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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
___________________________________________________________________________ 
FORM 10-Q
(Mark One) 
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2020
 
or 
    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 incorporation or organization)
 
 
 
(I.R.S. Employer 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)
_____________________________________________

Not Applicable 
(Former name, former address and former fiscal year, if changed since last period)
____________________________________________________________________ 

Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
MFA
New York Stock Exchange
7.50% Series B Cumulative Redeemable
Preferred Stock, par value $0.01 per share
MFA/PB
New York Stock Exchange
6.50% Series C Cumulative Redeemable
Preferred Stock, par value $0.01 per share
MFA/PC
New York Stock Exchange
8.00% Senior Notes due 2042
MFO
New York Stock Exchange

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 every Interactive Data File required to be submitted 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 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, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
 
 
 
Emerging growth company
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. o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes No x

453,330,456 shares of the registrant’s common stock, $0.01 par value, were outstanding as of July 31, 2020.
 




MFA FINANCIAL, INC.

TABLE OF CONTENTS
 
 
Page
 
 
PART I
FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





MFA FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
 (In Thousands Except Per Share Amounts)
 
June 30,
2020
 
December 31,
2019
 
 
(Unaudited)
 
 
Assets:
 
 

 
 
Residential whole loans:
 
 
 
 
Residential whole loans, at carrying value ($4,556,213 and $4,847,782 pledged as collateral, respectively) (1)
 
$
4,813,119

 
$
6,069,370

Residential whole loans, at fair value ($691,660 and $794,684 pledged as collateral, respectively) (1)
 
1,200,981

 
1,381,583

Allowance for credit losses on residential whole loans held at carrying value
 
(136,589
)
 
(3,025
)
Total residential whole loans, net
 
5,877,511

 
7,447,928

Residential mortgage securities, at fair value ($148,210 and $3,966,591 pledged as collateral, respectively)
 
148,343

 
3,983,519

Mortgage servicing rights (“MSR”) related assets ($255,035 and $1,217,002 pledged as collateral, respectively)
 
254,228

 
1,217,002

Cash and cash equivalents
 
666,172

 
70,629

Restricted cash
 
7,680

 
64,035

Other assets
 
613,474

 
784,251

Total Assets
 
$
7,567,408

 
$
13,567,364

 
 
 
 
 
Liabilities:
 
 
 
 
Financing agreements ($4,194,324 and $0 held at fair value, respectively)
 
$
5,011,356

 
$
10,031,606

Other liabilities
 
35,001

 
151,806

Total Liabilities
 
$
5,046,357

 
$
10,183,412

 
 
 
 
 
Commitments and contingencies (See Note 10)
 


 


 
 
 
 
 
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

Preferred stock, $.01 par value; 6.50% Series C fixed-to-floating rate cumulative redeemable;
12,650 shares authorized; 11,000 shares issued and outstanding ($275,000 aggregate liquidation preference)
 
110

 

Common stock, $.01 par value; 874,300 and 886,950 shares authorized; 453,244 and 452,369 shares issued
and outstanding, respectively
 
4,532

 
4,524

Additional paid-in capital, in excess of par
 
3,922,399

 
3,640,341

Accumulated deficit
 
(1,451,783
)
 
(631,040
)
Accumulated other comprehensive income
 
45,713

 
370,047

Total Stockholders’ Equity
 
$
2,521,051

 
$
3,383,952

Total Liabilities and Stockholders’ Equity
 
$
7,567,408

 
$
13,567,364

 

(1)
Includes approximately $181.4 million and $186.4 million of Residential whole loans, at carrying value and $506.7 million and $567.4 million of Residential whole loans, at fair value transferred to consolidated variable interest entities (“VIEs”) at June 30, 2020 and December 31, 2019, respectively. Such assets 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


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(In Thousands, Except Per Share Amounts)
 
2020
 
2019
 
2020
 
2019
Interest Income:
 
 
 
 
 
 
 
 
Residential whole loans held at carrying value
 
$
69,427

 
$
57,879

 
$
152,913

 
$
107,499

Residential mortgage securities
 
4,975

 
72,395

 
49,349

 
151,037

MSR-related assets
 
9,741

 
12,338

 
23,948

 
22,958

Other interest-earning assets
 
3,165

 
1,287

 
6,072

 
2,593

Cash and cash equivalent investments
 
60

 
1,036

 
546

 
1,800

Interest Income
 
$
87,368

 
$
144,935

 
$
232,828

 
$
285,887

 
 
 
 
 
 
 
 
 
Interest Expense:
 
 

 
 
 
 

 
 
Asset-backed and other collateralized financing arrangements
 
$
82,085

 
$
81,826

 
$
159,945

 
$
158,841

Other interest expense
 
5,906

 
3,218

 
11,805

 
5,229

Interest Expense
 
$
87,991

 
$
85,044

 
$
171,750

 
$
164,070

 
 
 
 
 
 
 
 
 
Net Interest (Expense)/Income
 
$
(623
)
 
$
59,891

 
$
61,078

 
$
121,817

 
 
 
 
 
 
 
 
 
Reversal/(Provision) for credit and valuation losses on residential whole loans and other financial instruments
 
$
85,377

 
$
(385
)
 
$
(65,334
)
 
$
(1,190
)
Net Interest Income/(Expense) after Provision for Credit and Valuation Losses
 
$
84,754

 
$
59,506

 
$
(4,256
)
 
$
120,627

 
 
 
 
 
 
 
 
 
Other Income, net:
 
 
 
 
 
 
 
 
Impairment and other losses on securities available-for-sale and other assets
 
$
(5,094
)
 
$

 
$
(424,745
)
 
$

Net realized gain/(loss) on sales of residential mortgage securities and residential whole loans
 
49,485

 
7,710

 
(188,895
)
 
32,319

Net unrealized gain/(loss) on residential mortgage securities measured at fair value through earnings
 
64,438

 

 
(13,523
)
 
