101.4
%
 
$
681,154

 
51
 
3.04
%
 
100
%
 
7.5
%
3.0%
 
272,518

 
105.9

 
103.1

 
280,885

 
57
 
3.49

 
100

 
12.0

3.5%
 
6,637

 
103.5

 
104.3

 
6,923

 
77
 
4.18

 
100

 
20.6

4.0%
 
320,603

 
103.5

 
105.5

 
338,173

 
76
 
4.40

 
80

 
14.2

4.5%
 
51,218

 
105.2

 
106.4

 
54,472

 
80
 
4.88

 
34

 
14.1

Total 15-Year Fixed Rate
 
$
1,322,703

 
104.3
%
 
102.9
%
 
$
1,361,607

 
60
 
3.54
%
 
92
%
 
10.4
%

December 31, 2016

Coupon
 
Current
Face
 
Weighted
Average
Purchase
Price
 
Weighted
Average
Market
Price
 
Fair
Value (1)
 
Weighted
Average
Loan Age
(Months) (2)
 
Weighted
Average
Loan Rate
 
Low Loan
Balance
and/or
HARP (3)
 
3 Month
Average
CPR
(Dollars in Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
15-Year Fixed Rate:
 
 

 
 

 
 

 
 

 
 
 
 

 
 

 
 

2.5%
 
$
700,388

 
104.0
%
 
101.6
%
 
$
711,696

 
48
 
3.04
%
 
100
%
 
9.9
%
3.0%
 
288,648

 
105.9

 
103.3

 
298,311

 
54
 
3.49

 
100

 
11.3

3.5%
 
7,244

 
103.5

 
104.6

 
7,576

 
74
 
4.18

 
100

 
15.7

4.0%
 
343,105

 
103.5

 
105.9

 
363,258

 
73
 
4.40

 
80

 
14.2

4.5%
 
55,100

 
105.2

 
106.4

 
58,620

 
77
 
4.88

 
34

 
14.5

Total 15-Year Fixed Rate
 
$
1,394,485

 
104.3
%
 
103.2
%
 
$
1,439,461

 
57
 
3.54
%
 
92
%
 
11.5
%

(1)  Does not include principal payments receivable of $1.1 million and $2.6 million at March 31, 2017 and December 31, 2016, respectively.
(2)  Weighted average is based on MBS current face at March 31, 2017 and December 31, 2016, respectively.
(3)  Low Loan Balance represents MBS collateralized by mortgages with an original loan balance less than or equal to $175,000.  HARP MBS are backed by refinanced loans with LTVs greater than or equal to 80% at origination.


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Table of Contents

The following table presents certain information regarding our Hybrid Agency MBS as of March 31, 2017 and December 31, 2016:
 
March 31, 2017
(Dollars in Thousands)
 
Current
Face
 
Weighted
Average
Purchase
Price
 
Weighted
Average
Market
Price
 
Fair
Value (1)
 
Weighted
Average
Coupon (2)
 
Weighted
Average
Loan Age
(Months) (2)
 
Weighted
Average
Months to
Reset (3)
 
Interest
Only (4)
 
3 Month
Average
CPR
Hybrid Post June 2009:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency 5/1
 
$
511,539

 
104.3
%
 
105.4
%
 
$
539,185

 
3.08
%
 
79
 
6
 
26
%
 
20.4
%
Agency 7/1
 
569,961

 
104.5

 
104.4

 
595,231

 
2.98

 
65
 
18
 
24

 
21.5

Agency 10/1
 
191,735

 
104.7

 
103.8

 
199,034

 
3.11

 
61
 
58
 
64

 
11.1

Total Hybrids Post June 2009
 
$
1,273,235

 
104.4
%
 
104.7
%
 
$
1,333,450

 
3.04
%
 
70
 
19
 
31
%
 
19.5
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hybrid Pre June 2009:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Coupon < 4.5% (5)
 
$
643,115

 
101.7
%
 
105.4
%
 
$
678,017

 
3.04
%
 
124
 
5
 
31
%
 
16.4
%
Coupon >= 4.5% (6)
 
24,653

 
101.4

 
105.1

 
25,901

 
5.73

 
115
 
4
 
70

 
18.8

Total Hybrids Pre June 2009
 
$
667,768

 
101.7
%
 
105.4
%
 
$
703,918

 
3.14
%
 
123
 
5
 
32
%
 
16.5
%
Total Hybrids
 
$
1,941,003

 
103.5
%
 
105.0
%
 
$
2,037,368

 
3.08
%
 
89
 
14
 
31
%
 
18.5
%

December 31, 2016

(Dollars in Thousands)
 
Current
Face
 
Weighted
Average
Purchase
Price
 
Weighted
Average
Market
Price
 
Fair
Value (1)
 
Weighted
Average
Coupon (2)
 
Weighted
Average
Loan Age
(Months) (2)
 
Weighted
Average
Months to
Reset (3)
 
Interest
Only (4)
 
3 Month
Average
CPR
Hybrid Post June 2009:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency 5/1
 
$
551,736

 
104.3
%
 
105.7
%
 
$
583,318

 
2.93
%
 
76
 
6
 
25
%
 
17.7
%
Agency 7/1
 
618,414

 
104.5

 
104.3

 
645,200

 
3.00

 
62
 
21
 
24

 
22.8

Agency 10/1
 
199,869

 
104.7

 
103.9

 
207,666

 
3.13

 
58
 
61
 
64

 
17.1

Total Hybrids Post June 2009
 
$
1,370,019

 
104.4
%
 
104.8
%
 
$
1,436,184

 
2.99
%
 
67
 
21
 
30
%
 
19.9
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Hybrid Pre June 2009:
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 

 
 

Coupon < 4.5% (5)
 
$
691,572

 
101.7
%
 
105.6
%
 
$
730,626

 
2.92
%
 
121
 
6
 
33
%
 
16.9
%
Coupon >= 4.5% (6)
 
28,847

 
101.4

 
105.5

 
30,426

 
5.71

 
112
 
7
 
69

 
18.1

Total Hybrids Pre June 2009
 
$
720,419

 
101.7
%
 
105.6
%
 
$
761,052

 
3.03
%
 
120
 
6
 
34
%
 
17.0
%
Total Hybrids
 
$
2,090,438

 
103.5
%
 
105.1
%
 
$
2,197,236

 
3.01
%
 
86
 
15
 
32
%
 
18.9
%

(1)  Does not include principal payments receivable of $1.1 million and $2.6 million at March 31, 2017 and December 31, 2016, respectively.
(2)  Weighted average is based on MBS current face at March 31, 2017 and December 31, 2016, respectively.
(3)  Weighted average months to reset is the number of months remaining before the coupon interest rate resets.  At reset, the MBS coupon will adjust based upon the underlying benchmark interest rate index, margin and periodic or lifetime caps.  The months to reset do not reflect scheduled amortization or prepayments.
(4)  Interest only represents MBS backed by mortgages currently in their interest-only period.  Percentage is based on MBS current face at March 31, 2017 and December 31, 2016, respectively.
(5)  Agency 3/1, 5/1, 7/1 and 10/1 Hybrid ARM-MBS with coupon less than 4.5%.
(6)  Agency 3/1, 5/1, 7/1 and 10/1 Hybrid ARM-MBS with coupon greater than or equal to 4.5%.


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Table of Contents

Non-Agency MBS
 
The following table presents information with respect to our Non-Agency MBS at March 31, 2017 and December 31, 2016:
 
(In Thousands)
 
March 31, 2017
 
December 31, 2016
 
 Non-Agency MBS
 
 

 
 

 
Face/Par
 
$
5,785,664

 
$
6,206,598

 
Fair Value
 
5,468,178

 
5,825,816

 
Amortized Cost
 
4,862,659

 
5,234,223

 
Purchase Discount Designated as Credit Reserve and OTTI
 
(653,337
)
(1)
(694,241
)
(2)
Purchase Discount Designated as Accretable
 
(269,725
)
 
(278,191
)
 
Purchase Premiums
 
57

 
57

 

(1)  Includes discount designated as Credit Reserve of $636.2 million and OTTI of $17.1 million.
(2)  Includes discount designated as Credit Reserve of $675.6 million and OTTI of $18.6 million.

Purchase Discounts on Non-Agency MBS
 
The following table presents the changes in the components of purchase discount on Non-Agency MBS with respect to purchase discount designated as Credit Reserve and OTTI, and accretable purchase discount, for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended 
 March 31, 2017
 
Three Months Ended 
 March 31, 2016
 
 
Discount
Designated as
Credit Reserve and
OTTI
 
Accretable
Discount (1)
 
Discount
Designated as
Credit Reserve and
OTTI
 
Accretable
Discount (1)
(In Thousands)
 
 
 
 
 
 
 
 
Balance at beginning of period
 
$
(694,241
)
 
$
(278,191
)
 
$
(787,541
)
 
$
(312,182
)
Accretion of discount
 
—

 
21,616

 
—

 
21,406

Realized credit losses
 
12,324

 
—

 
18,050

 
—

Purchases
 
—

 
—

 
(4,294
)
 
1,606

Sales
 
19,741

 
(3,897
)
 
12,020

 
12,040

Net impairment losses recognized in earnings
 
(414
)
 
—

 
—

 
—

Transfers/release of credit reserve
 
9,253

 
(9,253
)
 
4,201

 
(4,201
)
Balance at the end of period
 
$
(653,337
)
 
$
(269,725
)
 
$
(757,564
)
 
$
(281,331
)

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

The following table presents information with respect to the yield components of our Non-Agency MBS for the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31, 2017
 
Three Months Ended March 31, 2016
 
 
Legacy
Non-Agency MBS
 
3 Year Step-up Securities
 
Legacy
Non-Agency MBS
 
3 Year Step-up Securities
Non-Agency MBS
 
 
 
 
 
 
 
 
Coupon Yield (1)
 
5.50
%
 
3.99
%
 
5.09
%
 
3.73
%
Effective Yield Adjustment (2)
 
3.40

 
0.03

 
2.52

 
0.24

Net Yield
 
8.90
%
 
4.02
%
 
7.61
%
 
3.97
%

(1) Reflects the annualized coupon interest income divided by the average amortized cost.  The discounted purchase price on Legacy Non-Agency MBS causes the coupon yield to be higher than the pass-through coupon interest rate.
(2) The effective yield adjustment is the difference between the net yield, calculated utilizing management’s estimates of timing and amount of future cash flows for Legacy Non-Agency MBS and 3 Year Step-up securities, less the current coupon yield.


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Table of Contents

Actual maturities of MBS are generally shorter than stated contractual maturities because actual maturities of MBS are affected by the contractual lives of the underlying mortgage loans, periodic payments of principal and prepayments of principal.  The following table presents certain information regarding the amortized costs, weighted average yields and contractual maturities of our MBS at March 31, 2017 and does not reflect the effect of prepayments or scheduled principal amortization on our MBS:
 
 
 
Within One Year
 
One to Five Years
 
Five to Ten Years
 
Over Ten Years
 
Total MBS
(Dollars in Thousands)
 
Amortized
Cost
 
Weighted
Average
Yield
 
Amortized
Cost
 
Weighted
Average
Yield
 
Amortized
Cost
 
Weighted
Average
Yield
 
Amortized
Cost
 
Weighted
Average
Yield
 
Total
Amortized
Cost
 
Total Fair
Value
 
Weighted
Average
Yield
Agency MBS:
 
 
 
 
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
—

 
—
%
 
$
291

 
2.46
%
 
$
285,467

 
3.14
%
 
$
2,502,473

 
2.02
%
 
$
2,788,231

 
$
2,808,236

 
2.14
%
Freddie Mac
 
—

 
—

 
—

 
—

 
135,790

 
2.79

 
551,824

 
1.84

 
687,614

 
678,899

 
2.03

Ginnie Mae
 
—

 
—

 
—

 
—

 
110

 
1.95

 
7,251

 
1.92

 
7,361

 
7,479

 
1.92

Total Agency MBS
 
$
—

 
—
%
 
$
291

 
—
%
 
$
421,367

 
3.03
%
 
$
3,061,548

 
1.99
%
 
$
3,483,206

 
$
3,494,614

 
2.12
%
Non-Agency MBS
 
$
—

 
—

 
$
245,845

 
5.12
%
 
$
3,033

 
8.07
%
 
$
4,613,781

 
6.67
%
 
$
4,862,659

 
$
5,468,178

 
6.59
%
Total MBS
 
$
—

 
—
%
 
$
246,136

 
4.34
%
 
$
424,400

 
3.06
%
 
$
7,675,329

 
4.78
%
 
$
8,345,865

 
$
8,962,792

 
4.72
%

At March 31, 2017, our CRT securities had an amortized cost of $467.2 million, a fair value of $498.1 million, a weighted average yield of 6.09% and a weighted average time to maturity of 9.0 years. At December 31, 2016, our CRT securities had an amortized cost of $382.7 million, a fair value of $404.9 million, a weighted average yield of 5.86% and weighted average time to maturity of 9.0 years.

