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MFA Financial Is a Warning Sign for the Economy

For anyone that has lived through the Great Recession – or watched the film The Big Short – the words leverage and mortgages in combination tends to at least raise eyebrows, if not send involuntary shudders. And sure enough, MFA Financial (NYSE:MFA), which specializes in leveraged mortgage-backed securities, has been one of the worst-hit companies during the present crisis. Year-to-date, MFA stock has dropped more than 66%.

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Source: Shutterstock

At the same time, shares have done very well since hitting a spike low in late March. For a brief moment, MFA stock closed down at 32 cents, demonstrating the extreme power of collective investor panic. Fortunately, cooler heads quickly prevailed. Since early April, MFA’s equity valuation has charted an encouraging bullish trend channel.

Now, the only question is, will the trajectory continue? Unfortunately for the optimists, I believe the ride will end soon. If you’re not careful, the situation can turn very ugly for MFA stock over the next several weeks. But before we dive into this narrative, let’s remind ourselves how the underlying company got into this mess.

MFA Stock Is a Victim of Circumstances and Timing

Unlike other stocks where I have a negative outlook, I can’t fault MFA Financial for anything that the company did. Rather, management fell prey to circumstances beyond its control. As well, the timing of its business strategy shift couldn’t have been uglier.

MFA Financial as I just mentioned deals with mortgage-backed securities. For a long time, its portfolio consisted of mostly government-backed securities. This platform has an obvious benefit: if the mortgage borrower defaults, a government agency will step in.

Now, the company also invested in residential MBS “that are not guaranteed by any agency of the U.S. Government or any federally chartered corporation,” according to MFA’s Form 10-K filing. In 2019, MFA focused more on this business than the government-backed variety.

Today, we recognize that move as incredibly short-sighted. But you must also appreciate the impact that lower interest rates – a byproduct of the governmental response to the Great Recession – had on MFA’s earnings. Last year, because of an economic slowdown and a protracted U.S.-China trade war, the Federal Reserve was essentially forced into lowering benchmark interest rates.

MFA Financial EPS vs 10-year Treasury rate
Click to Enlarge
Source: Chart by Josh Enomoto

Of course, lower interest rates hurt MFA stock due to the negative impact to its underlying business. Therefore, management reasoned that it should take a calculated risk through non-government backed MBS. Otherwise, it wouldn’t get anywhere with government-backed MBS in a low-yield environment.

As Monday morning quarterbacks, we can comfortably say this was the wrong decision. However, would you have done anything different if you didn’t know about the novel coronavirus?

Why It’s Going to Get Worse

I like to think of myself as an optimistic person. However, I’m also a realist and this side of my brain tends to dominate any internal discussions. So, you’ll have to forgive me that I don’t really see a high-probability upside narrative here.

As the Washington Post’s Andrew Van Dam warned recently, “An indicator that presaged the housing crisis is flashing red again.” Specifically, Van Dam writes:

New mortgage delinquencies hit a record in April, well above anything seen during the Great Recession.

Some 3.4 percent of Americans became at least 30 days delinquent on their mortgage in April, according to an analysis from CoreLogic. The real estate data firm’s figures include about three of four U.S. mortgages, going back to 1999.

To be fair, Van Dam is quick to note that we may not see a repeat of the wave of foreclosures that hit during the last housing crisis. It’s possible that government agencies, which learned painful lessons from the Great Recession, will step in. On the surface, that’s good news for MFA stock.

However, the $2 trillion government bailout – known as the CARES Act – and its future implications are now political stumbling blocks. Not surprisingly, many Republicans are worried about the cost of continuing to give bailouts to the American people and industries.

If the issue turns into another Washington gridlock, I don’t see good things for MFA stock. Bear in mind that those homeowners who took advantage of forbearance programs must eventually pay up; forbearance is not to be confused with forgiveness.

Plus, with the federal program designed to bolster state unemployment checks about to expire soon, we could still get a torrent of negative economic news.

Take the Smart Play

At this point, the only bullish reason to buy MFA stock is that it’s cheap and you anticipate a return to normal. That logic had more credibility about a month ago. Today, with exploding coronavirus cases and hospitalizations, that path looks far less likely to materialize.

Also, you must consider the weekly initial jobless claims. On a consecutive basis, those filing for unemployment benefits number in the millions. Until this dubious tally drops substantially, housing-related stocks appear unnecessarily risky. Here, I believe investors should take the smart approach and avoid MFA.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare. As of this writing, he did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2020/07/mfa-stock-financial-warning-sign-for-economy/.

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