8,672

Net gain/(loss) on residential whole loans measured at fair value through earnings
 
20,320

 
51,473

 
(32,440
)
 
76,740

Loss on terminated swaps previously designated as hedges for accounting purposes
 
(49,857
)
 

 
(49,857
)
 

Other, net
 
(2,935
)
 
(2,321
)
 
(4,946
)
 
(9,700
)
Other Income/(Loss), net
 
$
76,357

 
$
56,862

 
$
(714,406
)
 
$
108,031

 
 
 
 
 
 
 
 
 
Operating and Other Expense:
 
 
 
 
 
 
 
 
Compensation and benefits
 
$
8,578

 
$
7,841

 
$
17,477

 
$
16,395

Other general and administrative expense
 
7,652

 
5,934

 
12,227

 
10,579

Loan servicing and other related operating expenses
 
8,337

 
9,553

 
19,617

 
19,787

Costs associated with restructuring/forbearance agreement
 
39,966

 

 
44,434

 
$

Operating and Other Expense
 
$
64,533

 
$
23,328

 
$
93,755

 
$
46,761

 
 
 
 
 
 
 
 
 
Net Income/(Loss)
 
$
96,578

 
$
93,040

 
$
(812,417
)
 
$
181,897

Less Preferred Stock Dividend Requirement
 
$
8,144

 
$
3,750

 
$
13,359

 
7,500

Net Income/(Loss) Available to Common Stock and Participating Securities
 
$
88,434

 
$
89,290

 
$
(825,776
)
 
$
174,397

 
 
 
 
 
 
 
 
 
Basic Earnings/(Loss) per Common Share
 
$
0.19

 
$
0.20

 
$
(1.82
)
 
$
0.39

Diluted Earnings/(Loss) per Common Share
 
$
0.19

 
$
0.20

 
$
(1.82
)
 
$
0.38



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

2


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
(UNAUDITED)
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
(In Thousands)
 
2020
 
2019
 
2020
 
2019
Net income/(loss)
 
$
96,578

 
$
93,040

 
$
(812,417
)
 
$
181,897

Other Comprehensive Income/(Loss):
 
 
 
 
 
 
 
 
Unrealized gains on securities available-for-sale
 
48,715

 
24,008

 
393,503

 
44,307

Reclassification adjustment for MBS sales included in net income
 
(144,736
)
 
(6,371
)
 
(389,067
)
 
(21,576
)
Reclassification adjustment for impairments included in net income
 

 

 
(344,269
)
 

Derivative hedging instrument fair value changes, net
 

 
(19,706
)
 
(50,126
)
 
(30,151
)
Reclassification adjustment for losses/(gains) related to hedging instruments included in net income
 
64,032

 
(743
)
 
65,625

 
(1,084
)
Other Comprehensive Income/(Loss)
 
(31,989
)
 
(2,812
)
 
(324,334
)
 
(8,504
)
Comprehensive income before preferred stock dividends
 
$
64,589

 
$
90,228

 
$
(1,136,751
)
 
$
173,393

Dividends required on preferred stock
 
(8,144
)
 
(3,750
)
 
(13,359
)
 
(7,500
)
Comprehensive Income/(Loss) Available to Common Stock and Participating Securities
 
$
56,445

 
$
86,478

 
$
(1,150,110
)
 
$
165,893

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

3


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(UNAUDITED)
 
 
Six Months Ended June 30, 2020
(In Thousands, 
Except Per Share Amounts)
 
Preferred Stock
6.50% Series C Fixed-to-Floating Rate Cumulative Redeemable - Liquidation Preference $25.00 per Share
 
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
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2019
 

 
$

 
8,000

 
$
80

 
452,369

 
$
4,524

 
$
3,640,341

 
$
(631,040
)
 
$
370,047

 
$
3,383,952

Cumulative effect adjustment on adoption of new accounting standard ASU 2016-13
 

 

 

 

 

 

 

 
(8,326
)
 

 
(8,326
)
Net loss
 

 

 

 

 

 

 

 
(908,995
)
 

 
(908,995
)
Issuance of Series C Preferred Stock, net of expenses
 
11,000

 
110

 

 

 

 

 
265,919

 

 

 
266,029

Issuance of common stock, net of expenses
 

 

 

 

 
1,106

 
7

 
680

 

 

 
687

Repurchase of shares of common stock (1)
 

 

 

 

 
(337
)
 

 
(2,652
)
 

 

 
(2,652
)
Equity based compensation expense
 

 

 

 

 

 

 
1,266

 

 

 
1,266

Accrued dividends attributable to stock-based awards
 

 

 

 

 

 

 
1,059

 

 

 
1,059

Change in unrealized gains on MBS, net
 

 

 

 

 

 

 

 

 
(243,812
)
 
(243,812
)
Derivative hedging instrument fair value changes and amortization, net
 

 

 

 

 

 

 

 

 
(48,533
)
 
(48,533
)
Balance at March 31, 2020
 
11,000

 
$
110

 
8,000

 
$
80

 
453,138

 
$
4,531

 
$
3,906,613

 
$
(1,548,361
)
 
$
77,702

 
$
2,440,675

Net income
 

 

 

 

 

 

 

 
96,578

 

 
96,578

Issuance of common stock, net of expenses
 

 

 

 

 
106

 
1

 
36

 

 

 
37

Equity based compensation expense
 

 

 

 

 

 

 
1,709

 

 

 
1,709

Change in unrealized gains on MBS, net
 

 

 

 

 

 

 

 

 
(96,021
)
 
(96,021
)
Derivative hedging instrument fair value changes, net
 

 

 

 

 

 

 

 

 
64,032

 
64,032

Warrants Issued
 

 

 

 

 

 

 
14,041

 

 

 
14,041

Balance at June 30, 2020
 
11,000

 
$
110

 
8,000

 
$
80

 
453,244

 
$
4,532

 
$
3,922,399

 
$
(1,451,783
)
 
$
45,713

 
$
2,521,051


(1)  For the six months ended June 30, 2020 includes approximately $2.7 million (337,026 shares) surrendered for tax purposes related to equity-based compensation awards.