Residential Whole Loans

The following table presents the contractual maturities of our residential whole loans held by consolidated trusts at March 31, 2017 and does not reflect estimates of prepayments or scheduled amortization. For residential whole loans at carrying value, amounts presented are estimated based on the underlying loan contractual amounts.

(In Thousands)
 
Residential Whole Loans
at Carrying Value
 
Residential Whole Loans
at Fair Value
Amount due:
 
 
 
 

Within one year
 
$
1,267

 
$
6,366

After one year:
 
 
 
 
Over one to five years
 
3,305

 
7,649

Over five years
 
569,143

 
761,137

Total due after one year
 
$
572,448

 
$
768,786

Total residential whole loans
 
$
573,715

 
$
775,152



The following table presents at March 31, 2017, the dollar amount of our residential whole loans at fair value, contractually maturing after one year, and indicates whether the loans have fixed interest rates or adjustable interest rates:

(In Thousands)
 
Residential Whole Loans
at Fair Value (1)
Interest rates:
 
 

Fixed
 
$
451,985

Adjustable
 
316,801

Total
 
$
768,786


(1)  Includes loans on which borrowers have defaulted and are not making payments of principal and/or interest as of March 31, 2017.



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Table of Contents

Information is not presented for residential whole loans at carrying value as income is recognized based on pools of assets with similar risk characteristics using an estimated yield based on cash flows expected to be collected over the lives of the loans in such pools rather than on the contractual coupons of the underlying loans.

The following table presents additional information regarding our residential whole loans at fair value at March 31, 2017 and December 31, 2016:
 
 
Residential Whole Loans,
at Fair Value
(Dollars in Thousands)
 
March 31, 2017
 
December 31, 2016
Loans 90 days or more past due:
 
 
 
 
Number of Loans
 
2,248

 
2,560

Aggregate Amount Outstanding
 
$
523,637

 
$
570,025


Income on residential whole loans at carrying value is recognized based on pools of assets with similar credit risk characteristics using an estimated yield based on cash flows expected to be collected over the lives of the loans in such pools rather than the contractual coupons of the underlying loans. As the unit of account is at the pool level rather than the individual loan level, none of our residential whole loans at carrying value are currently considered 90 days or more past due.


Exposure to Financial Counterparties
 
We finance a significant portion of our residential mortgage assets with repurchase agreements and other advances. In connection with these financing arrangements, we pledge our assets as collateral to secure the borrowing. The amount of collateral pledged will typically exceed the amount of the financing with the extent of over-collateralization ranging from 1% - 5% of the amount borrowed (U.S. Treasury and Agency MBS collateral) to up to 35% (Non-Agency MBS collateral). Consequently, while repurchase agreement financing results in us recording a liability to the counterparty in our consolidated balance sheets, we are exposed to the counterparty, if during the term of the repurchase agreement financing, a lender should default on its obligation and we are not able to recover our pledged assets. The amount of this exposure is the difference between the amount loaned to us plus interest due to the counterparty and the fair value of the collateral pledged by us to the lender including accrued interest receivable on such collateral.
 
In addition, we use Swaps to manage interest rate risk exposure in connection with our repurchase agreement financings. We will make cash payments or pledge securities as part of a margin arrangement in connection with interest rate Swaps that are not centrally cleared that are in an unrealized loss position. In the event a counterparty for a Swap that is not subject to central clearing were to default on its obligation, we would be exposed to a loss to a Swap counterparty to the extent that the amount of cash or securities pledged exceeded the unrealized loss on the associated Swaps and we were not able to recover the excess collateral.


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Table of Contents

The table below summarizes our exposure to our counterparties at March 31, 2017, by country:
Country
 
Number of
Counterparties
 
Repurchase
Agreement
Financing
 
Swaps at Fair
Value
 
Exposure (1)
 
Exposure as a
Percentage of
MFA Total
Assets
(Dollars in Thousands)
 
 
 
 
 
 
 
 
 
 
European Countries:  (2)
 
 
 
 

 
 

 
 

 
 

Switzerland (3)
 
3
 
$
1,318,776

 
$
—

 
$
436,139

 
3.67
%
United Kingdom
 
3
 
343,625

 
—

 
114,986

 
0.97

France
 
2
 
611,773

 
—

 
141,688

 
1.19

Holland
 
1
 
200,413

 
39

 
14,710

 
0.12

Germany
 
1
 
—

 
40

 
(85
)
 
—

Total
 
10
 
2,474,587

 
79

 
707,438

 
5.95
%
Other Countries:
 
 
 
 

 
 

 
 

 
 

United States
 
14
 
$
4,119,499

 
$
40

 
$
903,130

 
7.59
%
Canada (4)
 
4
 
1,218,349

 
—

 
268,154

 
2.25

Japan (5)
 
3
 
536,310

 
—

 
41,073

 
0.35

China (5)
 
1
 
288,798

 
—

 
14,381

 
0.12

Total
 
22
 
6,162,956

 
40

 
1,226,738

 
10.31
%
Total Counterparty Exposure
 
32
 
$
8,637,543

(6)
$
119

 
$
1,934,176

 
16.26
%

(1)
Represents for each counterparty the amount of cash and/or securities pledged as collateral less the aggregate of repurchase agreement financing, Swaps at fair value, and net interest receivable/payable on all such instruments.
(2)
Includes European-based counterparties as well as U.S.-domiciled subsidiaries of the European parent entity.
(3)
Includes London branch of one counterparty and Cayman Islands branch of the other counterparty.
(4)
Includes Canada-based counterparties as well as U.S.-domiciled subsidiaries of Canadian parent entities. In the case of one counterparty, also includes exposure of $234.4 million to Barbados-based affiliate of the Canadian parent entity.
(5)
Exposure is to U.S.-domiciled subsidiary of the Japanese or Chinese parent entity, as the case may be.
(6)
Includes $500.0 million of repurchase agreements entered into in connection with contemporaneous repurchase and reverse repurchase agreements with a single counterparty.
 
At March 31, 2017, we did not use credit default swaps or other forms of credit protection to hedge the exposures summarized in the table above.
 
Uncertainty in the global financial market and weak economic conditions in Europe, including as a result of the United Kingdom’s recent vote to leave the European Union (commonly known as “Brexit”), could potentially impact our major European financial counterparties, with the possibility that this would also impact the operations of their U.S. domiciled subsidiaries. This could adversely affect our financing and operations as well as those of the entire mortgage sector in general. Management monitors our exposure to our repurchase agreement and Swap counterparties on a regular basis, using various methods, including review of recent rating agency actions or other developments and by monitoring the amount of cash and securities collateral pledged and the associated loan amount under repurchase agreements and/or the fair value of Swaps with our counterparties. We intend to make reverse margin calls on our counterparties to recover excess collateral as permitted by the agreements governing our financing arrangements, or take other necessary actions to reduce the amount of our exposure to a counterparty when such actions are considered necessary. 

Tax Considerations
 
Current period estimated taxable and items expected to impact future taxable income

We estimate that for the three months ended March 31, 2017, our taxable income was approximately $117.0 million. Based on dividends paid or declared during the three months ended March 31, 2017, we have undistributed taxable income of approximately $97.4 million, or $0.26 per share. We have until the filing of our 2017 tax return (due not later than October 15, 2018) to declare the distribution of any 2017 REIT taxable income not previously distributed.

During the first quarter of 2017 we unwound our remaining resecuritization transaction. We currently estimate that the unwind will generate taxable income (but not GAAP income) of an amount in excess of $0.13 per share.



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Table of Contents

Key differences between GAAP net income and REIT Taxable Income for Non-Agency MBS and Residential Whole Loans
 
Our total Non-Agency MBS portfolio for tax differs from our portfolio reported for GAAP primarily due to the fact that for tax purposes; (i) certain of the MBS contributed to the VIEs used to facilitate resecuritization transactions were deemed to be sold; and (ii) the tax basis of underlying MBS considered to be re-acquired in connection with the unwind of such transactions becomes the fair market value of such securities at the time of the unwind. For GAAP reporting purposes the underlying MBS that were included in these resecuritization transactions were not considered to be sold. In addition, for our Non-Agency MBS tax portfolio, potential timing differences arise with respect to the accretion of market discount into income and recognition of realized losses for tax purposes as compared to GAAP.  Consequently, our REIT taxable income calculated in a given period may differ significantly from our GAAP net income.
 
The determination of taxable income attributable to Non-Agency MBS and residential whole loans is dependent on a number of factors, including principal payments, defaults, loss mitigation efforts and loss severities.  In estimating taxable income for Non-Agency MBS and residential whole loans during the year, management considers estimates of the amount of discount expected to be accreted.  Such estimates require significant judgment and actual results may differ from these estimates.  Moreover, the deductibility of realized losses from Non-Agency MBS and residential whole loans, and their effect on market discount accretion is analyzed on an asset-by-asset basis and while they will result in a reduction of taxable income, this reduction tends to occur gradually and primarily for Non-Agency MBS in periods after the realized losses are reported. In addition, for resecuritization transactions that were treated as a sale of the underlying MBS for tax purposes, taxable gain or loss, if any, resulting from the unwind of such transactions is not recognized in GAAP net income.
 
Resecuritization transactions result in differences between GAAP net income and REIT Taxable Income
 
For tax purposes, depending on the transaction structure, a resecuritization transaction may be treated either as a sale or a financing of the underlying MBS.  Income recognized from resecuritization transactions will differ for tax and GAAP.  For tax purposes, we own and may in the future acquire interests in resecuritization trusts, in which several of the classes of securities are or will be issued with Original Issue Discount (or OID).  As the holder of the retained interests in the trust, we generally will be required to include OID in our current gross interest income over the term of the applicable securities as the OID accrues.  The rate at which the OID is recognized into taxable income is calculated using a constant rate of yield to maturity, with realized losses impacting the amount of OID recognized in REIT taxable income once they are actually incurred.  For tax purposes, REIT taxable income may be recognized in excess of economic income (i.e., OID) or in advance of the corresponding cash flow from these assets, thereby effecting our dividend distribution requirement to stockholders. In addition, for resecuritization transactions that were treated as a sale of the underlying MBS for tax purposes, the unwind of any such transaction will likely result in a taxable gain or loss that is likely not recognized in GAAP net income as resecuritization transactions are typically accounted for as financing transactions for GAAP purposes. The tax basis of underlying MBS re-acquired in connection with the unwind of such transactions becomes the fair market value of such securities at the time of the unwind.
 

Regulatory Developments
 
The U.S. Congress, Board of Governors of the Federal Reserve System, U.S. Treasury, Federal Deposit Insurance Corporation, SEC and other governmental and regulatory bodies have taken and continue to consider additional actions in response to the 2007-2008 financial crisis.  In particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act (or the Dodd-Frank Act) created a new regulator, an independent bureau housed within the Federal Reserve System and known as the Consumer Financial Protection Bureau (or the CFPB). The CFPB has broad authority over a wide range of consumer financial products and services, including mortgage lending.  One portion of the Dodd-Frank Act, the Mortgage Reform and Anti-Predatory Lending Act (or Mortgage Reform Act), contains underwriting and servicing standards for the mortgage industry, as well as restrictions on compensation for mortgage originators.  In addition, the Mortgage Reform Act grants broad discretionary regulatory authority to the CFPB to prohibit or condition terms, acts or practices relating to residential mortgage loans that the CFPB finds abusive, unfair, deceptive or predatory, as well as to take other actions that the CFPB finds are necessary or proper to ensure responsible affordable mortgage credit remains available to consumers.  The Dodd-Frank Act also affects the securitization of mortgages (and other assets) with requirements for risk retention by securitizers and requirements for regulating Rating Agencies.


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The Dodd-Frank Act requires that numerous regulations be issued, many of which (including those mentioned above regarding underwriting and mortgage originator compensation) have only recently been implemented and operationalized. As a result, we are unable to fully predict at this time how the Dodd-Frank Act, as well as other laws that may be adopted in the future, will affect our business, results of operations and financial condition, or the environment for repurchase financing and other forms of borrowing, the investing environment for Agency MBS, Non-Agency MBS and/or residential mortgage loans, the securitization industry, Swaps and other derivatives.  However, at a minimum, we believe that the Dodd-Frank Act and the regulations promulgated thereunder are likely to continue to increase the economic and compliance costs for participants in the mortgage and securitization industries, including us.

