MFA Financial (NYSE:MFA) is a real estate investment trust (“REIT”) that has had a rough year. To date, MFA stock is down more than 62% as of Oct. 9, but it is likely to have a significant turnaround.
I suspect that the REIT has reached an inflection point in its finances and is likely to do much better for the rest of this year and next.
One important fact to note right at the start is that MFA stock is selling well below its book value. Most of the company’s assets are real estate securities, rather than actual real estate.
For example, as of June 30, the company said that its “economic” book value, or a market-related assessment of its residential whole loans, is $4.46 per share. Therefore, MFA stock is trading for around 60% of its economic book value.
Moreover, this implies that the stock could rise over 55% if it were to begin trading for the true value of its residential whole loans. This is because $4.46 per share divided by $2.87 is 1.554, or 55.4% above $2.87.
Other Catalysts for MFA Stock
In the company’s Aug. 6 letter to shareholders, MFA Financial’s management indicated that it had made big changes. For one, it completely restructured its leverage and asset portfolios.
For example, instead of owning mortgage-backed securities, its portfolio now mainly consists of residential whole loans. In other words, it had gotten rid of derivative type securities, which require lots of daily “mark-to-market” collateral. That means that it collects the interest from mortgages directly, and the loans don’t change much in value on a daily basis.
Second, the company restored its common stock dividend payments. However, instead of paying a quarterly dividend of 20 cents per share, the company now pays a 5 cents per share quarterly dividend.
Moreover, MFA indicated that it already has an undistributed REIT taxable income of 16 cents per share. In effect, then, MFA Financial can afford its restored 5 cents per share quarterly dividend.
In fact, depending on how the Q3 and Q4 quarters proceed, I suspect there is a good chance the company may have to increase its dividend. REITs are required to distribute 90% of their taxable income in order to preserve their tax-free structure.
Therefore, this dividend gives MFA stock a very attractive dividend yield. For example, the annualized dividend of 20 cents per share divided by the MFA stock price of $2.87 per share is 6.97%.
Another Catalyst for MFA
Another catalyst for MFA stock is that the company will likely report its Q3 earnings on or about Nov. 6, a few weeks from now.
It is likely to show that its economic book value has risen, along with the rise in its underlying loan value assets. This is because the U.S. economy has continued to turn around from the lows of the second quarter.
This has a leveraged effect on the stock’s upside potential.
For example, let’s assume that economic book value has risen 10% to $4.91 per share by the end of the year. That means MFA stock could rise 71% to reach book value.
This represents a potential 16% increase from its existing 55% potential upside (see above). So you see the leverage – every 10% increase in book value could lead to a 16% higher price.
What to Do Next With MFA Stock
Recently, Starwood Capital took an 8.39% equity position in the company by buying shares in the company in the market. Starwood, led by Barry Sternlicht, is well known as an astute value investment firm in the real estate sector.
This is a major catalyst for MFA stock. For one, the investment sort of underlines that the stock is too cheap. Barry Sternlicht is known for making very successful long-term value investments.
The firm normally invests in hard assets. For them to buy a mortgage-related REIT like MFA Financial is very significant. He probably attracted by like its huge discount – from 55% to 71% – to the economic book value.
Second, they likely believe MFA will continue to be able to afford its dividend, despite the high yield. This also underscores the value that the dividend gives MFA stock. I have shown there is a good possibility the dividend could rise over the coming year.
The patient value investor will consider these catalysts and take a position before the Nov. 6 Q3 earnings release or shortly thereafter. They are likely to make a good ROI over the next year.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.