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



4


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(UNAUDITED)
 
 
Six Months Ended June 30, 2019
(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, 2018
 
8,000

 
$
80

 
449,787

 
$
4,498

 
$
3,623,275

 
$
(632,040
)
 
$
420,288

 
$
3,416,101

Net income
 

 

 

 

 

 
88,857

 

 
88,857

Issuance of common stock, net of expenses
 

 

 
1,066

 
7

 
544

 

 

 
551

Repurchase of shares of common stock (1)
 

 

 
(370
)
 

 
(2,610
)
 

 

 
(2,610
)
Equity based compensation expense
 

 

 

 

 
992

 

 

 
992

Accrued dividends attributable to stock-based awards
 

 

 

 

 
435

 

 

 
435

Dividends declared on common stock ($0.20 per share)
 

 

 

 

 

 
(90,097
)
 

 
(90,097
)
Dividends declared on preferred stock ($0.46875 per share)
 

 

 

 

 

 
(3,750
)
 

 
(3,750
)
Dividends attributable to dividend equivalents
 

 

 

 

 

 
(256
)
 

 
(256
)
Change in unrealized losses on MBS, net
 

 

 

 

 

 

 
5,094

 
5,094

Derivative hedging instruments fair value changes, net
 

 

 

 

 

 

 
(10,786
)
 
(10,786
)
Balance at March 31, 2019
 
8,000

 
$
80

 
450,483

 
$
4,505

 
$
3,622,636

 
$
(637,286
)
 
$
414,596

 
$
3,404,531

Net income
 

 

 

 

 

 
93,040

 

 
93,040

Issuance of common stock, net of expenses
 

 

 
139

 
1

 
585

 

 

 
586

Equity based compensation expense
 

 

 

 

 
2,438

 

 

 
2,438

Accrued dividends attributable to stock-based awards
 

 

 

 

 
(260
)
 

 

 
(260
)
Dividends declared on common stock ($0.20 per share)
 

 

 

 

 

 
(90,124
)
 

 
(90,124
)
Dividends declared on preferred stock ($0.46875 per share)
 

 

 

 

 

 
(3,750
)
 

 
(3,750
)
Dividends attributable to dividend equivalents
 

 

 

 

 

 
(276
)
 

 
(276
)
Change in unrealized losses on MBS, net
 

 

 

 

 

 

 
17,637

 
17,637

Derivative hedging instruments fair value changes, net
 

 

 

 

 

 

 
(20,449
)
 
(20,449
)
Balance at June 30, 2019
 
8,000

 
$
80

 
450,622

 
$
4,506

 
$
3,625,399

 
$
(638,396
)
 
$
411,784

 
$
3,403,373


(1)  For the six months ended June 30, 2019, includes approximately $2.6 million (370,244 shares) surrendered for tax purposes related to equity-based compensation awards.

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


5


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Six Months Ended
June 30,
(In Thousands)
 
2020
 
2019
Cash Flows From Operating Activities:
 
 

 
 

Net (loss)/income
 
$
(812,417
)
 
$
181,897

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

 
 
Loss on sales of residential whole loans
 
273,848

 

Gain on sales of residential mortgage securities, MSR-related assets, and other assets
 
(84,953
)
 
(32,319
)
Gain on sales of real estate owned
 
(6,104
)
 
(3,692
)
Gain on liquidation of residential whole loans
 
(2,633
)
 
(9,661
)
Impairment and other losses on securities available-for-sale and other assets
 
424,745

 

Loss on terminated swaps previously designated as hedges for accounting purposes
 
49,857

 

Accretion of purchase discounts on residential mortgage securities, residential whole loans and MSR-related assets
 
(20,244
)
 
(33,193
)
Amortization of purchase premiums on residential mortgage securities and residential whole loans, and amortization of terminated hedging instruments
 
35,594

 
19,422

Depreciation and amortization on real estate, fixed assets and other assets
 
3,970

 
1,084

Equity-based compensation expense
 
2,827

 
3,436

Unrealized losses/(gains) on residential whole loans at fair value
 
72,546

 
(20,128
)
Provision for credit and valuation losses on residential whole loans and other financial instruments
 
65,334

 

Unrealized losses on residential mortgage securities and interest rate swap agreements (“Swaps”) and other
 
57,981

 
1,363

Decrease/(increase) in other assets
 
22,084

 
(26,978
)
(Decrease)/increase in other liabilities
 
(25,791
)
 
4,716

Net cash provided by operating activities
 
$
56,644

 
$
85,947

 
 
 
 
 
Cash Flows From Investing Activities:
 
 

 
 

Purchases of residential whole loans, loan related investments and capitalized advances
 
$
(1,285,106
)
 
$
(1,943,860
)
Proceeds from sales of residential whole loans
 
1,505,458

 

Principal payments on residential whole loans
 
862,480

 
523,600

Principal payments on residential mortgage securities and MSR-related assets
 
590,921

 
930,591

Proceeds from sales of residential mortgage securities, MSR-related assets, and other assets
 
3,790,032

 
404,796

Purchases of residential mortgage securities and MSR-related assets
 
(163,748
)
 
(697,973
)
Proceeds from sales of real estate owned
 
113,359

 
56,073

Purchases of real estate owned and capital improvements
 
(8,798
)
 
(10,561
)
Additions to leasehold improvements, furniture and fixtures
 
837

 
(1,043
)
Net cash provided by/(used in) investing activities
 
$
5,405,435

 
$
(738,377
)
 
 
 
 
 
Cash Flows From Financing Activities:
 
 

 
 
Principal payments on financing agreements with mark-to-market collateral provisions
 
$
(21,021,793
)
 
$
(38,068,063
)
Proceeds from borrowings under financing agreements with mark-to-market collateral provisions
 