In addition to the regulatory actions being implemented under the Dodd-Frank Act, on August 31, 2011, the SEC issued a concept release under which it is reviewing interpretive issues related to Section 3(c)(5)(C) of the Investment Company Act.  Section 3(c)(5)(C) excludes from the definition of “investment company” entities that are primarily engaged in, among other things, “purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.”  Many companies that engage in the business of acquiring mortgages and mortgage-related instruments seek to rely on existing interpretations of the SEC Staff with respect to Section 3(c)(5)(C) so as not to be deemed an investment company for the purpose of regulation under the Investment Company Act.  In connection with the concept release, the SEC requested comments on, among other things, whether it should reconsider its existing interpretation of Section 3(c)(5)(C). To date the SEC has not taken or otherwise announced any further action in connection with the concept release.

The Federal Housing Finance Agency (or FHFA) and both houses of Congress have discussed and considered separate measures intended to restructure the U.S. housing finance system and the operations of Fannie Mae and Freddie Mac. Congress may continue to consider legislation that would significantly reform the country’s mortgage finance system, including, among other things, eliminating Freddie Mac and Fannie Mae and replacing them with a single new MBS insurance agency. Many details remain unsettled, including the scope and costs of the agencies’ guarantee and their affordable housing mission, some of which could be addressed even in the absence of large-scale reform.  While the likelihood of enactment of major mortgage finance system reform in the short term remains uncertain, it is possible that the adoption of any such reforms could adversely affect the types of assets we can buy, the costs of these assets and our business operations.  As the FHFA and both houses of Congress continue to consider various measures intended to dramatically restructure the U.S. housing finance system and the operations of Fannie Mae and Freddie Mac, we expect debate and discussion on the topic to continue throughout 2017. However, we cannot be certain if any housing and/or mortgage-related legislation will emerge from committee, or be approved by Congress, and if so, what the effect will be on our business.
 




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Results of Operations

Quarter Ended March 31, 2017 Compared to the Quarter Ended March 31, 2016
 
General
 
For the first quarter of 2017, we had net income available to our common stock and participating securities of $74.3 million, or $0.20 per basic and diluted common share. Net income available to common stock and participating securities was also $74.3 million, or $0.20 per basic and diluted common share, for the first quarter of 2016.

Net Interest Income
 
Net interest income represents the difference between income on interest-earning assets and expense on interest-bearing liabilities.  Net interest income depends primarily upon the volume of interest-earning assets and interest-bearing liabilities and the corresponding interest rates earned or paid.  Our net interest income varies primarily as a result of changes in interest rates, the slope of the yield curve (i.e., the differential between long-term and short-term interest rates), borrowing costs (i.e., our interest expense) and prepayment speeds on our MBS.  Interest rates and CPRs (which measure the amount of unscheduled principal prepayment on a bond as a percentage of the bond balance) vary according to the type of investment, conditions in the financial markets, and other factors, none of which can be predicted with any certainty.
 
The changes in average interest-earning assets and average interest-bearing liabilities and their related yields and costs are discussed in greater detail below under “Interest Income” and “Interest Expense.”
 
For the first quarter of 2017, our net interest spread and margin were 2.27% and 2.63%, respectively, compared to a net interest spread and margin of 2.22% and 2.51%, respectively, for the first quarter of 2016. Our net interest income decreased by $2.9 million, or 4.17%, to $66.9 million from $69.8 million for the first quarter of 2016.  Current quarter net interest income from Agency MBS and Legacy Non-Agency MBS declined compared to the first quarter of 2016 by approximately $7.3 million, primarily due to lower average amounts invested in these securities and higher funding costs, partially offset by higher yields earned on Legacy Non-Agency MBS. In addition, net interest income on 3 Year Step-up securities was $1.0 million lower compared to the first quarter of 2016 primarily due to the higher funding costs for these securities. These decreases were partially offset by higher net interest income on CRT securities, residential whole loans at carrying value and other interest-earning investments of approximately $6.0 million compared to the first quarter of 2016, primarily due to higher average balances invested in and yields earned on CRT securities and higher average balances of residential loans at carrying value and other interest-earning investments. In addition, net interest income also includes $4.2 million of interest expense associated with residential whole loans at fair value, reflecting a $711,000 increase in borrowing costs related to these investments compared to the first quarter of 2016. Coupon interest income received from residential whole loans at fair value is presented as a component of the total income earned on these investments and therefore is included in Other income, net rather than net interest income.




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Analysis of Net Interest Income
 
The following table sets forth certain information about the average balances of our assets and liabilities and their related yields and costs for the three months ended March 31, 2017 and 2016.  Average yields are derived by dividing annualized interest income by the average amortized cost of the related assets, and average costs are derived by dividing annualized interest expense by the daily average balance of the related liabilities, for the periods shown.  The yields and costs include premium amortization and purchase discount accretion which are considered adjustments to interest rates.
 
 
Three Months Ended March 31,
 
 
2017
 
2016
(Dollars in Thousands)
 
Average Balance
 
Interest
 
Average Yield/Cost
 
Average Balance
 
Interest
 
Average Yield/Cost
Assets:
 
 

 
 

 
 

 
 

 
 

 
 

Interest-earning assets:
 
 

 
 

 
 

 
 

 
 

 
 

Agency MBS (1)
 
$
3,616,362

 
$
17,894

 
1.98
%
 
$
4,626,159

 
$
23,997

 
2.07
%
Legacy Non-Agency MBS (1)
 
2,522,857

 
56,104

 
8.90

 
3,164,902

 
60,222

 
7.61

3 Year Step-up securities (1)
 
2,601,918

 
26,139

 
4.02

 
2,613,715

 
25,930

 
3.97

Total MBS
 
8,741,137

 
100,137

 
4.58

 
10,404,776

 
110,149

 
4.23

CRT securities (1)
 
430,355

 
6,376

 
5.93

 
199,438

 
2,692

 
5.40

Residential whole loans, at carrying value (2)
 
584,641

 
8,690

 
5.95

 
275,399

 
4,436

 
6.44

Other interest-earning investments
 
86,226

 
1,699

 
7.88

 
—

 
—

 
—

Cash and cash equivalents (3)
 
324,827

 
355

 
0.44

 
232,271

 
140

 
0.24

Total interest-earning assets
 
10,167,186

 
117,257

 
4.61

 
11,111,884

 
117,417

 
4.23

Total non-interest-earning assets (2)
 
2,110,316

 
 

 
 

 
1,890,919

 
 

 
 

Total assets
 
$
12,277,502

 
 

 
 

 
$
13,002,803

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities and stockholders’ equity:
 
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing liabilities:
 
 

 
 

 
 

 
 

 
 

 
 

Total repurchase agreements and other advances
 
$
8,494,853

 
$
48,339

 
2.28
%
 
$
9,238,772

 
$
45,395

 
1.94
%
Securitized debt
 
—

 
—

 
—

 
18,425

 
196

 
4.21

Senior Notes
 
96,737

 
2,010

 
8.31

 
96,700

 
2,009

 
8.31

Total interest-bearing liabilities
 
8,591,590

 
50,349

 
2.34

 
9,353,897

 
47,600

 
2.01

Total non-interest-bearing liabilities
 
623,085

 
 

 
 

 
762,992

 
 

 
 
Total liabilities
 
9,214,675

 
 

 
 

 
10,116,889

 
 

 
 
Stockholders’ equity
 
3,062,827

 
 

 
 

 
2,885,914

 
 

 
 
Total liabilities and stockholders’ equity
 
$
12,277,502

 
 

 
 

 
$
13,002,803

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest income/net interest rate spread (5)
 
 

 
$
66,908

 
2.27
%
 
 

 
$
69,817

 
2.22
%
Net interest-earning assets/net interest margin (6)
 
$
1,575,596

 
 

 
2.63
%
 
$
1,757,987

 
 

 
2.51
%
Ratio of interest-earning assets to
   interest-bearing liabilities
 
1.18
x
 
 

 
 

 
1.19
x
 
 

 
 

 

(1)
Yields presented throughout this Quarterly Report on Form 10-Q are calculated using average amortized cost data for securities which excludes unrealized gains and losses and includes principal payments receivable on securities.  For GAAP reporting purposes, purchases and sales are reported on the trade date. Average amortized cost data used to determine yields is calculated based on the settlement date of the associated purchase or sale as interest income is not earned on purchased assets and continues to be earned on sold assets until settlement date.  Includes Non-Agency MBS transferred to consolidated VIEs.
(2)
Excludes residential whole loans held at fair value that are reported as a component of total non-interest-earning assets.
(3)
Includes average interest-earning cash, cash equivalents and restricted cash.
(4)
Average cost of repurchase agreements includes the cost of Swaps allocated based on the proportionate share of the overall estimated weighted average portfolio duration.
(5)
Net interest rate spread reflects the difference between the yield on average interest-earning assets and average cost of funds.
(6)
Net interest margin reflects annualized net interest income divided by average interest-earning assets.

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Rate/Volume Analysis

The following table presents the extent to which changes in interest rates (yield/cost) and changes in the volume (average balance) of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated.  Information is provided in each category with respect to: (i) the changes attributable to changes in volume (changes in average balance multiplied by prior rate); (ii) the changes attributable to changes in rate (changes in rate multiplied by prior average balance); and (iii) the net change.  The changes attributable to the combined impact of volume and rate have been allocated proportionately, based on absolute values, to the changes due to rate and volume.
 
 
Three Months Ended March 31, 2017
 
 
Compared to
 
 
Three Months Ended March 31, 2016
 
 
Increase/(Decrease) due to
 
Total Net
Change in
Interest Income/Expense
(In Thousands)
 
Volume
 
Rate
 
Interest-earning assets:
 
 

 
 

 
 

Agency MBS
 
$
(5,046
)
 
$
(1,057
)
 
$
(6,103
)
Legacy Non-Agency MBS
 
(13,361
)
 
9,243

 
(4,118
)
3 Year Step-up securities
 
(120
)
 
329

 
209

CRT securities
 
3,398

 
286

 
3,684

Residential whole loans, at carrying value (1)
 
4,622

 
(368
)
 
4,254

Other interest-earning investments
 
1,699

 
—

 
1,699

Cash and cash equivalents
 
71

 
144

 
215

Total net change in income from interest-earning assets
 
$
(8,737
)
 
$
8,577

 
$
(160
)
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 

 
 

 
 

Agency repurchase agreements and FHLB advances
 
$
(3,432
)
 
$
2,172

 
$
(1,260
)
Legacy Non-Agency repurchase agreements
 
(2,770
)
 
1,350

 
(1,420
)
3 Year Step-up securities repurchase agreements
 
(1
)
 
1,230

 
1,229

CRT securities repurchase agreements
 
985

 
104

 
1,089

Residential whole loan at carrying value repurchase agreements
 
2,071

 
92

 
2,163

Residential whole loan at fair value repurchase agreements
 
747

 
(36
)
 
711

Other repurchase agreements
 
432

 
—

 
432

Securitized debt
 
(196
)
 
—

 
(196
)
Senior Notes
 
—

 
1

 
1

Total net change in expense of interest-bearing liabilities
 
$
(2,164
)
 
$
4,913

 
$
2,749

Net change in net interest income
 
$
(6,573
)
 
$
3,664

 
$
(2,909
)
 
(1)
Excludes residential whole loans held at fair value which are reported as a component of non-interest-earning assets.


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The following table presents certain quarterly information regarding our net interest spread and net interest margin for the quarterly periods presented:
 
 
 
Total Interest-Earning Assets and Interest-
Bearing Liabilities
 
Net Interest
Spread (1)
 
Net Interest
Margin (2)
Quarter Ended
 
 
March 31, 2017
 
2.27
%
 
2.63
%
December 31, 2016
 
2.12

 
2.46

September 30, 2016
 
2.13

 
2.46

June 30, 2016
 
2.14

 
2.46

March 31, 2016
 
2.22

 
2.51

 
(1)  Reflects the difference between the yield on average interest-earning assets and average cost of funds.
(2)  Reflects annualized net interest income divided by average interest-earning assets.

