MFA Financial (MFA) has two preferred stocks: MFA-B (NYSE:MFA.PB) and MFA-C (MFA.PC). I cover all of these stocks in my frequent articles on mortgage REITs, but I rarely focus on the whole Article on a share. This can make it difficult for some investors to find the articles if they are not following me.
MFA-B has a fixed-rate dividend that has clearly fallen out of favor today as interest rates have moved higher. In addition to higher Treasury rates, we also see wider credit spreads. This combination pushes stock prices down and creates a nice bargain.
MFA-B has a yield of 10.24%. If we adjust for the dividend accrual (as we should for preferred stocks), the stripped yield is 10.3%.
Even with high government bond rates, that’s a significant margin. The coupon rate on MFA-B is only 7.5%. With a stripped yield of 10.3%, this is 2.8% above the starting price.
Is that just because the 10-year Treasury yields 3.7%?
no In 2018, the 10-year government bond yield broke above 3%.
For most of 2018, MFA-B typically traded between $24.00 and $25.50. At that point, investors were content with a reduced yield of just over 7.5%.
This makes it clear that we are also seeing dramatic widening in credit spreads.
When MFA (a few years ago) issued another preferred stock, they issued MFA-C with a 6.5% coupon. MFA-C is finally moving to a floating rate, and this feature is very attractive today. The floating rate on MFA-C will not come into effect until 03/31/2025, but still represents a significant increase in the dividend rate if short-term interest rates remain near current levels. For reference, 3-month LIBOR is around 3.6% today. That would drive the yield of MFA-C much higher.
With MFA-C issued with a 6.5% coupon and MFA-B trading in the $24.00-$25.50 range while the 10-year Treasuries traded over 3% in 2018, we can be confident that MFA-B’s weakness is significantly influenced by credit spreads.
Really, the price was in the $24.00-$25.00 range:
Let’s not say that a stripped yield of 10.3% is terrible just because the 10-year Treasury hit 3.7% today.
MFA is a mortgage REIT. They’re not focused on agency MBS, but market prices for agency mortgage REIT preferred stock are also low. This is a general trend for mortgage REIT preferred stocks. We see dramatic discounts to call value (ie potential upside ahead of a soft cap on call risk) and huge returns.
If the loans owned by the MFA default, that would be a problem. However, their typical loans include a significant discount on the purchase price. The homeowners have to raise significantly more equity than with the typical agency MBS. Consequently, home values must go down before the home would be worth less than the mortgage.
During the pandemic, some investors expected MFA to go bankrupt. They didn’t go broke. They weren’t even close to reporting the biggest losses in the industry, let alone going under. They suffered some damage, but the damage to the portfolio was far less than the fall in the stock price and much less than bears predicted.
There is significant risk to real estate values as the Federal Reserve drives up mortgage rates and drives many potential buyers out of the market. However, the common stocks offer a significant cushion. MFA uses relatively low leverage as they take credit risk. Between the lower leverage and a significant proportion of common stock compared to preferred stock, MFA-B has a respectable shield to absorb losses.
The ideal scenario for MFA-B is one in which inflation falls and the Federal Reserve realizes that it has pushed interest rates too high. Ideally, this happens without a severe recession caused by the Federal Reserve’s desire to appear competent. Because the Federal Reserve primarily looks at lagging indicators and doesn’t evaluate what’s happening today, it may be slow to recognize when yields need to fall. While investors wait for this environment, they are earning a very attractive return.
Even if interest rates remain high, the economic recovery could push credit spreads much tighter. This could result in MFA-B rising by more than 20%, the gap between MFA-B yield and government bond yields remains very wide.
Investors get the stripped yield of 10.3%, and shares would have to rise 36.5% just to reach the $25 call value. Adjusted for the dividend accrual, it’s about 37%. When stocks are trading near the call value, the potential for capital gains is much less, as investors would be unwise to spend much more than $25.00 on a stock that is calling for $25.00 (plus accrued dividends). can.
I find the combination of yield and upside attractive.
I have a small position in MFA, MFA-B and MFA-C. I see compelling values in each of them. All 3 land in our strong buy offer today.
Ratings: Strong buy at MFA, MFA-B, MFA-C