13,537,087

 
38,819,598

Proceeds from borrowings under financing agreements with non-mark-to-market collateral provisions
 
2,036,597

 

Proceeds from issuance of senior secured credit agreement
 
480,959

 

Principal payments on securitized debt
 
(57,404
)
 
(57,496
)
Proceeds from issuance of convertible senior notes
 

 
223,444

Payments made for settlements and unwinds of Swaps
 
(88,405
)
 
(47,131
)
Proceeds from issuance of series C preferred stock
 
275,000

 

Payments made for costs related to series C preferred stock issuance
 
(8,948
)
 

Proceeds from issuances of common stock
 
724

 
1,137

Proceeds from the issuance of warrants
 
14,041

 

Dividends paid on preferred stock
 

 
(7,500
)
Dividends paid on common stock and dividend equivalents
 
(90,749
)
 
(180,551
)
Net cash (used in)/provided by financing activities
 
$
(4,922,891
)
 
$
683,438

Net increase in cash, cash equivalents and restricted cash
 
$
539,188

 
$
31,008

Cash, cash equivalents and restricted cash at beginning of period
 
$
134,664

 
$
88,709

Cash, cash equivalents and restricted cash at end of period
 
$
673,852

 
$
119,717


6


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
 
 
 
Supplemental Disclosure of Cash Flow Information
 
 
 
 
Interest Paid
 
$
165,333

 
$
169,852

 
 
 
 
 
Non-cash Investing and Financing Activities:
 
 
 
 
Transfer from residential whole loans to real estate owned
 
$
59,219

 
$
131,644

Dividends and dividend equivalents declared and unpaid
 
$

 
$
90,400

Payable for unsettled residential whole loan purchases
 
$

 
$
86,987

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

7

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

 
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 taxable REIT subsidiaries (“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 Note 2(n))
 
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 in accordance with 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, 2019.  In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at June 30, 2020 and results of operations for all periods presented have been made.  The results of operations for the three and six months ended June 30, 2020 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 impairment, valuation allowances and loss allowances on residential whole loans (see Note 3), mortgage-backed securities (“MBS”) (see Note 4) and Other Assets (see Note 5), valuation of MBS, CRT securities and MSR-related assets (see Notes 4 and 14), income recognition and valuation of residential whole loans (see Notes 3 and 14), valuation of derivative instruments (see Notes 5(c) and 14) and income recognition on certain Non-Agency MBS (defined below) purchased at a discount (see Note 4).  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(n)).  Actual results could differ from those estimates.

The Company has one reportable segment since 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 entities established to facilitate transactions related to the acquisition and securitization of residential whole loans completed in prior years. Certain prior period amounts have been reclassified to conform to the current period presentation.


8

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

(b Residential Whole Loans (including Residential Whole Loans transferred to consolidated VIEs)

Residential whole loans included in the Company’s consolidated balance sheets are primarily comprised of pools of fixed- and adjustable-rate residential mortgage loans acquired through consolidated trusts in secondary market transactions. 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 for Purchased Credit Deteriorated Loans that are held at carrying value is typically utilized by the Company for Purchased Credit Deteriorated Loans where the underlying borrower has a delinquency status of less than 60 days at the acquisition date. The Company also acquires Purchased Performing Loans that are typically held at carrying value, but the accounting methods for income recognition and determination and measurement of any required credit loss reserves (as discussed below) differ from those used for Purchased Credit Deteriorated Loans held at carrying value. The accounting model described below for residential whole loans held 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 financing agreements are included in the consolidated balance sheets with amounts pledged disclosed parenthetically.  Purchases and sales of residential whole loans that are subject to an extended period of due diligence that crosses a reporting date are recorded in our balance sheet at amounts 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. Residential whole loans purchased under flow arrangements with loan origination partners are generally recorded at the transaction settlement date. 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 financing agreement until the closing of the purchase transaction. Interest income, credit related losses and changes in the fair value of loans held at fair value are recorded post settlement for acquired loans and until transaction settlement for sold loans (see Notes 3, 6, 7, 14 and 15).

Residential Whole Loans at Carrying Value

Purchased Performing Loans

Acquisitions of Purchased Performing Loans to date have been primarily comprised of: (i) loans to finance (or refinance) one-to-four family residential properties that are not considered to meet the definition of a “Qualified Mortgage” in accordance with guidelines adopted by the Consumer Financial Protection Bureau (“Non-QM loans”), (ii) short-term business purpose loans collateralized by residential properties made to non-occupant borrowers who intend to rehabilitate and sell the property for a profit (“Rehabilitation loans” or “Fix and Flip loans”), (iii) loans to finance (or refinance) non-owner occupied one-to four-family residential properties that are rented to one or more tenants (“Single-family rental loans”), and (iv) previously originated loans secured by residential real estate that is generally owner occupied (“Seasoned performing loans”). Purchased Performing Loans are initially recorded at their purchase price. Interest income on Purchased Performing Loans acquired at par is accrued based on each loan’s current interest bearing balance and current interest rate, net of related servicing costs. Interest income on such loans purchased at a premium/discount to par is recorded each period based on the contractual coupon net of any amortization of premium or accretion of discount, adjusted for actual prepayment activity. For loans acquired with related servicing rights retained by the seller, interest income is reported net of related serving costs.