The following table presents the components of the net interest spread earned on our Agency MBS, Legacy Non-Agency MBS and 3 Year Step-up securities for the quarterly periods presented:
 
 
 
Agency MBS
 
Legacy Non-Agency MBS
 
3 Year Step-up Securities
 
Total MBS
Quarter Ended
 
Net
Yield 
(1)
 
Cost of
Funding (2)
 
Net Interest
Rate
Spread (3)
 
Net
Yield 
(1)
 
Cost of
Funding (2)
 
Net Interest
Rate
Spread (3)
 
Net
Yield 
(1)
 
Cost of
Funding (2)
 
Net Interest
Rate
Spread (3)
 
Net
Yield 
(1)
 
Cost of
Funding (2)
 
Net Interest
Rate
Spread (3)
March 31, 2017
 
1.98
%
 
1.49
%
 
0.49
%
 
8.90
%
 
3.05
%
 
5.85
%
 
4.02
%
 
2.30
%
 
1.72
%
 
4.58
%
 
2.15
%
 
2.43
%
December 31, 2016
 
1.92

 
1.41

 
0.51

 
8.24

 
3.01

 
5.23

 
3.94

 
2.16

 
1.78

 
4.35

 
2.07

 
2.28

September 30, 2016
 
1.83

 
1.28

 
0.55

 
8.09

 
2.98

 
5.11

 
3.86

 
2.05

 
1.81

 
4.24

 
1.96

 
2.28

June 30, 2016
 
1.96

 
1.26

 
0.70

 
7.72

 
2.88

 
4.84

 
3.83

 
2.01

 
1.82

 
4.19

 
1.91

 
2.28

March 31, 2016
 
2.07

 
1.25

 
0.82

 
7.61

 
2.81

 
4.80

 
3.97

 
2.03

 
1.94

 
4.23

 
1.91

 
2.32

 
(1)
Reflects annualized interest income on MBS divided by average amortized cost of MBS.
(2)
Reflects annualized interest expense divided by average balance of repurchase agreements and other advances, including the cost of Swaps allocated based on the proportionate share of the overall estimated weighted average portfolio duration and securitized debt. Agency cost of funding includes 60, 65, 62, 63 and 65 basis points and Legacy Non-Agency cost of funding includes 58, 69, 74, 69 and 65 basis points associated with Swaps to hedge interest rate sensitivity on these assets for the quarters ended March 31, 2017, December 31, 2016, September 30, 2016, June 30, 2016 and March 31, 2016, respectively.
(3)
Reflects the difference between the net yield on average MBS and average cost of funds on MBS.
 
Interest Income
 
Interest income on our Agency MBS for the first quarter of 2017 decreased by $6.1 million, or 25.4% to $17.9 million from $24.0 million for the first quarter of 2016.  This change primarily reflects a $1.0 billion decrease in the average amortized cost of our Agency MBS portfolio to $3.6 billion for the first quarter of 2017 from $4.6 billion for the first quarter of 2016. In addition, the net yield on our Agency MBS decreased to 1.98% for the first quarter of 2017 from 2.07% for the first quarter of 2016. At the end of the first quarter of 2017, the average coupon on mortgages underlying our Agency MBS was higher compared to the end of the first quarter of 2016.  However, during the first quarter of 2017, our Agency MBS portfolio experienced a 15.1% CPR and we recognized $8.3 million of net premium amortization compared to a CPR of 11.7% and $8.1 million of net premium amortization for the first quarter of 2016, which resulted in the quarter on quarter decline in net yield. At March 31, 2017, we had net purchase premiums on our Agency MBS of $126.8 million, or 3.8% of current par value, compared to net purchase premiums of $135.1 million, or 3.8% of par value at December 31, 2016.
 
Interest income on our Non-Agency MBS (which includes Non-Agency MBS transferred to consolidated VIEs) decreased $3.9 million, or 4.5%, for the first quarter of 2017 to $82.2 million compared to $86.2 million for the first quarter of 2016. This decrease is primarily due to the decrease in the average amortized cost of our Non-Agency MBS portfolio of $653.8 million or 11.3%, to $5.1 billion from $5.8 billion for the first quarter of 2016. This decrease more than offset the impact of the higher yields generated on our Legacy Non-Agency MBS portfolio, which were 8.90% for the first quarter of 2017 compared to 7.61% for the first quarter of 2016. The increase in the net yield on our Legacy Non-Agency MBS portfolio reflects the impact of the cash proceeds received during 2016 in connection with the settlement of litigation related to certain Countrywide and Citigroup sponsored

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residential mortgage backed securitization trusts, the improved performance of loans underlying the Legacy Non-Agency MBS portfolio, which has resulted in credit reserve releases, in the current and prior year and the impact of redemptions during 2017 of certain securities that had been previously purchased at a discount. Our 3 Year Step-up securities portfolio yielded 4.02% for the first quarter of 2017 compared to 3.97% for the first quarter of 2016.

During the first quarter of 2017, we recognized net purchase discount accretion of $21.6 million on our Non-Agency MBS, compared to $21.5 million for the first quarter of 2016.  At March 31, 2017, we had net purchase discounts of $921.6 million, including Credit Reserve and previously recognized OTTI of $653.3 million, on our Legacy Non-Agency MBS, or 27.6% of par value.  During the first quarter of 2017 we reallocated $9.3 million of purchase discount designated as Credit Reserve to accretable purchase discount.

The following table presents the coupon yield and net yields earned on our Agency MBS, Legacy Non-Agency MBS and 3 Year Step-up securities and weighted average CPRs experienced for such MBS for the quarterly periods presented:
 
 
 
Agency MBS
 
Legacy Non-Agency MBS
 
3 Year Step-up Securities
Quarter Ended
 
Coupon Yield (1)
 
Net Yield (2)
 
3 Month Average CPR (3)
 
Coupon Yield (1)
 
Net Yield (2)
 
3 Month Average CPR (3)
 
Coupon Yield (1)
 
Net Yield (2)
 
3 Month Average Bond CPR (4)
March 31, 2017
 
2.90
%
 
1.98
%
 
15.1
%
 
5.50
%
 
8.90
%
 
16.8
%
 
3.99
%
 
4.02
%
 
25.7
%
December 31, 2016
 
2.86

 
1.92

 
15.9

 
5.40

 
8.24

 
17.3

 
3.91

 
3.94

 
25.6

September 30, 2016
 
2.83

 
1.83

 
16.7

 
5.28

 
8.09

 
15.9

 
3.83

 
3.86

 
32.2

June 30, 2016
 
2.80

 
1.96

 
13.9

 
5.19

 
7.72

 
16.1

 
3.81

 
3.83

 
25.4

March 31, 2016
 
2.78

 
2.07

 
11.7

 
5.09

 
7.61

 
13.3

 
3.73

 
3.97

 
23.0

 
(1)
Reflects the annualized coupon interest income divided by the average amortized cost. The discounted purchase price on Legacy Non-Agency MBS causes the coupon yield to be higher than the pass-through coupon interest rate.
(2)
Reflects annualized interest income on MBS divided by average amortized cost of MBS.
(3)
3 month average CPR weighted by positions as of the beginning of each month in the quarter.
(4)
All principal payments are considered to be prepayments for CPR purposes.

Interest Expense
 
Our interest expense for the first quarter of 2017 increased by $2.7 million, or 5.8%, to $50.3 million from $47.6 million for the first quarter of 2016.  The effective interest rate paid on our borrowings increased to 2.34% for the quarter ended March 31, 2017, from 2.01% for the quarter ended March 31, 2016.  This increase primarily reflects an increase in financing rates on our repurchase agreement financings, an increase in our average borrowings to finance residential whole loans, CRT securities and other interest-earning investments, which was partially offset by a decrease in our average repurchase agreement borrowings and other advances to finance Agency MBS and Legacy Non-Agency MBS and securitized debt.
 
At March 31, 2017, we had repurchase agreement borrowings of $8.1 billion, of which $2.9 billion was hedged with Swaps.  At March 31, 2017, our Swaps designated in hedging relationships had a weighted average fixed-pay rate of 1.89% and extended 32 months on average with a maximum remaining term of approximately 77 months.
  
Payments made and/or received on our Swaps are a component of our borrowing costs and accounted for interest expense of $7.8 million, or 36 basis points, for the first quarter of 2017, as compared to interest expense of $10.7 million, or 46 basis points, for the first quarter of 2016.  The weighted average fixed-pay rate on our Swaps designated as hedges increased to 1.88% for the quarter ended March 31, 2017 from 1.82% for the quarter ended and March 31, 2016.  The weighted average variable interest rate received on our Swaps increased to 0.79% for the quarter ended March 31, 2017 from 0.42% for the quarter ended March 31, 2016.  During the quarter ended March 31, 2017, we did not enter into any new Swaps and had Swaps with an aggregate notional amount of $50.0 million and weighted average fixed-pay rate of 0.67% amortize and/or expire.
 

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We expect that our interest expense and funding costs for the remainder of 2017 will be impacted by market interest rates, the amount of our borrowings and incremental hedging activity, existing and future interest rates on our hedging instruments and the extent to which we execute additional longer-term structured financing transactions.  As a result of these variables, our borrowing costs cannot be predicted with any certainty.  (See Notes 5(c), 6 and 15 to the accompanying consolidated financial statements, included under Item 1 of this Quarterly Report on Form 10-Q.)
   
OTTI
 
During the first quarter of 2017, we recognized OTTI charges through earnings against certain of our Non-Agency MBS of $414,000. We did not recognize any OTTI charges through earnings against our Non-Agency MBS during the first quarter of 2016. These impairment charges reflected changes in our estimated cash flows for such securities based on an updated assessment of the estimated future performance of the underlying collateral, including the expected principal loss over the term of the securities and changes in the expected timing of receipt of cash flows. At March 31, 2017, we had 349 Agency MBS with a gross unrealized loss of $32.1 million and 27 Non-Agency MBS with a gross unrealized loss of $2.3 million.  Impairments on Agency MBS in an unrealized loss position at March 31, 2017 are considered temporary and not credit related.  Unrealized losses on Non-Agency MBS for which no OTTI was recorded during the quarter are considered temporary based on an assessment of changes in the expected cash flows for such securities, which considers recent bond performance and expected future performance of the underlying collateral.  Significant judgment is used both in our analysis of expected cash flows for our Legacy Non-Agency MBS and any determination of the credit component of OTTI.

Other Income, net

For the first quarter of 2017, Other Income, net increased by $5.3 million, or 23.3%, to $28.0 million compared to $22.7 million for the first quarter of 2016.  Other income, net for the first quarter of 2017 primarily reflects a $13.8 million net gain recorded on residential whole loans held at fair value, $5.6 million of unrealized gains on CRT securities accounted for at fair value and $9.7 million of net gains realized on the sale of $160.7 million of Non-Agency MBS and U.S. Treasury securities. Other Income, net for the first quarter of 2016 primarily reflects an $12.3 million net gain recorded on residential whole loans held at fair value, and $9.7 million of gross gains realized on the sale of $32.0 million Non-Agency MBS.
 
Operating and Other Expense

For the first quarter of 2017, we had compensation and benefits and other general and administrative expenses of $12.0 million, or 1.57% of average equity, compared to $11.3 million, or 1.57% of average equity, for the first quarter of 2016.  Compensation and benefits expense increased $386,000 to $7.8 million for the first quarter of 2017, compared to $7.4 million for the first quarter of 2016, which primarily reflects higher headcount and recognition for accounting purposes of additional expense associated with long term incentive awards. Our other general and administrative expenses increased by $307,000 to $4.2 million for the quarter ended March 31, 2017 compared to $3.9 million for the quarter ended March 31, 2016 primarily due to higher professional services related costs and data analytics and pricing services related expenses. 

Operating and Other Expense for the first quarter of 2017 also includes $4.4 million of loan servicing and other related operating expenses related to our residential whole loan activities. These expenses increased compared to the prior year period by approximately $1.3 million, consistent with the overall growth in this asset class since the first quarter of 2016. The overall increase is primarily due to non-recoverable advances on REO, increased loan servicing and modification fees and higher loan acquisition related expenses, which were partially offset by a decrease in the provision for loan losses recognized this quarter.


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Selected Financial Ratios
 
The following table presents information regarding certain of our financial ratios at or for the dates presented:
 
At or for the Quarter Ended
 
Return on
Average Total
Assets (1)
 
Return on
Average Total
Stockholders’
Equity (2)
 
Total Average
Stockholders’
Equity to Total
Average Assets (3)
 
Dividend Payout
Ratio (4)
 
Leverage Multiple (5)
 
Book Value
per Share
of Common
Stock (6)
March 31, 2017
 
2.42
%
 
10.19
%
 
24.95
%
 
1.00
 
2.9
 
$
7.66

December 31, 2016
 
2.18

 
9.52

 
24.19

 
1.11
 
3.1
 
7.62

September 30, 2016
 
2.47

 
11.05

 
23.46

 
0.95
 
3.1
 
7.64

June 30, 2016
 
2.33

 
10.83

 
22.58

 
1.00
 
3.3
 
7.41

March 31, 2016
 
2.29

 
10.82

 
22.19

 
1.00
 
3.4
 
7.17


(1)
Reflects annualized net income available to common stock and participating securities divided by average total assets.
(2)
Reflects annualized net income divided by average total stockholders’ equity.
(3)
Reflects total average stockholders’ equity divided by total average assets.
(4)
Reflects dividends declared per share of common stock divided by earnings per share.
(5)
Represents the sum of borrowings under repurchase agreements, FHLB advances, securitized debt, payable for unsettled purchases, and obligations to return securities obtained as collateral and Senior Notes divided by stockholders’ equity.
(6)
Reflects total stockholders’ equity less the preferred stock liquidation preference divided by total shares of common stock outstanding.