An allowance for credit losses is recorded at acquisition, and maintained on an ongoing basis, for all losses expected to be incurred over the life of the respective loan. Any required credit loss allowance would reduce the net carrying value of the loan with a corresponding charge to earnings, and may increase or decrease over time. Significant judgments are required in determining any allowance for credit loss, including assumptions regarding the loan cash flows expected to be collected, the value of the underlying collateral and the ability of the Company to collect on any other forms of security, such as a personal guaranty provided either by the borrower or an affiliate of the borrower. Income recognition is suspended, and interest accruals are reversed against income, for loans at the earlier of the date at which payments become 90 days past due or when, in the opinion of management, a full recovery of income and principal becomes doubtful (i.e., such loans are placed on nonaccrual status). For nonaccrual loans other than Fix and Flip loans, all payments are applied to principal under the cost recovery method. For nonaccrual Fix and Flip loans, interest income is recorded under the cash basis method as interest payments are received. Interest accruals are resumed when the loan becomes contractually current and performance is demonstrated to be resumed. A loan is written off when it is no longer realizable and/or it is legally discharged. Modified loans are considered “troubled debt restructurings” if the Company grants a concession to a borrower who is experiencing financial difficulty (including the interpretation of this definition set forth in OCC Bulletin 2020-35).

9

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020


The aggregate allowance for credit losses is equal to the sum of the losses expected to be incurred over the life of each respective loan. These losses were estimated by projecting each loan’s expected cash flows based on their contractual terms, expected prepayments, and estimated default and loss severity rates. The default and severity rates were estimated based on the following steps: (i) obtained the Company’s historical experience through an entire economic cycle for each loan type or, to the extent the Company did not have sufficient historical loss experience for a given loan type, publicly available data derived from the historical loss experience of certain banks, which data the Company believes is generally representative of its portfolio, (ii) obtained historical economic data (U.S. unemployment rates and home price appreciation) over the same period, and (iii) estimated default and severity rates during three distinct future periods based on historical default and severity rates during periods when economic conditions similar to those forecasted were experienced. The three periods were as follows: (i) a one-year forecast of economic conditions based on U.S. unemployment rates and home price appreciation, followed by (ii) a two-year “reversion” period during which economic conditions (U.S. unemployment rates and home price appreciation) are projected to revert to historical averages on a straight line basis, followed by (iii) the remaining life of each loan, during which period economic conditions (U.S. unemployment rates and home price appreciation) are projected to equal historical averages. In addition, a liability is established (and recorded in Other Liabilities) each period using a similar methodology for committed but undrawn loan amounts. This methodology has not changed from the calculation of the allowance for credit losses on January 1, 2020 pursuant to the transition to ASU 2016-13 as described below under “New Accounting Standards and Interpretations,” other than a change in the reversion period from one year to two years to reflect the expected ongoing impact of current conditions (see Note 3).

Purchased Credit Deteriorated Loans

The Company has elected to account for these loans as credit impaired as they have experienced a more-than-insignificant deterioration in credit quality since origination and were acquired at discounted prices that reflect, in part, the impaired credit history of the borrower. Substantially all of these loans have previously experienced payment delinquencies and the amount owed may exceed the value of the property pledged as collateral. Consequently, these loans generally 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. Loans considered credit impaired are initially recorded at the purchase price on a net basis, after establishing an initial allowance for credit losses (their initial cost basis is equal to their purchase price plus the initial allowance for credit losses). Subsequent to acquisition, the gross recorded amount for these loans reflects the initial cost basis, 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 cost basis reduced by any allowance for credit losses. Interest income on such loans purchased is recorded each period based on the contractual coupon net of amortization of the difference between their cost basis and unpaid principal balance (“UPB”), subject to the Company’s nonaccrual policy.

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 the time of acquisition. For the majority of these loans, there is significant uncertainty associated with estimating the timing of and amount of cash flows that will be collected. Further, the cash flows ultimately collected may be dependent on the value of the property securing the loan. Consequently, the Company considers that accounting for these loans at fair value should result in a better reflection over time of the economic returns for the majority of 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 that 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 (loss)/gain on residential whole loans measured at fair value through earnings on the Company’s consolidated statements of operations.

Cash received (or accrued) representing coupon interest payments on residential whole loans held at fair value is not included in Interest Income, but rather is included in Net (loss)/gain on residential whole loans measured at fair value through earnings 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 unrealized gains or losses reported each period.


10

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

(c Residential Mortgage Securities
 
Prior to the quarter ended June 30, 2020, the Company had invested 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”). The Company disposed of its investments in Agency MBS during the quarter and has substantially reduced its investments in Non-Agency MBS. In addition, the Company has investments in CRT securities that are issued by or sponsored by Fannie Mae and Freddie Mac. The coupon payments on CRT securities are paid by the issuer and the principal payments received are dependent on the performance of loans in either a reference pool or an actual pool of loans. As the loans in the underlying pool are paid, the principal balance of the CRT securities is paid. As an investor in a CRT security, the Company may incur a principal loss if the performance of the actual or reference pool loans results in either an actual or calculated loss that exceeds the credit enhancement of the security owned by the Company.
 
Designation
 
MBS that the Company generally intends to hold until maturity, but that it may sell from time to time as part of the overall management of its business, are designated as “available-for-sale” (“AFS”). Such MBS are carried at their fair value with unrealized gains and losses excluded from earnings (except when an allowance for losses 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 had elected the fair value option for certain of its previously held Agency MBS that it did not intend to hold to maturity. These securities were 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 statements of operations.

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 statements of operations.
 
Revenue Recognition, Premium Amortization and Discount Accretion
 
Interest income on securities is accrued based on their 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.
 
Determination of Fair Value for Residential Mortgage Securities
 
In determining the fair value of the Company’s residential mortgage 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 14).
 

11

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

Allowance for credit losses

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, as well as securities for which a credit loss allowance had been previously recorded, on at least a quarterly basis and determines whether any changes to the allowance for credit losses are required.  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 a write-down 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 impaired security, only the portion of the impairment related to credit losses is recognized through a loss allowance charged to earnings with the remainder recognized through AOCI on the Company’s consolidated balance sheets.  Impairments recognized through other comprehensive income/(loss) (“OCI”) do not impact earnings.  Credit loss allowances are subject to reversal through earnings resulting from improvements in expected cash flows. The determination as to whether to record (or reverse) a credit loss allowance is subjective, as such determinations are based on factual information available at the time of assessment as well as the Company’s estimates of future performance and cash flow projections.  As a result, the timing and amount of losses constitute material estimates that are susceptible to significant change (see Note 4).

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, year of origination, loan-to-value ratios (“LTVs”), geographic concentrations 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 allowance 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 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 residential mortgage securities pledged as collateral against financing agreements 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. 

(d) MSR-Related Assets

The Company has investments in financial instruments whose cash flows are considered to be largely dependent on underlying MSRs that either directly or indirectly act as collateral for the investment. These financial instruments, which are referred to as MSR-related assets, are discussed in more detail below. The Company’s MSR-related assets pledged as collateral against repurchase agreements are included in the consolidated balance sheets with the amounts pledged disclosed parenthetically. Purchases and sales of MSR-related assets are recorded on the trade date (see Notes 4, 6, 7 and 14).

Term Notes Backed by MSR-Related Collateral
 
The Company has invested in term notes that are issued by special purpose vehicles (“SPV”) that have acquired rights to receive cash flows representing the servicing fees and/or excess servicing spread associated with certain MSRs. The Company considers payment of principal and interest on these term notes 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. 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.


12

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

The Company’s term notes backed by MSR-related collateral are treated as AFS securities and reported at fair value on the Company’s consolidated balance sheets with unrealized gains and losses excluded from earnings and reported in AOCI, subject to impairment and loss allowances. Interest income is recognized on an accrual basis on the Company’s consolidated statements of operations. The Company’s valuation process for such notes is similar to that used for residential mortgage securities and 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. Other factors taken into consideration include estimated changes in fair value of the related underlying MSR collateral, as applicable, and the financial performance of the ultimate parent or sponsoring entity of the issuer, which 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.

Corporate Loans
 
The Company has made or participated in loans to provide financing to entities that originate residential mortgage loans and own the related MSRs. These corporate loans are generally secured by certain MSRs, as well as certain other unencumbered assets owned by the borrower.

Corporate loans are recorded on the Company’s consolidated balance sheets at the drawn amount, on which interest income is recognized on an accrual basis on the Company’s consolidated statements of operations, subject to loss allowances. Commitment fees received on the undrawn amount are deferred and recognized as interest income over the remaining loan term at the time of draw. At the end of the commitment period, any remaining deferred commitment fees are recorded as Other Income on the Company’s consolidated statements of operations. The Company evaluates the recoverability of its corporate loans on a quarterly basis considering various factors, including the current status of the loan, changes in the fair value of the MSRs that secure the loan and the recent financial performance of the borrower.

(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 financing 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 June 30, 2020 and December 31, 2019. At June 30, 2020 and December 31, 2019, the Company had cash and cash equivalents of $666.2 million and $70.6 million, respectively. At June 30, 2020, the Company had $613.4 million of investments in overnight money market funds, which are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) or any other government agency. As of December 31, 2019, the Company had $39.6 million worth of investments in overnight money market funds. In addition, deposits in FDIC insured accounts generally exceed insured limits (see Notes 7 and 14).
 
(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 financing agreements that is not available to the Company for general corporate purposes. Restricted cash may be applied against amounts due to financing 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 and/or financing agreements.  The Company had aggregate restricted cash held as collateral or otherwise in connection with its financing agreements and/or Swaps of $7.7 million and $64.0 million at June 30, 2020 and December 31, 2019, respectively (see Notes 5(c), 6, 7 and 14).

(g) 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 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. The Company has acquired certain properties that it holds for investment purposes, including rentals to

13

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

third parties. These properties are held at their historical basis less depreciation, and are subject to impairment. Related rental income and expenses are recorded in Other Income, net (see Note 5).

(h Depreciation
 
Leasehold Improvements, Real estate 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. The building component of real estate held-for-investment is depreciated over 27.5 years.
 
(i Loan Securitization and Other Debt Issuance Costs
 
Loan securitization related costs are costs associated with the issuance of beneficial interests by consolidated VIEs and incurred by the Company in connection with various financing transactions completed by the Company.  Other debt issuance and related costs include costs incurred by the Company in connection with issuing its 6.25% Convertible Senior Notes due 2024 (“Convertible Senior Notes”) and its 8% Senior Notes due 2042 (“Senior Notes”). 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 the Convertible Senior Notes and Senior Notes, 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.

(j Financing Agreements

The Company finances the majority of its residential mortgage assets with financing agreements that include repurchase agreements and other forms of collateralized financing.  Under repurchase agreements, the Company sells assets to a lender and agrees to repurchase the same assets 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 and other forms of collateralized financing, the Company pledges its assets as collateral to secure the borrowing, in an amount which is equal 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 assets 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 assets 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 collateralized by residential mortgage securities and MSR-related assets typically have terms ranging from one month to six months at inception, while the majority of our financing arrangements collateralized by residential whole loans have terms of twelve months or longer.  Should a counterparty decide not to renew a financing arrangement at maturity, the Company must either refinance elsewhere or be in a position to satisfy the obligation.  If, during the term of a 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 on such collateral (see Notes 6, 7 and 14).
 
The Company has elected the fair value option on certain of its financing agreements. These agreements are reported at their fair value, with changes in fair value being recorded in earnings each period (or other comprehensive income, to the extent the change results from a change in instrument specific credit risk), as further detailed in Note 6. Financing costs, including “up front”

14

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

fees paid at inception related to financing agreements at fair value are expensed as incurred. Interest expense is recorded based on the current interest rate in effect for the related agreement.

(k 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. 
 