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Recent Accounting Standards to be Adopted in Future Periods

Intangibles - Goodwill and Other - Simplifying the Test for Goodwill Impairment

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other - Simplifying the Test for Goodwill Impairment (or ASU 2017-04). The amendments in ASU 2017-04 eliminate the requirement to calculate the implied fair value of goodwill (Step 2 from today’s goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value (i.e., measure the charge based on today’s Step 1). Public business entities should adopt the amendments in ASU 2017-04 for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The amendments of this ASU should be applied in a prospective basis. We do not expect the adoption of ASU 2017-04 to have a significant impact on our financial position or financial statement disclosures.

Statement of Cash Flows - Restricted Cash

In November 2016, the FASB issued ASU 2016-18, Restricted Cash (or 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. ASU 2016-18 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early application is permitted, provided that all of the amendments are adopted in the same period. The amendments of this ASU should generally be applied using a retrospective transition method to each period presented. We do not expect the adoption of ASU 2016-18 to have a significant impact on our 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 (or 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. ASU 2016-15 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. Early application is permitted, provided that all of the amendments are adopted in the same period. The amendments of this ASU should generally be applied using a retrospective transition method to each period presented. We do not expect the adoption of ASU 2016-15 to have a significant impact on our financial position or financial statement disclosures.

Financial Instruments - Credit Losses - Measurement of Credit Losses on Financial Instruments

In June 2016, the FASB issued ASU 2016-13, Measurements of Credit Losses on Financial Instruments (or ASU 2016-13). The amendments in ASU 2016-13 require entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. Entities will now use forward-looking information to better inform their credit loss estimates. ASU 2016-13 also requires enhanced financial statement disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. Under ASU 2016-13 credit losses for available-for-sale debt securities should be measured in a manner similar to current GAAP. However, the amendments in this ASU require that credit losses be recorded through an allowance for credit losses, which will allow subsequent reversals in credit loss estimates to be recognized in current income. In addition, the allowance on available-for-sale debt securities will be limited to the extent that the fair value is less than the amortized cost.

ASU 2016-13 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for all entities for annual periods beginning after December 15, 2018, and interim periods therein. The amendments in this ASU are required to be applied by recording a cumulative-effect adjustment to equity as of the beginning of the first reporting period in which the guidance is effective. A prospective transition approach is required for debt securities for which an OTTI had been recognized before the effective date. We are currently evaluating the effect that ASU 2016-13 will have on our consolidated financial statements and related disclosures.




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Leases

In February 2016, the FASB issued ASU 2016-02, Leases (or ASU 2016-02). The amendments in this ASU establish a right-of-use model that requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. While we continue to evaluate the potential impact that adoption of ASU 2016-02 will have on our financial reporting, given the relatively limited nature and extent of lease financing transactions that we have entered into, we do not expect that the adoption of ASU 2016-02 will have a significant impact on our financial position or financial statement disclosures.

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 (or 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 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017.  Early adoption is not permitted for public business entities, except for a provision related to financial statements of fiscal years or interim periods that have not yet been issued, to recognize in other comprehensive income, the change in fair value of a liability resulting from a change in the instrument-specific credit risk measured using the fair value option. The amendments in this ASU are required to be applied by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption. We do not expect that adoption of ASU 2016-01 will have a significant impact on our financial position or financial statement disclosures.

Revenue from Contracts with Customers

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (or 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 will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. ASU 2014-09 originally would have been effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2016.  Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. On April 29, 2015, the FASB proposed a one-year deferral of the effective date for ASU 2014-09. On July 9, 2015 the FASB affirmed its proposal to defer the effective date of the new revenue standard for all entities by one year. As a result, public entities would apply the new revenue standard to annual reporting periods beginning after December 15, 2017 and interim periods therein. The FASB would also permit entities to adopt the standard early, but not before the original public entity effective date. We continue to monitor overall industry efforts to implement this ASU, including evaluating recent implementation questions and practice issues that may impact our business. As this monitoring effort continues, we will continue to assess potential impacts to our financial reporting procedures and controls (if any) as well as any impact on our financial position or financial statement disclosures.

Proposed Accounting Standards

The FASB has recently issued or discussed a number of proposed standards on topics including hedge accounting and disclosures about liquidity risk and interest rate risk.  Some of the proposed changes are potentially significant and could have a material impact on our reporting.  We have not yet fully evaluated the potential impact of these proposals but will make such an evaluation as the standards are finalized.


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Liquidity and Capital Resources
 
General
 
Our principal sources of cash generally consist of borrowings under repurchase agreements and other collateralized financings, payments of principal and interest we receive on our investment portfolio, cash generated from our operating results and, to the extent such transactions are entered into, proceeds from capital market and structured financing transactions.  Our most significant uses of cash are generally to pay principal and interest on our financing transactions, to purchase residential mortgage assets, to make dividend payments on our capital stock, to fund our operations and to make other investments that we consider appropriate.

We seek to employ a diverse capital raising strategy under which we may issue capital stock and other types of securities.  To the extent we raise additional funds through capital market transactions, we currently anticipate using the net proceeds from such transactions to acquire additional securities and residential whole loans, consistent with our investment policy, and for working capital, which may include, among other things, the repayment of our financing transactions.  There can be no assurance, however, that we will be able to access the capital markets at any particular time or on any particular terms.  We have available for issuance an unlimited amount (subject to the terms and limitations of our charter) of common stock, preferred stock, depositary shares representing preferred stock, warrants, debt securities, rights and/or units pursuant to our automatic shelf registration statement and, at March 31, 2017, we had 14.0 million shares of common stock available for issuance pursuant to our DRSPP shelf registration statement.  During the three months ended March 31, 2017, we issued 514,324 shares of common stock through our DRSPP, raising net proceeds of approximately $4.0 million.

Our borrowings under repurchase agreements are uncommitted and renewable at the discretion of our lenders and, as such, our lenders could determine to reduce or terminate our access to future borrowings at virtually any time.  The terms of the repurchase transaction borrowings under our master repurchase agreements, as such terms relate to repayment, margin requirements and the segregation of all securities that are the subject of repurchase transactions, generally conform to the terms contained in the standard master repurchase agreement published by the Securities Industry and Financial Markets Association (or SIFMA) or the global master repurchase agreement published by SIFMA and the International Capital Market Association.  In addition, each lender typically requires that we include supplemental terms and conditions to the standard master repurchase agreement.  Typical supplemental terms and conditions, which differ by lender, may include changes to the margin maintenance requirements, required haircuts (as defined below), purchase price maintenance requirements, requirements that all controversies related to the repurchase agreement be litigated in a particular jurisdiction and cross default and setoff provisions.
 
With respect to margin maintenance requirements for repurchase agreements secured by harder to value assets, such as Non-Agency MBS and residential whole loans, margin calls are typically determined by our counterparties based on their assessment of changes in the fair value of the underlying collateral and in accordance with the agreed upon haircuts specified in the transaction confirmation with the counterparty.  We address margin call requests in accordance with the required terms specified in the applicable repurchase agreement and such requests are typically satisfied by posting additional cash or collateral on the same business day.  We review margin calls made by counterparties and assess them for reasonableness by comparing the counterparty valuation against our valuation determination.  When we believe that a margin call is unnecessary because our assessment of collateral value differs from the counterparty valuation, we typically hold discussions with the counterparty and are able to resolve the matter.  In the unlikely event that resolution cannot be reached, we will look to resolve the dispute based on the remedies available to us under the terms of the repurchase agreement, which in some instances may include the engagement of a third party to review collateral valuations.  For other agreements that do not include such provisions, we could resolve the matter by substituting collateral as permitted in accordance with the agreement or otherwise request the counterparty to return the collateral in exchange for cash to unwind the financing.
 

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The following table presents information regarding the margin requirements, or the percentage amount by which the collateral value is contractually required to exceed the loan amount (this difference is referred to as the “haircut”), on our repurchase agreements at March 31, 2017 and December 31, 2016:
 
At March 31, 2017

Weighted
Average
Haircut

Low

High
Repurchase agreement borrowings secured by:

 


 


 

Agency MBS

4.56
%
 
3.00
%
 
5.00
%
Legacy Non-Agency MBS

22.44

 
15.00

 
35.00

3 Year Step-up securities
 
21.52

 
15.00

 
30.00

U.S. Treasury securities

1.73

 
1.00

 
2.00

CRT securities
 
22.36

 
15.00

 
25.00

Residential whole loans
 
25.16

 
20.00

 
35.00

Other investments
 
50.00

 
50.00

 
50.00

 
 
 
 
 
 
 
At December 31, 2016

Weighted
Average
Haircut
 
Low
 
High
Repurchase agreement borrowings secured by:

 

 
 

 
 
Agency MBS

4.67
%
 
3.00
%
 
6.00
%
Legacy Non-Agency MBS

24.01

 
15.00

 
60.00

3 Year Step-up securities
 
21.70

 
15.00

 
40.00

U.S. Treasury securities

1.60

 
1.00

 
2.00

CRT securities
 
23.22

 
20.00

 
25.00

Residential whole loans
 
25.03

 
20.00

 
35.00

Other investments
 
50.00

 
50.00

 
50.00

 
During the first three month of 2017, the weighted average haircut requirements for the respective underlying collateral types for our repurchase agreements have remained fairly consistent compared to the end of 2016. Weighted average haircuts have decreased on Legacy Non-Agency MBS and CRT securities.
 
Repurchase agreement funding for our residential mortgage investments has been available to us at generally attractive market terms from multiple counterparties.  Typically, due to the risks inherent in credit sensitive residential mortgage investments, repurchase agreement funding involving such investments is available at terms requiring higher collateralization and higher interest rates, than repurchase agreement funding secured by Agency MBS and U.S. Treasury securities.  Therefore, we generally expect to be able to finance our acquisitions of Agency MBS on more favorable terms than financing for credit sensitive investments.

In July 2015, our wholly-owned subsidiary, MFA Insurance became a member of the FHLB. As a member of the FHLB, MFA Insurance had access to a variety of products and services offered by the FHLB, including secured advances (subject to our continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain agreements with the FHLB). However, in January, 2016, 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, MFA Insurance was required to repay all outstanding advances by February 19, 2017, and its FHLB membership was terminated on such date.

We maintain cash and cash equivalents, unpledged Agency and Non-Agency MBS and collateral in excess of margin requirements held by our counterparties (or collectively, “cash and other unpledged collateral”) to meet routine margin calls and protect against unforeseen reductions in our borrowing capabilities.  Our ability to meet future margin calls will be impacted by our ability to use cash or obtain financing from unpledged collateral, which can vary based on the market value of such collateral, our cash position and margin requirements.  Our cash position fluctuates based on the timing of our operating, investing and financing activities and is managed based on our anticipated cash needs.  (See our Consolidated Statements of Cash Flows, included under Item 1 of this Quarterly Report on Form 10-Q and “Interest Rate Risk” included under Item 3 of this Quarterly Report on Form 10-Q.)
 

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At March 31, 2017, we had a total of $9.9 billion of MBS, U.S. Treasury securities, CRT securities, residential whole loans and other investments and $11.0 million of restricted cash pledged against our repurchase agreements and Swaps. At March 31, 2017, we have access to various sources of liquidity which we estimate exceeds $903.8 million. This includes (i) $421.6 million of cash and cash equivalents; (ii) $212.4 million in estimated financing available from unpledged Agency MBS and other Agency MBS collateral that is currently pledged in excess of contractual requirements; and (iii) $269.8 million in estimated financing available from unpledged Non-Agency MBS. Our sources of liquidity do not include restricted cash.
 
The table below presents certain information about our borrowings under repurchase agreements and other advances, and securitized debt:
 
 
Repurchase Agreements and Other Advances
 
Securitized Debt
Quarter Ended (1)
 
Quarterly
Average
Balance
 
End of Period
Balance
 
Maximum
Balance at Any
Month-End
 
Quarterly
Average
Balance
 
End of Period
Balance
 
Maximum
Balance at Any
Month-End
(In Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
March 31, 2017
 
$
8,494,853

 
$
8,137,102

 
$
8,564,493

 
$
—

 
$
—

 
$
—

December 31, 2016
 
8,684,803

 
8,687,268

 
8,815,846

 
—

 
—

 
—

September 30, 2016
 
8,868,173

 
8,697,756

 
8,917,550

 
—

 
—

 
—

June 30, 2016
 
9,102,457

 
9,038,087

 
9,114,859

 
8,520

 
—

 
8,568

March 31, 2016
 
9,238,772

 
9,143,645

 
9,205,547

 
18,425

 
11,821

 
18,247


(1)  The information presented in the table above excludes Senior Notes issued in April 2012. The outstanding balance of Senior Notes has been unchanged at $100.0 million since issuance.
 
Cash Flows and Liquidity For the Three Months Ended March 31, 2017
 
Our cash and cash equivalents increased by $161.5 million during the three months ended March 31, 2017, reflecting:  $730.0 million provided by our investing activities, primarily from payments on our MBS; $43.5 million provided by our operating activities; and $612.0 million used in our financing activities.
 
At March 31, 2017, our debt-to-equity multiple was 2.9 times compared to 3.1 times at December 31, 2016. At March 31, 2017, we had borrowings under repurchase agreements of $8.1 billion with 31 counterparties, of which $3.1 billion were secured by Agency MBS, $1.6 billion were secured by Legacy Non-Agency MBS, $1.9 billion were secured by 3 Year Step-up securities, $366.5 million were secured by U.S. Treasuries, $345.5 million were secured by CRT securities, $836.2 million were secured by residential whole loans and $46.9 million were secured by other investments.  We continue to have available capacity under our repurchase agreement credit lines.  At December 31, 2016, we had borrowings under repurchase agreements of $8.5 billion with 31 counterparties, of which $3.1 billion were secured by Agency MBS, $1.7 billion were secured by Legacy Non-Agency MBS, $2.0 billion were secured by 3 Year Step-up securities, $504.6 million were secured by U.S. Treasuries, $271.2 million were secured by CRT securities, $832.1 million were secured by residential whole loans and $43.3 million were secured by other investments. In addition, at December 31, 2016, we had $215.0 million in outstanding FHLB advances, secured by Agency MBS, all of which were repaid in January 2017.

During the three months ended March 31, 2017, $730.0 million was provided through our investing activities.  We received cash of $762.7 million from prepayments and scheduled amortization on our MBS and CRT securities, of which $227.5 million was attributable to Agency MBS, $531.2 million was from Non-Agency MBS and $4.0 million was from CRT securities.  We purchased $150.0 million of Non-Agency MBS, $87.4 million of CRT securities and $7.2 million of other investments funded with cash and repurchase agreement borrowings.  While we generally intend to hold our MBS as long-term investments, we may sell certain of our securities in order to manage our interest rate risk and liquidity needs, meet other operating objectives and adapt to market conditions.  In addition, during the three months ended March 31, 2017 we sold certain of our Non-Agency MBS and U.S. Treasury securities for $160.7 million, realizing net gains of $9.7 million.
 
In connection with our repurchase agreement borrowings and Swaps, we routinely receive margin calls/reverse margin calls from our counterparties and make margin calls to our counterparties.  Margin calls and reverse margin calls, which requirements vary over time, may occur daily between us and any of our counterparties when the value of collateral pledged changes from the amount contractually required.  The value of securities pledged as collateral fluctuates reflecting changes in: (i) the face (or par) value of our MBS; (ii) market interest rates and/or other market conditions; and (iii) the market value of our Swaps.  Margin calls/reverse margin calls are satisfied when we pledge/receive additional collateral in the form of additional securities and/or cash.
 

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The table below summarizes our margin activity with respect to our repurchase agreement financings and derivative hedging instruments for the quarterly periods presented.
 
 
 
Collateral Pledged to Meet Margin Calls
 
Cash and
Securities Received for
Reverse Margin Calls
 
Net Assets
Received/(Pledged) for Margin Activity
For the Quarter Ended
 
Fair Value of
Securities
Pledged
 
Cash Pledged
 
Aggregate Assets
Pledged For
Margin Calls
 
 
(In Thousands)
 
 
 
 
 
 
 
 
 
 
March 31, 2017
 
$
150,264

 
$
1,500

 
$
151,764

 
$
246,168

 
$
94,404

December 31, 2016
 
337,694

 
8,000

 
345,694

 
357,163

 
11,469

September 30, 2016
 
343,351

 
28,700

 
372,051

 
343,139

 
(28,912
)
June 30, 2016
 
326,555

 
63,600

 
390,155

 
281,912

 
(108,243
)
March 31, 2016
 
269,027

 
117,800

 
386,827

 
325,233

 
(61,594
)
 
We are subject to various financial covenants under our repurchase agreements and derivative contracts, which include minimum net worth and/or profitability requirements, maximum debt-to-equity ratios and minimum market capitalization requirements.  We have maintained compliance with all of our financial covenants through March 31, 2017.
 
During the three months ended March 31, 2017, we paid $74.6 million for cash dividends on our common stock and dividend equivalents and paid cash dividends of $3.8 million on our preferred stock. On March 8, 2017, we declared our first quarter 2017 dividend on our common stock of $0.20 per share; on April 28, 2017, we paid this dividend, which totaled approximately $74.8 million, including dividend equivalents of approximately $227,000. 
 
We believe that we have adequate financial resources to meet our current obligations, including margin calls, as they come due, to fund dividends we declare and to actively pursue our investment strategies.  However, should the value of our MBS suddenly decrease, significant margin calls on our repurchase agreement borrowings could result and our liquidity position could be materially and adversely affected.  Further, should market liquidity tighten, our repurchase agreement counterparties may increase our margin requirements on new financings, reducing our ability to use leverage.  Access to financing may also be negatively impacted by the ongoing volatility in the world financial markets, potentially adversely impacting our current or potential lenders’ ability or willingness to provide us with financing. In addition, there is no assurance that favorable market conditions will continue to permit us to consummate additional securitization transactions if we determine to seek that form of financing.
 
Off-Balance Sheet Arrangements
 
We do not have any material off-balance sheet arrangements.

Inflation
 
Substantially all of our assets and liabilities are financial in nature.  As a result, changes in interest rates and other factors impact our performance far more than does inflation.  Our results of operations and reported assets, liabilities and equity are measured with reference to historical cost or fair value without considering inflation.



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Item 3.  Quantitative and Qualitative Disclosures About Market Risk.
 
We seek to manage our risks related to interest rates, liquidity, prepayment speeds, market value and the credit quality of our assets while, at the same time, seeking to provide an opportunity to stockholders to realize attractive total returns through ownership of our capital stock.  While we do not seek to avoid risk, we seek, consistent with our investment policies, to:  assume risk that can be quantified based on management’s judgment and experience and actively manage such risk; earn sufficient returns to justify the taking of such risks; and maintain capital levels consistent with the risks that we undertake.

Interest Rate Risk
  
We generally acquire interest-rate sensitive assets and fund them with interest-rate sensitive liabilities, a portion of which are hedged with Swaps. We are exposed to interest rate risk on our residential mortgage assets, as well as on our liabilities. Changes in interest rates can affect our net interest income and the fair value of our assets and liabilities.
We finance the majority of our investments in residential mortgage assets with short-term repurchase agreements. In general, when interest rates change, the borrowing costs of our repurchase agreements (net of the impact of Swaps) change more quickly than the yield on our assets. In a rising interest rate environment, the borrowing costs of our repurchase agreements may increase faster than the interest income on our assets, thereby reducing our net income. In order to mitigate compression in net income based on such interest rate movements, we use Swaps to lock in a portion of the net interest spread between assets and liabilities.

When interest rates change, the fair value of our residential mortgage assets could change at a different rate than the fair value of our liabilities. We measure the sensitivity of our portfolio to changes in interest rates by estimating the duration of our assets and liabilities. Duration is the approximate percentage change in fair value for a 100 basis point parallel shift in the yield curve. In general, our assets have higher duration than our liabilities and in order to reduce this exposure we use Swaps to reduce the gap in duration between our assets and liabilities.

In calculating the duration of our Agency MBS we take into account the characteristics of the underlying mortgage loans including whether the underlying loans are fixed rate, adjustable or hybrid; coupon, expected prepayment rates and lifetime and periodic caps. We use third-party financial models, combined with management’s assumptions and observed empirical data when estimating the duration of our Agency MBS.

In analyzing the interest rate sensitivity of our Legacy Non-Agency MBS we take into account the characteristics of the underlying mortgage loans, including credit quality and whether the underlying loans are fixed-rate, adjustable or hybrid. We estimate the duration of our Legacy Non-Agency MBS using management’s assumptions.

The majority of our 3 Year Step-up securities deal structures contain a contractual coupon step-up feature where the coupon increases up to 300 basis points if the bond is not redeemed by the issuer at 36 months or sooner. Therefore, we believe their fair value exhibits little sensitivity to changes in interest rates. We estimate the duration of these securities using management’s assumptions.

The fair value of our re-performing residential whole loans is dependent on the value of the underlying real estate collateral, past and expected delinquency status of the borrower as well as the level of interest rates. Because the borrower is not delinquent on their mortgage payments but is less likely to prepay the loan due to weak credit history and/or high LTV, we believe our re-performing residential whole loans exhibit positive duration. We estimate the duration of our re-performing residential whole loans using management’s assumptions.

The fair value of our non-performing residential whole loans is primarily dependent on the value of the underlying real estate collateral and the time required for collateral liquidation. Since neither the value of the collateral nor the liquidation timeline is generally sensitive to interest rates, we believe their fair value exhibits little sensitivity to interest rates. We estimate the duration of our non-performing residential whole loans using management’s assumptions.

We use Swaps as part of our overall interest rate risk management strategy. Such derivative financial instruments are intended to act as a hedge against future interest rate increases on our repurchase agreement financings, which rates are typically highly correlated with LIBOR. While our derivatives do not extend the maturities of our borrowings under repurchase agreements, they do, in effect, lock in a fixed rate of interest over their term for a corresponding amount of our repurchase agreement financings that are hedged. 


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At March 31, 2017, MFA’s $6.5 billion of Agency MBS and Legacy Non-Agency MBS were backed by Hybrid, adjustable and fixed-rate mortgages.  Additional information about these MBS, including average months to reset and three-month average CPR, is presented below:
 
 
 
Agency MBS
 
Legacy Non-Agency MBS (1)
 
Total (1)
Time to Reset
 
 Fair
Value (2)
 
Average Months to Reset (3)
 
3 Month 
Average CPR (4)
 
 Fair Value
 
Average Months to Reset (3)
 
3 Month 
Average CPR (4)
 
 Fair
Value (2)
 
Average Months to Reset (3)
 
3 Month 
Average CPR (4)
(Dollars in Thousands)
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

< 2 years (5)
 
$
1,747,023

 
7

 
18.7
%
 
$
2,053,959

 
4

 
16.6
%
 
$
3,800,982

 
6

 
17.5
%
2-5 years
 
268,158

 
33

 
19.6

 
—

 
—

 
—

 
268,158

 
33

 
19.6

> 5 years
 
116,773

 
66

 
6.6

 
—

 
—

 
—

 
116,773

 
66

 
6.6

ARM-MBS Total
 
$
2,131,954

 
14

 
18.2
%
 
$
2,053,959

 
4

 
16.6
%
 
$
4,185,913

 
9

 
17.3
%
15-year fixed (6)
 
$
1,361,607

 
 

 
10.4
%
 
$
4,949

 
 

 
26.1
%
 
$
1,366,556

 
 

 
10.7
%
30-year fixed (6)
 
—

 
 

 
—

 
930,294

 
 

 
17.4

 
930,294

 
 

 
17.4

40-year fixed (6)
 
—

 
 

 
—

 
26,048

 
 

 
5.8

 
26,048

 
 

 
5.8

Fixed-Rate Total
 
$
1,361,607

 
 

 
10.4
%
 
$
961,291

 
 

 
17.4
%
 
$
2,322,898

 
 

 
13.6
%
MBS Total
 
$
3,493,561

 
 

 
15.1
%
 
$
3,015,250

 
 

 
16.8
%
 
$
6,508,811

 
 

 
16.0
%
 
(1)
Excludes $2.5 billion of 3 Year Step-up securities. Refer to table below for further information.
(2)
Does not include principal payments receivable of $1.1 million.
(3)
Months to reset is the number of months remaining before the coupon interest rate resets.  At reset, the MBS coupon will adjust based upon the underlying benchmark interest rate index, margin and periodic and/or lifetime caps.  The months to reset do not reflect scheduled amortization or prepayments.
(4)
3 month average CPR weighted by positions as of the beginning of each month in the quarter.
(5)
Includes floating-rate MBS that may be collateralized by fixed-rate mortgages.
(6)
Information presented based on data available at time of loan origination.


The following table presents certain information about our 3 Year Step-up securities portfolio at March 31, 2017:
 
 
Fair Value
 
Net Coupon
 
Months to
Step-Up (1)
 
3 Month Average
Bond CPR (2)
(Dollars in Thousands)
 
 
 
 
 
 
 
 
Re-Performing loans
 
$
278,896

 
3.56
%
 
10

 
25.2
%
Non-Performing loans
 
1,891,700

 
3.89

 
17

 
27.4

Term Notes
 
282,332

 
5.71

 
33

 
14.6

Total 3 Year Step-up securities
 
$
2,452,928

 
4.06
%
 
18

 
25.7
%

(1)
Months to step-up is the weighted average number of months remaining before the coupon interest rate increases pursuant to the first coupon reset. We anticipate that the securities will be redeemed prior to the step-up date.
(2)
All principal payments are considered to be prepayments for CPR purposes.

At March 31, 2017, our CRT securities had a fair value of $498.1 million and their coupons reset monthly based on one-month LIBOR.


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Shock Table

The information presented in the following “Shock Table” projects the potential impact of sudden parallel changes in interest rates on our net interest income and portfolio value, including the impact of Swaps, over the next 12 months based on the assets in our investment portfolio at March 31, 2017.  All changes in income and value are measured as the percentage change from the projected net interest income and portfolio value under the base interest rate scenario at March 31, 2017.

Change in Interest Rates
 
Estimated
Value
of Assets (1)
 
Estimated
Value of
Swaps
 
Estimated
Value of
Financial
Instruments
 
Change in
Estimated
Value
 
Percentage
Change in Net
Interest
Income
 
Percentage
Change in
Portfolio
Value
(Dollars in Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 +100 Basis Point Increase
 
$
11,312,961

 
$
25,856

 
$
11,338,817

 
$
(85,541
)
 
(6.90
)%
 
(0.75
)%
 + 50 Basis Point Increase
 
$
11,392,094

 
$
(8,718
)
 
$
11,383,376

 
$
(40,982
)
 
(3.25
)%
 
(0.36
)%
Actual at March 31, 2017
 
$
11,467,649

 
$
(43,291
)
 
$
11,424,358

 
$
—

 
—

 
—

 - 50 Basis Point Decrease
 
$
11,539,624

 
$
(77,865
)
 
$
11,461,759

 
$
37,401

 
1.30
 %
 
0.33
 %
 -100 Basis Point Decrease
 
$
11,608,020

 
$
(112,438
)
 
$
11,495,582

 
$
71,224

 
2.78
 %
 
0.62
 %

(1)
  Such assets include MBS and CRT securities, residential whole loans and REO, Corporate Loan, cash and cash equivalents and restricted cash.

Certain assumptions have been made in connection with the calculation of the information set forth in the Shock Table and, as such, there can be no assurance that assumed events will occur or that other events will not occur that would affect the outcomes.  The base interest rate scenario assumes interest rates at March 31, 2017.  The analysis presented utilizes assumptions and estimates based on management’s judgment and experience.  Furthermore, while we generally expect to retain the majority of our assets and the associated interest rate risk to maturity, future purchases and sales of assets could materially change our interest rate risk profile.  It should be specifically noted that the information set forth in the above table and all related disclosure constitute forward-looking statements within the meaning of Section 27A of the 1933 Act and Section 21E of the 1934 Act.  Actual results could differ significantly from those estimated in the Shock Table above.
 
The Shock Table quantifies the potential changes in net interest income and portfolio value, which includes the value of our Swaps (which are carried at fair value), should interest rates immediately change (i.e., are shocked).  The Shock Table presents the estimated impact of interest rates instantaneously rising 50 and 100 basis points, and falling 50 and 100 basis points.  The cash flows associated with our portfolio of MBS for each rate shock are calculated based on assumptions, including, but not limited to, prepayment speeds, yield on replacement assets, the slope of the yield curve and composition of our portfolio.  Assumptions made with respect to the interest rate sensitive liabilities include anticipated interest rates, collateral requirements as a percent of repurchase agreement financings, and the amounts and terms of borrowing.  At March 31, 2017, we applied a floor of 0% for all anticipated interest rates included in our assumptions.  Due to this floor, it is anticipated that any hypothetical interest rate shock decrease would have a limited positive impact on our funding costs; however, because prepayments speeds are unaffected by this floor, it is expected that any increase in our prepayment speeds (occurring as a result of any interest rate shock decrease or otherwise) could result in an acceleration of premium amortization on our Agency MBS and discount accretion on our Non-Agency MBS and in the reinvestment of principal repayments in lower yielding assets.  As a result, because the presence of this floor limits the positive impact of interest rate decrease on our funding costs, hypothetical interest rate shock decreases could cause a decline in the fair value of our financial instruments and our net interest income.
 
At March 31, 2017, the impact on portfolio value was approximated using estimated effective duration (i.e., the price sensitivity to changes in interest rates), including the effect of Swaps, of 0.69 which is the weighted average of 1.79 for our Agency MBS, 1.16 for our Non-Agency investments, (2.46) for our Swaps, 0.17 for Other assets and zero for our cash and cash equivalents. Estimated convexity (i.e., the approximate change in duration relative to the change in interest rates) of the portfolio was (0.12), which is the weighted average of (0.41) for our Agency MBS, zero for our Swaps, zero for our Non-Agency MBS, zero for Other assets and zero for our cash and cash equivalents. The impact on our net interest income is driven mainly by the difference between portfolio yield and cost of funding of our repurchase agreements, which includes the cost and/or benefit from Swaps.  Our asset/liability structure is generally such that an increase in interest rates would be expected to result in a decrease in net interest income, as our borrowings are generally shorter in term than our interest-earning assets. When interest rates are shocked, prepayment assumptions are adjusted based on management’s expectations along with the results from the prepayment model.


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Table of Contents

Credit Risk
 
Although we do not believe that we are exposed to credit risk in our Agency MBS portfolio, we are exposed to credit risk through our credit-sensitive residential mortgage investments, in particular Legacy Non-Agency MBS and residential whole loans and to a lesser extent our investments in 3 Year Step-up securities and CRT securities. Our exposure to credit risk from our credit sensitive investments is discussed in more detail below:

Legacy Non-Agency MBS

In the event of the return of less than 100% of par on our Legacy Non-Agency MBS, credit support contained in the MBS deal structures and the discounted purchase prices we paid mitigate our risk of loss on these investments.  Over time, we expect the level of credit support remaining in certain MBS deal structures to decrease, which will result in an increase in the amount of realized credit loss experienced by our Legacy Non-Agency MBS portfolio.  Our investment process for Legacy Non-Agency MBS involves analysis focused primarily on quantifying and pricing credit risk.  When we purchase Legacy Non-Agency MBS, we assign certain assumptions to each of the MBS, including but not limited to, future interest rates, voluntary prepayment rates, mortgage modifications, default rates and loss severities, and generally allocate a portion of the purchase discount as a Credit Reserve which provides credit protection for such securities.  As part of our surveillance process, we review our Legacy Non-Agency MBS by tracking their actual performance compared to the securities’ expected performance at purchase or, if we have modified our original purchase assumptions, compared to our revised performance expectations.  To the extent that actual performance of a Legacy Non-Agency MBS is less favorable than its expected performance, we may revise our performance expectations.  As a result, we could reduce the accretable discount on the security and/or recognize an other-than-temporary impairment through earnings, either of which could have a material adverse impact on our operating results. 

In evaluating our asset/liability management and Legacy Non-Agency MBS credit performance, we consider the credit characteristics of the mortgage loans underlying our Legacy Non-Agency MBS.  The following table presents certain information about our Legacy Non-Agency MBS portfolio at March 31, 2017.  Information presented with respect to the weighted average FICO scores and other information aggregated based on information reported at the time of mortgage origination are historical and, as such, do not reflect the impact of the general changes in home prices or changes in borrowers’ credit scores or the current use of the mortgaged properties.
 

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Table of Contents

The information in the table below is presented as of March 31, 2017:
 
 
 
Securities with Average Loan FICO
of 715 or Higher (1)
 
Securities with Average Loan FICO
Below 715 (1)
 
 
Year of Securitization (2)
 
2007
 
2006
 
2005
and Prior
 
2007
 
2006
 
2005
and Prior
 
Total
(Dollars in Thousands)
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Number of securities
 
88

 
72

 
94

 
30

 
58

 
66

 
408

MBS current face (3)
 
$
900,626

 
$
623,580

 
$
669,682

 
$
187,994

 
$
458,017

 
$
495,739

 
$
3,335,638

Total purchase discounts, net (3)
 
$
(253,389
)
 
$
(177,346
)
 
$
(120,595
)
 
$
(59,275
)
 
$
(164,965
)
 
$
(146,011
)
 
$
(921,581
)
Purchase discount designated as Credit Reserve and OTTI (3)(4)
 
$
(161,260
)
 
$
(89,125
)
 
$
(65,923
)
 
$
(51,961
)
 
$
(173,605
)
 
$
(111,463
)
 
$
(653,337
)
Purchase discount designated as Credit Reserve and OTTI as percentage of current face
 
17.9
%
 
14.3
%
 
9.8
%
 
27.6
%
 
37.9
%
 
22.5
%
 
19.6
%
MBS amortized cost (3)
 
$
647,237

 
$
446,234

 
$
549,087

 
$
128,719

 
$
293,052

 
$
349,728

 
$
2,414,057

MBS fair value (3)
 
$
816,949

 
$
561,739

 
$
630,620

 
$
164,895

 
$
390,060

 
$
450,987

 
$
3,015,250

Weighted average fair value to current face
 
90.7
%
 
90.1
%
 
94.2
%
 
87.7
%
 
85.2
%
 
91.0
%
 
90.4
%
Weighted average coupon (5)
 
3.99
%
 
3.37
%
 
3.52
%
 
4.86
%
 
5.08
%
 
4.60
%
 
4.07
%
Weighted average loan age (months) (5)(6)
 
120

 
129

 
143

 
125

 
131

 
143

 
131

Weighted average current loan size (5)(6)
 
$
513

 
$
486

 
$
304

 
$
348

 
$
246

 
$
242

 
$
380

Percentage amortizing (7)
 
78
%
 
99
%
 
100
%
 
93
%
 
99
%
 
100
%
 
93
%
Weighted average FICO score at origination (5)(8)
 
730

 
728

 
726

 
706

 
702

 
703

 
720

Owner-occupied loans
 
90.8
%
 
90.5
%
 
86.3
%
 
83.6
%
 
86.3
%
 
84.1
%
 
87.8
%
Rate-term refinancings
 
29.6
%
 
21.2
%
 
14.8
%
 
21.6
%
 
15.7
%
 
14.4
%
 
20.4
%
Cash-out refinancings
 
35.2
%
 
36.5
%
 
28.1
%
 
44.1
%
 
43.3
%
 
38.6
%
 
36.1
%
3 Month CPR (6)
 
17.1
%
 
17.2
%
 
18.1
%
 
20.8
%
 
16.8
%
 
15.2
%
 
17.2
%
3 Month CRR (6)(9)
 
14.7
%
 
15.1
%
 
15.3
%
 
17.7
%
 
12.9
%
 
12.5
%
 
14.5
%
3 Month CDR (6)(9)
 
2.9
%
 
2.6
%
 
3.9
%
 
3.5
%
 
4.6
%
 
3.4
%
 
3.4
%
3 Month loss severity
 
52.1
%
 
43.1
%
 
37.4
%
 
48.9
%
 
54.5
%
 
64.9
%
 
49.6
%
60+ days delinquent (8)
 
11.7
%
 
12.1
%
 
9.1
%
 
15.7
%
 
16.4
%
 
13.4
%
 
12.4
%
Percentage of always current borrowers (Lifetime) (10)
 
36.1
%
 
34.1
%
 
41.6
%
 
30.2
%
 
25.4
%
 
30.1
%
 
34.1
%
Percentage of always current borrowers (12M) (11)
 
77.2
%
 
76.0
%
 
78.9
%
 
70.2
%
 
68.0
%
 
69.1
%
 
74.5
%
Weighted average credit enhancement (8)(12)
 
0.2
%
 
0.4
%
 
4.7
%
 
0.0
%
 
1.3
%
 
3.4
%
 
1.8
%


(1)
FICO score is used by major credit bureaus to indicate a borrower’s creditworthiness at time of loan origination.
(2)
Information presented based on the initial year of securitization of the underlying collateral. Certain of our Non-Agency MBS have been resecuritized.  The historical information presented in the table is based on the initial securitization date and data available at the time of original securitization (and not the date of resecuritization). No information has been updated with respect to any MBS that have been resecuritized.
(3)
Excludes Non-Agency MBS issued since 2012 in which the underlying collateral consists of 3 Year Step-up securities. These Non-Agency MBS have a current face of $2.5 billion, amortized cost of $2.4 billion, fair value of $2.5 billion and purchase discounts of $1.4 million at March 31, 2017.
(4)
Purchase discounts designated as Credit Reserve and OTTI are not expected to be accreted into interest income.
(5)
Weighted average is based on MBS current face at March 31, 2017.
(6)
Information provided is based on loans for individual groups owned by us.
(7)
Percentage of face amount for which the original mortgage note contractually calls for principal amortization in the current period.
(8)
Information provided is based on loans for all groups that provide credit enhancement for MBS with credit enhancement.
(9)
CRR represents voluntary prepayments and CDR represents involuntary prepayments.
(10)
Percentage of face amount of loans for which the borrower has not been delinquent since origination.
(11)
Percentage of face amount of loans for which the borrower has not been delinquent in the last twelve months.
(12)
Credit enhancement for a particular security is expressed as a percentage of all outstanding mortgage loan collateral.  A particular security will not be subject to principal loss as long as its credit enhancement is greater than zero.  As of March 31, 2017, a total of 287 Non-Agency MBS in our portfolio representing approximately $2.5 billion or 75% of the current face amount of the portfolio had no credit enhancement.


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Table of Contents

The mortgages securing our Legacy Non-Agency MBS are located in many geographic regions across the United States.  The following table presents the five largest geographic concentrations by state of the mortgages collateralizing our Legacy Non-Agency MBS at March 31, 2017:
Property Location
Percent of Unpaid Principal Balance
California
43.1
%
Florida
7.6
%
New York
6.3
%
Virginia
4.0
%
New Jersey
3.9
%

3 Year Step-up Securities

Re-performing and Non-Performing Loans

Our 3 Year Step-up securities backed by re-performing and non-performing loans were purchased primarily through new issue at prices at or around par and represent the senior tranches of the related securitizations. The majority of these securities are structured with significant credit enhancement (typically approximately 50%) and the subordinate tranches absorb all credit losses (until those tranches are extinguished) and typically receive no cash flow (interest or principal) until the senior tranche is paid off. Prior to purchase, we analyze the deal structure in order to assess the associated credit risk. Subsequent to purchase, the ongoing credit risk associated with the deal is evaluated by analyzing the extent to which actual credit losses occur that result in a reduction in the amount of subordination enjoyed by our bond.

Term Notes

We have invested in certain term notes that are issued by special purpose vehicles (or SPV) 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 by us 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. In addition, 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.
CRT Securities

We are exposed to potential credit losses from our investments in CRT securities issued by Fannie Mae and Freddie Mac. While CRT securities are debt obligations of these GSEs, payment of principal on these securities is not guaranteed. As an investor in a CRT security, we may incur a loss if the loans in the associated reference pool experience delinquencies exceeding specified thresholds or other specified credit events occur. We assess the credit risk associated with our investment in CRT securities by assessing the current performance of the loans in the associated reference pool.

Residential Whole Loans

We are also exposed to credit risk from our investments in residential whole loans. Our investment process for residential whole loans is generally similar to that used for Legacy Non-Agency MBS and is likewise focused on quantifying and pricing credit risk. Consequently, these loans are acquired at purchase prices that are generally discounted (often substantially) to the contractual loan balances based on a number of factors, including the impaired credit history of the borrower and the value of the collateral securing the loan. In addition, as the owner of the servicing rights, our process is also focused on selecting a sub-servicer with the appropriate expertise to mitigate losses and maximize our overall return. This involves, among other things, performing due diligence on the sub-servicer prior to their engagement as well as ongoing oversight and surveillance. To the extent that loan delinquencies and defaults are higher than our expectation at the time the loans were purchased, the discounted purchase price at which the asset is acquired is intended to provide a level of protection against financial loss.


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Table of Contents

The following table presents the five largest geographic concentrations by state of our credit sensitive residential whole loan portfolio at March 31, 2017:
Property Location
Percent of Interest-Bearing Unpaid Principal Balance
California
21.4
%
New York
14.7
%
Florida
7.8
%
New Jersey
6.9
%
Maryland
5.2
%

Corporate Loan

We have entered into a loan agreement with an entity that originates loans and owns MSRs. We assess the credit risk associated with this loan 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.



Liquidity Risk

The primary liquidity risk we face arises from financing long-maturity assets with shorter-term borrowings primarily in the form of repurchase agreement financings.  We pledge residential mortgage assets and cash to secure our repurchase agreements and Swaps.  At March 31, 2017, we had access to various sources of liquidity which we estimate to be in excess of $903.8 million, an amount which includes: (i) $421.6 million of cash and cash equivalents, (ii) $212.4 million in estimated financing available from unpledged Agency MBS and other Agency MBS collateral that are currently pledged in excess of contractual requirements, and (iii) $269.8 million in estimated financing available from currently unpledged Non-Agency MBS.  Our sources of liquidity do not include restricted cash. Should the value of our residential mortgage assets pledged as collateral suddenly decrease, margin calls under our repurchase agreements would likely increase, causing an adverse change in our liquidity position.  Additionally, if one or more of our financing counterparties chose not to provide ongoing funding, our ability to finance our long-maturity assets would decline or be available on possibly less advantageous terms. As such, we cannot assure you that we will always be able to roll over our repurchase agreement financings and other advances.  Further, should market liquidity tighten, our repurchase agreement counterparties may increase our margin requirements on new financings, including repurchase agreement borrowings that we roll with the same counterparty, reducing our ability to use leverage.

Prepayment Risk

Premiums arise when we acquire a MBS at a price in excess of the aggregate principal balance of the mortgages securing the MBS (i.e., par value).  Conversely, discounts arise when we acquire a MBS at a price below the aggregate principal balance of the mortgages securing the MBS or when we acquire residential whole loans at a price below their aggregate principal balance.  Premiums paid on our MBS are amortized against interest income and accretable purchase discounts on our MBS are accreted to interest income.  Purchase premiums, which are primarily carried on our Agency MBS and certain CRT securities, are amortized against interest income over the life of each security using the effective yield method, adjusted for actual prepayment activity.  An increase in the prepayment rate, as measured by the CPR, will typically accelerate the amortization of purchase premiums, thereby reducing the IRR/interest income earned on these assets.  Generally, if prepayments on Non-Agency MBS and residential whole loans purchased at significant discounts and not accounted for at fair value are less than anticipated, we expect that the income recognized on these assets will be reduced and impairments and/or loan loss reserves may result.


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Table of Contents

Item 4.  Controls and Procedures
 
(a) Evaluation of Disclosure Controls and Procedures
 
Management, under the direction of its Chief Executive Officer and Chief Financial Officer, is responsible for maintaining disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the 1934 Act) that are designed to ensure that information required to be disclosed in reports filed or submitted under the 1934 Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to management, including the Company’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.
 
In connection with the preparation of this Quarterly Report on Form 10-Q, management reviewed and evaluated the Company’s disclosure controls and procedures.  The evaluation was performed under the direction of the Company’s Chief Executive Officer and Chief Financial Officer to determine the effectiveness, as of March 31, 2017, of the design and operation of the Company’s disclosure controls and procedures.  Based on that review and evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures, as designed and implemented, were effective as of March 31, 2017. Notwithstanding the foregoing, a control system, no matter how well designed, implemented and operated, can provide only reasonable, not absolute, assurance that it will detect or uncover failures within the Company to disclose material information otherwise required to be set forth in the Company’s current periodic reports.
  
(b) Changes in Internal Control over Financial Reporting

There have been no changes in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2017 that materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.

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PART II. OTHER INFORMATION
 
Item 1.  Legal Proceedings
 
There are no material pending legal proceedings to which we are a party or any of our assets are subject.

Item 1A. Risk Factors
 
For a discussion of the Company’s risk factors, see Part 1, Item 1A. “Risk Factors” of the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. There are no material changes from the risk factors set forth in such Annual Report on Form 10-K. However, the risks and uncertainties that the Company faces are not limited to those set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. Additional risks and uncertainties not currently known to the Company (or that it currently believes to be immaterial) may also adversely affect the Company’s business and the trading price of our securities.
 
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
Purchases of Equity Securities
 
As previously disclosed, in August 2005, the Company’s Board authorized a Repurchase Program, to repurchase up to 4.0 million shares of the Company’s outstanding common stock under the Repurchase Program.  The Board reaffirmed such authorization in May 2010.  In December, 2013, the Company’s Board increased the number of shares authorized for repurchase to an aggregate of 10.0 million shares (under which approximately 6.6 million shares remain available for repurchase). Such authorization does not have an expiration date and, at present, there is no intention to modify or otherwise rescind such authorization.  Subject to applicable securities laws, repurchases of common stock under the Repurchase Program are made at times and in amounts as we deem appropriate (including, in our discretion, through the use of one or more plans adopted under Rule 10b-5-1 promulgated under the 1934 Act), using available cash resources.  Shares of common stock repurchased by the Company under the Repurchase Program are cancelled and, until reissued by the Company, are deemed to be authorized but unissued shares of the Company’s common stock.  The Repurchase Program may be suspended or discontinued by the Company at any time and without prior notice.

The Company engaged in no share repurchase activity during the first quarter of 2017 pursuant to the Repurchase Program.  The Company did, however, withhold restricted shares (under the terms of grants under our Equity Plan) to offset tax withholding obligations that occur upon the vesting and release of restricted stock awards and/or RSUs.  The following table presents information with respect to (i) such withheld restricted shares and (ii) eligible shares remaining for repurchase under the Repurchase Program:
Month 
 
Total
Number of
Shares
Purchased
 
Weighted
Average Price
Paid Per
Share (1)
 
Total Number of
Shares Repurchased as
Part of Publicly
Announced
Repurchase Program
or Employee Plan
 
Maximum Number of
Shares that May Yet be
Purchased Under the
Repurchase Program or
Employee Plan
January 1-31, 2017:
 
 

 
 

 
 

 
 

Repurchase Program
(2)
—

 
$
—

 
—

 
6,616,355

Employee Transactions
(3)
488,569

 
7.84

 
N/A

 
N/A

February 1-28, 2017:
 
 

 
 

 
 

 
 

Repurchase Program
(2)
—

 
—

 
—

 
6,616,355

Employee Transactions
(3)
—

 
—

 
N/A

 
N/A

March 1-31, 2017:
 
 

 
 

 
 

 
 

Repurchase Program
(2)
—

 
—

 
—

 
6,616,355

Employee Transactions
(3)
3,878

 
$
8.08

 
N/A

 
N/A

Total Repurchase Program
(2)
—

 
$
—

 
—

 
6,616,355

Total Employee Transactions
(3)
492,447

 
$
7.84

 
N/A

 
N/A

 
(1)  Includes brokerage commissions.
(2)  As of March 31, 2017, the Company had repurchased an aggregate of 3,383,645 shares under the Repurchase Program.
(3)  The Company’s Equity Plan provides that the value of the shares delivered or withheld be based on the price of its common stock on the date the relevant transaction occurs.
 

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Item 6. Exhibits
 
The list of exhibits required to be filed as exhibits to this report are listed on page E-1 hereof, under “Exhibit Index,” which is incorporated herein by reference.

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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
Date: May 4, 2017
MFA FINANCIAL, INC.
 
(Registrant)
 
 
 
 
By:
/s/ William S. Gorin
 
 
William S. Gorin
 
 
Chief Executive Officer
 
 
 
 
By:
/s/ Stephen D. Yarad
 
 
Stephen D. Yarad
 
 
Chief Financial Officer
 
 
(Principal Financial Officer)

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EXHIBIT INDEX

The following exhibits are filed as part of this Quarterly Report:

Exhibit
 
Description
 
 
 
3.1
 
Amended and Restated Bylaws of MFA Financial, Inc. (as amended and restated through April 10, 2017) (incorporated herein by reference to Exhibit 3.1 to the Company’s Form 8-K, dated April 12, 2017 (Commission File No. 1-13991)).
 
 
 
10.1
 
Form of Phantom Share Award Agreement (Performance-Based Vesting) (Gorin and Knutson) relating to the Company’s Equity Compensation Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Form 8-K, dated January 11, 2017 (Commission File No. 1-13991)).
 
 
 
10.2
 
Form of Phantom Share Award Agreement (Performance-Based Vesting) relating to the Company’s Equity Compensation Plan (incorporated herein by reference to Exhibit 10.2 to the Company’s Form 8-K, dated January 11, 2017 (Commission File No. 1-13991)).
 
 
 
99.1
 
Notice, dated February 28, 2017, to Directors and Executive Officers of MFA Financial, Inc., regarding extension of Blackout Period (incorporated herein by reference to Exhibit 99.1 to the Company’s Form 8-K, dated February 28, 2017 (Commission File No. 1-13991)).
 
 
 
99.2
 
Notice, dated March 15, 2017, to Directors and Executive Officers of MFA Financial, Inc., regarding end of Blackout Period (incorporated herein by reference to Exhibit 99.1 to the Company’s Form 8-K, dated March 15, 2017 (Commission File No. 1-13991)).
 
 
 
31.1
 
Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1
 
Certification of the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.2
 
Certification of the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101.INS*
 
XBRL Instance Document
 
 
 
101.SCH*
 
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL*
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.DEF*
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
101.LAB*
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
101.PRE*
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
*These interactive data files are furnished and deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of  the Securities Act of 1933, as amended, deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

E-1