The Company has made annual grants of restricted stock units (“RSUs”) certain of which cliff vest after a three-year period, subject only to continued employment, and others of which cliff vest after a three-year period, subject to both continued employment and the achievement of certain performance criteria based on a formula tied to the Company’s achievement of average total shareholder return during that three-year period, as well as the total shareholder return (“TSR”) of the Company relative to the TSR of a group of peer companies (over the three-year period) selected by the Compensation Committee of the Company’s Board of Directors (the “Compensation Committee”) at the date of grant. The features in these awards related to the attainment of total shareholder 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 makes dividend equivalent payments in connection with certain of its equity-based awards.   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 Company’s Equity Compensation Plan (the “Equity Plan”), and they are paid in cash or other consideration at such times and in accordance with such rules, terms and conditions, as the Compensation Committee may determine in its discretion.  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 (i) do not or are not expected to vest and (ii) grantees are not required to return payments of dividends or dividend equivalents to the Company (see Notes 2(l) and 13).
 
(l 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 dividend equivalents attached to/associated with RSUs, 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 RSUs outstanding that are unvested and have dividends that are subject to forfeiture, and for the effect of outstanding warrants, 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 (if any), are used to repurchase shares of the Company’s outstanding common stock at the average market price during the reported period.  In addition, the Company’s Convertible Senior Notes are included in the calculation of diluted EPS if the assumed conversion into common shares is dilutive, using the “if-converted” method. This involves adding back the periodic interest expense associated with the Convertible Senior Notes to the numerator and by adding the shares that would be issued in an assumed conversion (regardless of whether the conversion option is in or out of the money) to the denominator for the purposes of calculating diluted EPS (see Note 12).
 
(m 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 terminated hedging relationships, and is reduced by dividends declared on the Company’s preferred stock and issuance costs of redeemed preferred stock.
 

15

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

(n 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% of 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 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 domestic TRS is subject to U.S. federal, state and local corporate income taxes. Since a portion of the Company’s business is conducted through one or more TRS, the net taxable income earned by its domestic TRS, if any, is subject to corporate income taxation. To maintain the Company’s REIT election, no more than 20% of the value of the Company’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 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 net deferred tax benefit was recorded by the Company for the six months ended June 30, 2020 and 2019, related to the net taxable losses in the TRS, since a valuation allowance for the full amount of the associated deferred tax asset of approximately $76.3 million was recognized as its recovery is not considered more likely than not. The related net operating loss carryforwards generated prior to 2018 will begin to expire in 2034; those generated in 2020, 2019 and 2018 can be carried back to each of the five taxable years preceding the taxable year of such loss and thereafter can be carried forward and do not expire.

 Based on its analysis of any potentially 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 June 30, 2020, December 31, 2019, or June 30, 2019. As of the date of this filing the Company’s tax returns for tax years 2016 through 2018 are open to examination.

(o 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 have generally been comprised of Swaps, the majority of which were 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 the inception of a hedge and on a quarterly basis thereafter, whether or not the hedge is “highly effective.”
 

16

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

During the first quarter of 2020, the Company terminated all of its Swaps. Prior to their termination, Swaps were carried on the Company’s consolidated balance sheets at fair value, in Other assets, if their fair value was positive, or in Other liabilities, if their fair value was negative.  Changes in the fair value of the Company’s Swaps previously designated in hedging transactions are recorded in OCI provided that the hedge remains effective.  Periodic payments accrued in connection with Swaps designated as hedges are included in interest expense and are treated as an operating cash flow.

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 (see Notes 5(c), 7 and 14).

Changes in the fair value of the Company’s Swaps not designated in hedging transactions are recorded in Other income, net on the Company’s consolidated statements of operations.

(p 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 financial assets and liabilities at the time of acquisition or issuance. Subsequent changes in the fair value of these financial instruments are reported in Other income, net, in 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(b), 2(c), 3, 4 and 14).

(q 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 the 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) the holders of the equity investment at risk 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 entered into several financing transactions which resulted in the Company forming entities to facilitate these transactions.  In determining the accounting treatment to be applied to these transactions, the Company concluded that the entities used to facilitate these transactions are VIEs and that they should be consolidated.  If the Company had determined that consolidation was not required, it would have then assessed whether the transfers of the underlying assets would qualify as sales or should be accounted for as secured financings under GAAP (see Note 15).

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.


17

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

(r Offering Costs Related to Issuance and Redemption of Preferred Stock

Offering costs related to the 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.

(s New Accounting Standards and Interpretations

Accounting Standards Adopted in 2020

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

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU” 2016-13, Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which has subsequently been amended by ASUs 2019-11, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, 2019-05, Financial Instruments - Credit Losses (Topic 326): Targeted Transition Relief, 2019-04, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, 2018-19, Codification Improvements to Topic 326, Financial Instruments - Credit Losses, 2020-02 Financial Instruments-Credit Losses (Topic 326)-Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date (SEC Update), and 2020-03 Codification Improvements to Financial Instruments. The amendments in ASU 2016-13 require entities to measure all expected credit losses (rather than incurred losses) for financial assets held at the reporting date, based on historical experience, current conditions and reasonable and supportable forecasts. 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. The amendments in this ASU were 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. The Company adopted the new ASU on January 1, 2020. The impact of adoption was that the allowance for credit losses on Purchased Performing Loans increased by approximately $8.3 million. This transition adjustment was recorded as an increase in the Company’s allowance for credit losses and an adjustment to decrease retained earnings as of the adoption date. In addition, for Purchased Credit Deteriorated Loans, the carrying value of the portfolio was adjusted on transition to include an estimate of the allowance for credit losses as required by the new standard. For financial statement reporting purposes, this adjusted carrying value is presented net of the estimated allowance for credit losses. Consequently, the adjustments recorded on transition for Purchased Credit Deteriorated Loans do not result in any adjustment to retained earnings as of the adoption date. The Company does not consider these transition adjustments to be material to its financial position or previously reported GAAP or economic book value.

Under ASU 2016-13, credit losses for available-for-sale debt securities are measured in a manner similar to prior 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. Under prior GAAP, credit impairment losses were generally required to be recorded as “other than temporary” impairment, which directly reduced the carrying amount of impaired securities, and was recorded in earnings and was not reversed if expected cash flows subsequently recovered. Under the new guidance, credit impairments on such securities (other than those related to expected sales) are recorded as an allowance for credit losses that is also recorded in earnings, but the allowance can be reversed through earnings in a subsequent period if expected cash flows subsequently recover. Transition to the new available-for-sale debt securities guidance did not result in a change to our retained earnings.


18

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

Reference Rate Reform - Facilitation of the Effects of Reference Rate Reform on Financial Reporting

In March 2020, the FASB issued ASU 2020-04, Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU 2020-04”). The amendments in this ASU provide temporary optional expedients to ease the financial reporting burden of the expected transition from the London Interbank Offered Rate (“LIBOR”) to an alternative reference rate such as the Secured Overnight Financing Rate (“SOFR”). The amendments in the ASU are elective and apply to all entities, subject to meeting certain criteria, that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments in ASU 2020-04 were effective for all entities as of March 12, 2020 and will generally no longer be available to apply after December 31, 2022. The Company adopted this ASU as of the effective date and will utilize the optional expedients to the extent that they apply to the Company.

19

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

3.    Residential Whole Loans

Included on the Company’s consolidated balance sheets at June 30, 2020 and December 31, 2019 are approximately $5.9 billion and $7.4 billion, respectively, of residential whole loans arising from the Company’s interests in certain trusts established to acquire the loans and certain entities established in connection with its loan securitization transactions. The Company has assessed that these entities are required to be consolidated for financial reporting purposes.

Residential Whole Loans, at Carrying Value

The following table presents the components of the Company’s Residential whole loans, at carrying value at June 30, 2020 and December 31, 2019:
(Dollars In Thousands)
 
June 30, 2020
 
December 31, 2019
Purchased Performing Loans:
 
 
 
 
Non-QM loans
 
$
2,574,184

 
$
3,707,245

Rehabilitation loans
 
862,895

 
1,026,097

Single-family rental loans
 
494,248

 
460,742

Seasoned performing loans
 
155,279

 
176,569

Total Purchased Performing Loans
 
4,086,606

 
5,370,653

Purchased Credit Deteriorated Loans (1)
 
726,513

 
698,717

Total Residential whole loans, at carrying value
 
$
4,813,119

 
$
6,069,370

Allowance for credit losses on residential whole loans held at carrying value
 
(136,589
)
 
(3,025
)
Total Residential whole loans at carrying value, net
 
$
4,676,530

 
$
6,066,345

 
 
 
 
 
Number of loans
 
14,689

 
17,082



(1) The amortized cost basis of Purchased Credit Deteriorated Loans was increased by $62.6 million on January 1, 2020 in connection with the adoption of ASU 2016-13.

The following table presents the components of interest income on the Company’s Residential whole loans, at carrying value for the three and six months ended June 30, 2020 and 2019:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 (In Thousands)
 
2020
 
2019
 
2020
 
2019
Purchased Performing Loans:
 
 
 
 
 
 
 
 
Non-QM loans
 
$
37,259

 
$
26,578

 
$
86,329

 
$
48,992

Rehabilitation loans
 
13,312

 
13,256

 
28,639

 
23,189

Single-family rental loans
 
7,268

 
3,926

 
14,611

 
6,627

Seasoned performing loans
 
2,253

 
3,122

 
4,853

 
6,295

Total Purchased Performing Loans
 
60,092

 
46,882

 
134,432

 
85,103

Purchased Credit Deteriorated Loans
 
9,335

 
10,997

 
18,481

 
22,396

Total Residential whole loans, at carrying value
 
$
69,427

 
$
57,879

 
$
152,913

 
$
107,499






20

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2020

The following table presents additional information regarding the Company’s Residential whole loans, at carrying value at June 30, 2020:

June 30, 2020
 
 
Carrying Value
 
Amortized Cost Basis
 
Unpaid Principal Balance (“UPB”)
 
Weighted Average Coupon (1)
 
Weighted Average Term to Maturity (Months)
 
Weighted Average LTV Ratio (2)
 
Weighted Average Original FICO (3)
 
Aging by Amortized Cost Basis
 
 
 
 
 
 
 
 
 
 
 
Past Due Days
(Dollars In Thousands)
 
 
 
 
 
 
 
 
Current
 
30-59
 
60-89
 
90+
Purchased Performing Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-QM loans (4)
 
$
2,542,831

 
$
2,574,184

 
$
2,501,547

 
5.87
%
 
354
 
64
%
 
712
 
$
2,502,521

 
$
24,927

 
$
23,192

 
$
23,544

Rehabilitation loans (4)
 
832,895

 
862,895

 
862,895

 
7.26

 
6
 
63

 
720
 
620,315

 
60,762

 
65,226

 
116,592

Single-family rental loans (4)
 
487,317

 
494,248

 
489,947

 
6.28

 
321
 
70

 
734
 
444,308

 
25,428

 
12,730

 
11,782

Seasoned performing loans (4)
 
155,055

 
155,279

 
169,469

 
3.76

 
176
 
42

 
723
 
150,800

 
1,740

 
442

 
2,297

Purchased Credit Deteriorated Loans (4)(5)
 
658,432

 
726,513

 
838,673

 
4.46

 
291
 
79

 
N/A
 
N/M

 
N/M

 
N/M

 
105,536

Residential whole loans, at carrying value, total or weighted average
 
$
4,676,530

 
$
4,813,119

 
$
4,862,531

 
5.86
%
 
272
 
 
 
 
 
 
 
 
 
 
 
 

December 31, 2019
 
 
Carrying Value
 
Amortized Cost Basis
 
Unpaid Principal Balance (“UPB”)
 
Weighted Average Coupon (1)
 
Weighted Average Term to Maturity (Months)
 
Weighted Average LTV Ratio (2)
 
Weighted Average Original FICO (3)
 
Aging by UPB
 
 
 
 
 
 
 
 
 
 
 
Past Due Days
(Dollars In Thousands)
 
 
 
 
 
 
 
 
Current
 
30-59
 
60-89
 
90+
Purchased
   Performing Loans: