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EX-32.2 - EXHIBIT 32.2 - MFA FINANCIAL, INC.exhibit322certificationofc.htm
EX-31.1 - EXHIBIT 31.1 - MFA FINANCIAL, INC.exhibit311certificationofc.htm
EX-32.1 - EXHIBIT 32.1 - MFA FINANCIAL, INC.exhibit321certificationofc.htm
EX-31.2 - EXHIBIT 31.2 - MFA FINANCIAL, INC.exhibit312certificationofc.htm

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549 
_____________________________________________ 
FORM 10-Q
 
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2016
 
OR
 
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                              to                             
 
Commission File Number: 1-13991
 
MFA FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
_____________________________________________ 
Maryland
 
13-3974868
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
350 Park Avenue, 20th Floor, New York, New York
 
10022
(Address of principal executive offices)
 
(Zip Code)
 
(212) 207-6400
(Registrant’s telephone number, including area code) 
_____________________________________________
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x
 
371,072,639 shares of the registrant’s common stock, $0.01 par value, were outstanding as of April 28, 2016.
 



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






MFA FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS

 (In Thousands Except Per Share Amounts)
 
March 31,
2016
 
December 31,
2015
 
 
(Unaudited)
 
 
Assets:
 
 

 
 

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

 
 

Agency MBS, at fair value ($4,317,158 and $4,532,094 pledged as collateral, respectively)
 
$
4,544,883

 
$
4,752,244

Non-Agency MBS, at fair value ($5,003,131 and $4,874,372 pledged as collateral, respectively)
 
5,902,305

 
5,822,519

Non-Agency MBS transferred to consolidated variable interest entities (“VIEs”), at fair value (1)
 
198,452

 
598,298

CRT securities, at fair value ($196,350 and $170,352 pledged as collateral, respectively)
 
215,803

 
183,582

Securities obtained and pledged as collateral, at fair value
 
513,409

 
507,443

Residential whole loans, at carrying value ($200,854 and $93,692 pledged as collateral, respectively)
 
376,235

 
271,845

Residential whole loans, at fair value ($609,769 and $585,971 pledged as collateral, respectively)
 
647,360

 
623,276

Cash and cash equivalents
 
146,236

 
165,007

Restricted cash
 
123,676

 
71,538

Other assets
 
176,082

 
166,799

Total Assets
 
$
12,844,441

 
$
13,162,551

 
 
 
 
 
Liabilities:
 
 

 
 

Repurchase agreements and other advances
 
$
9,143,645

 
$
9,387,622

Securitized debt (2)
 
11,821

 
21,868

Obligation to return securities obtained as collateral, at fair value
 
513,409

 
507,443

8% Senior Notes due 2042 (“Senior Notes”)
 
96,706

 
96,697

Other liabilities
 
217,214

 
181,660

Total Liabilities
 
$
9,982,795

 
$
10,195,290

 
 
 
 
 
Commitments and contingencies (See Note 14)
 


 


 
 
 
 
 
Stockholders’ Equity:
 
 

 
 

Preferred stock, $.01 par value; 7.50% Series B cumulative redeemable; 8,050 shares authorized;
8,000 shares issued and outstanding ($200,000 aggregate liquidation preference)
 
$
80

 
$
80

Common stock, $.01 par value; 886,950 shares authorized; 370,977 and 370,584 shares issued
and outstanding, respectively
 
3,710

 
3,706

Additional paid-in capital, in excess of par
 
3,019,891

 
3,019,956

Accumulated deficit
 
(572,445
)
 
(572,332
)
Accumulated other comprehensive income
 
410,410

 
515,851

Total Stockholders’ Equity
 
$
2,861,646

 
$
2,967,261

Total Liabilities and Stockholders’ Equity
 
$
12,844,441

 
$
13,162,551

 

(1)
Non-Agency MBS transferred to consolidated VIEs represent assets of the consolidated VIEs that can be used only to settle the obligations of each respective VIE.
(2)
Securitized debt represents third-party liabilities of consolidated VIEs and excludes liabilities of the VIEs acquired by the Company that eliminate on consolidation.  The third-party beneficial interest holders in the VIEs have no recourse to the general credit of the Company.  (See Notes 14 and 19 for further discussion.)

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

1


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
 
Three Months Ended 
 March 31,
(In Thousands, Except Per Share Amounts)
 
2016
 
2015
Interest Income:
 
 

 
 

Agency MBS
 
$
23,997

 
$
31,673

Non-Agency MBS
 
80,305

 
81,248

Non-Agency MBS transferred to consolidated VIEs
 
5,847

 
12,043

CRT securities
 
2,692

 
1,360

Residential whole loans held at carrying value
 
4,496

 
3,591

Cash and cash equivalent investments
 
140

 
27

Interest Income
 
$
117,477

 
$
129,942

 
 
 
 
 
Interest Expense:
 
 

 
 

Repurchase agreements and other advances
 
$
45,395

 
$
41,182

Senior Notes and other interest expense
 
2,205

 
2,758

Interest Expense
 
$
47,600

 
$
43,940

 
 
 
 
 
Net Interest Income
 
$
69,877

 
$
86,002

 
 
 
 
 
Other-Than-Temporary Impairments:
 
 

 
 

Total other-than-temporary impairment losses
 
$

 
$
(395
)
Portion of loss reclassed from other comprehensive income
 

 
(12
)
Net Impairment Losses Recognized in Earnings
 
$

 
$
(407
)
 
 
 
 
 
Other Income, net:
 
 

 
 

Net gain on residential whole loans held at fair value
 
$
11,881

 
$
2,034

Gain on sales of MBS
 
9,745

 
6,435

Other, net
 
1,026

 
311

Other Income, net
 
$
22,652

 
$
8,780

 
 
 
 
 
Operating and Other Expense:
 
 

 
 

Compensation and benefits
 
$
7,407

 
$
6,746

Other general and administrative expense
 
3,918

 
3,457

Loan servicing and other related operating expenses
 
3,134

 
1,999

Operating and Other Expense
 
$
14,459

 
$
12,202

 
 
 
 
 
Net Income
 
$
78,070

 
$
82,173

Less Preferred Stock Dividends
 
3,750

 
3,750

Net Income Available to Common Stock and Participating Securities
 
$
74,320

 
$
78,423

 
 
 
 
 
Earnings per Common Share - Basic and Diluted
 
$
0.20

 
$
0.21

 
 
 
 
 
Dividends Declared per Share of Common Stock
 
$
0.20

 
$
0.20


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

2


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS)/INCOME
(UNAUDITED)

 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2016
 
2015
Net income
 
$
78,070

 
$
82,173

Other Comprehensive (Loss)/Income:
 
 

 
 

Unrealized gain on Agency MBS, net
 
13,226

 
12,885

Unrealized (loss)/gain on Non-Agency MBS, net
 
(58,840
)
 
26,150

Reclassification adjustment for MBS sales included in net income
 
(10,485
)
 
(6,423
)
Reclassification adjustment for other-than-temporary impairments included in net income
 

 
(407
)
Unrealized loss on derivative hedging instruments, net
 
(49,342
)
 
(32,367
)
Cumulative effect adjustment on adoption of revised accounting standard for repurchase agreement financing
 

 
4,537

Other Comprehensive (Loss)/Income
 
(105,441
)
 
4,375

Comprehensive (loss)/income before preferred stock dividends
 
$
(27,371
)
 
$
86,548

Dividends declared on preferred stock
 
(3,750
)
 
(3,750
)
Comprehensive (Loss)/Income Available to Common Stock and Participating Securities
 
$
(31,121
)
 
$
82,798

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

3


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(UNAUDITED)

 
 
Three Months Ended March 31, 2016
(In Thousands, 
Except Per Share Amounts)
 
Preferred Stock
7.50% Series B Cumulative Redeemable - Liquidation Preference $25.00 per Share
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated
Deficit
 
Accumulated Other Comprehensive Income
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2015
 
8,000

 
$
80

 
370,584

 
$
3,706

 
$
3,019,956

 
$
(572,332
)
 
$
515,851

 
$
2,967,261

Net income
 

 

 

 

 

 
78,070

 

 
78,070

Issuance of common stock, net of expenses (1)
 

 

 
589

 
4

 
302

 

 

 
306

Repurchase of shares of common stock (1)
 

 

 
(196
)
 

 
(1,324
)
 

 

 
(1,324
)
Equity based compensation expense
 

 

 

 

 
1,130

 

 

 
1,130

Accrued dividends attributable to stock-based awards
 

 

 

 

 
(173
)
 

 

 
(173
)
Dividends declared on common stock
 

 

 

 

 

 
(74,215
)
 

 
(74,215
)
Dividends declared on preferred stock
 

 

 

 

 

 
(3,750
)
 

 
(3,750
)
Dividends attributable to dividend equivalents
 

 

 

 

 

 
(218
)
 

 
(218
)
Change in unrealized losses on MBS, net
 

 

 

 

 

 

 
(56,099
)
 
(56,099
)
Change in unrealized losses on derivative hedging instruments, net
 

 

 

 

 

 

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

 
$
80

 
370,977

 
$
3,710

 
$
3,019,891

 
$
(572,445
)
 
$
410,410

 
$
2,861,646


 
 
Three Months Ended March 31, 2015
(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, 2014
 
8,000

 
$
80

 
370,084

 
$
3,701

 
$
3,013,634

 
$
(568,596
)
 
$
754,453

 
$
3,203,272

Cumulative effect adjustment on adoption of revised accounting standard for repurchase agreement financing
 

 

 

 

 

 
(4,537
)
 
4,537

 

Net income
 

 

 

 

 

 
82,173

 

 
82,173

Issuance of common stock, net of expenses (1)
 

 

 
61

 

 
312

 

 

 
312

Repurchase of shares of common stock (1)
 

 

 
(11
)
 

 
(151
)
 

 

 
(151
)
Equity based compensation expense
 

 

 

 

 
912

 

 

 
912

Accrued dividends attributable to stock-based awards
 

 

 

 

 
(113
)
 

 

 
(113
)
Dividends declared on common stock
 

 

 

 

 

 
(74,072
)
 

 
(74,072
)
Dividends declared on preferred stock
 

 

 

 

 

 
(3,750
)
 

 
(3,750
)
Dividends attributable to dividend equivalents
 

 

 

 

 

 
(249
)
 

 
(249
)
Change in unrealized gains on MBS, net
 

 

 

 

 

 

 
32,205

 
32,205

Change in unrealized losses on derivative hedging instruments, net
 

 

 

 

 

 

 
(32,367
)
 
(32,367
)
Balance at March 31, 2015
 
8,000

 
$
80

 
370,134

 
$
3,701

 
$
3,014,594

 
$
(569,031
)
 
$
758,828

 
$
3,208,172


(1)  For the three months ended March 31, 2016 and 2015, includes approximately $1.3 million (196,333 shares) and $87,000 (11,074 shares), respectively surrendered for tax purposes related to equity-based compensation awards.

4


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2016
 
2015
Cash Flows From Operating Activities:
 
 

 
 

Net income
 
$
78,070

 
$
82,173

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

 
 

Gain on sales of MBS
 
(9,745
)
 
(6,435
)
(Gain)/loss on sales of real estate owned
 
(509
)
 
26

Other-than-temporary impairment charges
 

 
407

Accretion of purchase discounts on MBS and CRT securities and residential whole loans
 
(22,083
)
 
(25,254
)
Amortization of purchase premiums on MBS
 
8,143

 
9,122

Depreciation and amortization on real estate, fixed assets and other assets
 
272

 
115

Equity-based compensation expense
 
1,134

 
912

Unrealized gain on residential whole loans at fair value
 
(6,226
)
 
(602
)
Increase in other assets
 
(6,259
)
 
(13,910
)
(Decrease)/increase in other liabilities
 
(3,798
)
 
4,693

Net cash provided by operating activities
 
$
38,999

 
$
51,247

 
 
 
 
 
Cash Flows From Investing Activities:
 
 

 
 

Principal payments on MBS and CRT securities
 
$
807,349

 
$
588,088

Proceeds from sales of MBS
 
32,034

 
10,845

Purchases of MBS and CRT securities
 
(375,404
)
 
(518,127
)
Purchases of residential whole loans and capitalized advances
 
(165,510
)
 
(40,168
)
Principal payments on residential whole loans
 
21,666

 
6,260

Proceeds from sales of real estate owned
 
6,157

 
581

Redemption of Federal Home Loan Bank stock
 
10,475

 

Additions to leasehold improvements, furniture and fixtures
 
(56
)
 
(158
)
Net cash provided by investing activities
 
$
336,711

 
$
47,321

 
 
 
 
 
Cash Flows From Financing Activities:
 
 

 
 

Principal payments on repurchase agreements and other advances
 
$
(19,776,510
)
 
$
(23,325,613
)
Proceeds from borrowings under repurchase agreements and other advances
 
19,532,131

 
23,348,218

Principal payments on securitized debt
 
(10,133
)
 
(19,186
)
Payments made for margin calls on repurchase agreements and interest rate swap agreements (“Swaps”)
 
(117,800
)
 
(98,000
)
Proceeds from reverse margin calls on repurchase agreements and Swaps
 
55,700

 
60,000

Proceeds from issuances of common stock
 
306

 
312

Dividends paid on preferred stock
 
(3,750
)
 
(3,750
)
Dividends paid on common stock and dividend equivalents
 
(74,425
)
 
(74,269
)
Net cash used in financing activities
 
$
(394,481
)
 
$
(112,288
)
Net decrease in cash and cash equivalents
 
$
(18,771
)
 
$
(13,720
)
Cash and cash equivalents at beginning of period
 
$
165,007

 
$
182,437

Cash and cash equivalents at end of period
 
$
146,236

 
$
168,717

 
 
 
 
 
Non-cash Investing and Financing Activities:
 
 

 
 

MBS and CRT securities recorded upon adoption of revised accounting standard for repurchase agreement financing
 
$

 
$
1,917,813

Repurchase agreements recorded upon adoption of revised accounting standard for repurchase agreement financing
 
$

 
$
1,519,593

Net (decrease)/increase in securities obtained as collateral/obligation to return securities obtained as collateral
 
$
(5,175
)
 
$
20,990

Transfer from residential whole loans to real estate owned
 
$
22,280

 
$
3,448

Dividends and dividend equivalents declared and unpaid
 
$
74,583

 
$
74,581

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

5

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


 
1.   Organization
 
MFA Financial, Inc. (the “Company”) was incorporated in Maryland on July 24, 1997 and began operations on April 10, 1998.  The Company has elected to be treated as a real estate investment trust (“REIT”) for U.S. federal income tax purposes.  In order to maintain its qualification as a REIT, the Company must comply with a number of requirements under federal tax law, including that it must distribute at least 90% of its annual REIT taxable income to its stockholders.  The Company has elected to treat certain of its subsidiaries as a taxable REIT subsidiary (“TRS”). In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate related business. (See Notes 2(o) and 15)
 
2.   Summary of Significant Accounting Policies
 
(aBasis of Presentation and Consolidation
 
The interim unaudited consolidated financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted according to these SEC rules and regulations.  Management believes that the disclosures included in these interim unaudited consolidated financial statements are adequate to make the information presented not misleading.  The accompanying unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.  In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31, 2016 and results of operations for all periods presented have been made.  The results of operations for the three months ended March 31, 2016 should not be construed as indicative of the results to be expected for the full year.
 
The accompanying consolidated financial statements of the Company have been prepared on the accrual basis of accounting in accordance with GAAP.  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Although the Company’s estimates contemplate current conditions and how it expects them to change in the future, it is reasonably possible that actual conditions could differ from those estimates, which could materially impact the Company’s results of operations and its financial condition.  Management has made significant estimates in several areas, including other-than-temporary impairment (“OTTI”) on MBS (See Note 3), valuation of MBS and CRT securities (See Notes 3 and 18), income recognition and valuation of residential whole loans (See Notes 4 and 18), valuation of derivative instruments (See Notes 6 and 18) and income recognition on certain Non-Agency MBS purchased at a discount (See Note 3).  In addition, estimates are used in the determination of taxable income used in the assessment of REIT compliance and contingent liabilities for related taxes, penalties and interest (See Note 2(o)).  Actual results could differ from those estimates.

The Company has one reportable segment as we manage our business and analyze and report our 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; significant intercompany accounts and transactions have been eliminated. In addition, the Company consolidates the special purpose entities created to facilitate the resecuritization transactions completed in prior years and the acquisition of residential whole loans. Certain prior period amounts have been reclassified to conform to the current period presentation.
 

6

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


(bMBS (including Non-Agency MBS transferred to consolidated VIEs) and CRT Securities
 
The Company has investments in residential MBS that are issued or guaranteed as to principal and/or interest by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae (collectively, “Agency MBS”), and residential MBS that are not guaranteed by any U.S. Government agency or any federally chartered corporation (“Non-Agency MBS”). In addition, the Company has investments in CRT securities that are issued by Fannie Mae and Freddie Mac. The coupon payments on CRT securities are paid by Fannie Mae and Freddie Mac and the principal payments received are based on the performance of loans in a reference pool of recently securitized MBS. As the loans in the underlying reference pool are paid, the principal balance of the CRT securities is paid. As an investor in a CRT security, the Company may incur a loss if certain defined credit events occur, including if the loans in the reference pool experience delinquencies exceeding specified thresholds.
 
Designation
 
The Company generally intends to hold its MBS until maturity; however, from time to time, it may sell any of its securities as part of the overall management of its business.  As a result, all of the Company’s MBS are designated as “available-for-sale” (“AFS”) and, accordingly, are carried at their fair value with unrealized gains and losses excluded from earnings (except when an OTTI is recognized, as discussed below) and reported in Accumulated other comprehensive income/(loss) (“AOCI”), a component of Stockholders’ Equity.
 
Upon the sale of an AFS security, any unrealized gain or loss is reclassified out of AOCI to earnings as a realized gain or loss using the specific identification method.

The Company has elected the fair value option for certain of its CRT securities as it considers this method of accounting more appropriately reflects the risk sharing structure of these securities. Such securities are carried at their fair value with changes in fair value included in earnings for the period and reported in Other Income, net on the Company’s consolidated statement of operations.
 
Revenue Recognition, Premium Amortization and Discount Accretion
 
Interest income on securities is accrued based on the outstanding principal balance and their contractual terms. Premiums and discounts associated with Agency MBS and Non-Agency MBS assessed as high credit quality at the time of purchase are amortized into interest income over the life of such securities using the effective yield method. Adjustments to premium amortization are made for actual prepayment activity.
 
Interest income on the Non-Agency MBS that were purchased at a discount to par value and/or are considered to be of less than high credit quality is recognized based on the security’s effective interest rate which is the security’s internal rate of return (“IRR”). The IRR is determined using management’s estimate of the projected cash flows for each security, which are based on the Company’s observation of current information and events and include assumptions related to fluctuations in interest rates, prepayment speeds and the timing and amount of credit losses. On at least a quarterly basis, the Company reviews and, if appropriate, makes adjustments to its cash flow projections based on input and analysis received from external sources, internal models, and its judgment about interest rates, prepayment rates, the timing and amount of credit losses, and other factors. Changes in cash flows from those originally projected, or from those estimated at the last evaluation, may result in a prospective change in the IRR/ interest income recognized on these securities or in the recognition of OTTIs.  (See Note 3)
 
Based on the projected cash flows from the Company’s Non-Agency MBS purchased at a discount to par value, a portion of the purchase discount may be designated as non-accretable purchase discount (“Credit Reserve”), which effectively mitigates the Company’s risk of loss on the mortgages collateralizing such MBS and is not expected to be accreted into interest income.  The amount designated as Credit Reserve may be adjusted over time, based on the actual performance of the security, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors.  If the performance of a security with a Credit Reserve is more favorable than forecasted, a portion of the amount designated as Credit Reserve may be reallocated to accretable discount and recognized into interest income over time.  Conversely, if the performance of a security with a Credit Reserve is less favorable than forecasted, the amount designated as Credit Reserve may be increased, or impairment charges and write-downs of such securities to a new cost basis could result.
 

7

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


Determination of Fair Value for MBS and CRT Securities
 
In determining the fair value of the Company’s MBS and CRT securities, management considers a number of observable market data points, including prices obtained from pricing services, brokers and repurchase agreement counterparties, dialogue with market participants, as well as management’s observations of market activity.  (See Note 18)
 
Impairments/OTTI

When the fair value of an AFS security is less than its amortized cost at the balance sheet date, the security is considered impaired.  The Company assesses its impaired securities on at least a quarterly basis and designates such impairments as either “temporary” or “other-than-temporary.”  If the Company intends to sell an impaired security, or it is more likely than not that it will be required to sell the impaired security before its anticipated recovery, then the Company must recognize an OTTI through charges to earnings equal to the entire difference between the investment’s amortized cost and its fair value at the balance sheet date.  If the Company does not expect to sell an other-than-temporarily impaired security, only the portion of the OTTI related to credit losses is recognized through charges to earnings with the remainder recognized through AOCI on the consolidated balance sheets.  Impairments recognized through other comprehensive income/(loss) (“OCI”) do not impact earnings.  Following the recognition of an OTTI through earnings, a new cost basis is established for the security and may not be adjusted for subsequent recoveries in fair value through earnings.  However, OTTIs recognized through charges to earnings may be accreted back to the amortized cost basis of the security on a prospective basis through interest income.  The determination as to whether an OTTI exists and, if so, the amount of credit impairment recognized in earnings is subjective, as such determinations are based on factual information available at the time of assessment as well as the Company’s estimates of the future performance and cash flow projections.  As a result, the timing and amount of OTTIs constitute material estimates that are susceptible to significant change.  (See Note 3)

Non-Agency MBS that are assessed to be of less than high credit quality and on which impairments are recognized have experienced, or are expected to experience, credit-related adverse cash flow changes.  The Company’s estimate of cash flows for its Non-Agency MBS is based on its review of the underlying mortgage loans securing the MBS.  The Company considers information available about the past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, Fair Isaac Corporation (“FICO”) scores at loan origination, year of origination, loan-to-value ratios (“LTVs”), geographic concentrations, as well as reports by credit rating agencies, such as Moody’s Investors Services, Inc. (“Moody’s”), Standard & Poor’s Corporation (“S&P”), or Fitch, Inc. (collectively, “Rating Agencies”), general market assessments, and dialogue with market participants.  As a result, significant judgment is used in the Company’s analysis to determine the expected cash flows for its Non-Agency MBS.  In determining the OTTI related to credit losses for securities that were purchased at significant discounts to par and/or are considered to be of less than high credit quality, the Company compares the present value of the remaining cash flows expected to be collected at the purchase date (or last date previously revised) against the present value of the cash flows expected to be collected at the current financial reporting date.  The discount rate used to calculate the present value of expected future cash flows is the current yield used for income recognition purposes.  Impairment assessment for Non-Agency MBS and CRT Securities that were purchased at prices close to par and/or are otherwise considered to be of high credit quality involves comparing the present value of the remaining cash flows expected to be collected against the amortized cost of the security at the assessment date.  The discount rate used to calculate the present value of the expected future cash flows is based on the instrument’s IRR.
 
Balance Sheet Presentation
 
The Company’s MBS and CRT Securities pledged as collateral against repurchase agreements, Federal Home Loan Bank advances and Swaps are included on the consolidated balance sheets with the fair value of the securities pledged disclosed parenthetically.  Purchases and sales of securities are recorded on the trade date. 


8

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


(cSecurities Obtained and Pledged as Collateral/Obligation to Return Securities Obtained as Collateral
 
The Company has obtained securities as collateral under collateralized financing arrangements in connection with its financing strategy for Non-Agency MBS.  Securities obtained as collateral in connection with these transactions are recorded on the Company’s consolidated balance sheets as an asset along with a liability representing the obligation to return the collateral obtained, at fair value.  While beneficial ownership of securities obtained remains with the counterparty, the Company has the right to sell the collateral obtained or to pledge it as part of a subsequent collateralized financing transaction.  (See Note 2(k) for Repurchase Agreements and Reverse Repurchase Agreements)

(dResidential Whole Loans

Residential whole loans included in the Company’s consolidated balance sheets are comprised of pools of fixed and adjustable rate residential mortgage loans acquired through consolidated trusts in secondary market transactions at discounted purchase prices. The accounting model utilized by the Company is determined at the time each loan package is initially acquired and is generally based on the delinquency status of the majority of the underlying borrowers in the package at acquisition. The accounting model described below under “Residential Whole Loans at Carrying Value” is typically utilized by the Company for loans where the underlying borrower has a delinquency status of less than 60 days at the acquisition date. The accounting model described below under “Residential Whole Loans at Fair Value” is typically utilized by the Company for loans where the underlying borrower has a delinquency status of 60 days or more at the acquisition date. The accounting model initially applied is not subsequently changed.

The Company’s residential whole loans pledged as collateral against repurchase agreements are included in the consolidated balance sheets with amounts pledged disclosed parenthetically.  Purchases and sales of residential whole loans are recorded on the trade date, with amounts recorded reflecting management’s current estimate of assets that will be acquired or disposed at the closing of the transaction. This estimate is subject to revision at the closing of the transaction, pending the outcome of due diligence performed prior to closing.

Residential Whole Loans at Carrying Value

Notwithstanding that the majority of these loans are considered to be performing substantially in accordance with their current contractual terms and conditions, the Company has elected to account for these loans as credit impaired as they were acquired at discounted prices that reflect, in part, the impaired credit history of the borrower. Substantially all of the borrowers have previously experienced payment delinquencies and the amount owed on the mortgage loan may exceed the value of the property pledged as collateral. Consequently, the Company has assessed that these loans have a higher likelihood of default than newly originated mortgage loans with LTVs of 80% or less to credit worthy borrowers. The Company believes that amounts paid to acquire these loans represent fair market value at the date of acquisition. Such loans are initially recorded at fair value with no allowance for loan losses. Subsequent to acquisition, the recorded amount reflects the original investment amount, plus accretion of interest income, less principal and interest cash flows received. These loans are presented on the Company’s consolidated balance sheets at carrying value, which reflects the recorded amount reduced by any allowance for loan losses established subsequent to acquisition.

Under the application of this accounting model the Company may aggregate into pools loans acquired in the same fiscal quarter that are assessed as having similar risk characteristics. For each pool established, or on an individual loans basis for loans not aggregated into pools, the Company estimates at acquisition and periodically on at least a quarterly basis, the principal and interest cash flows expected to be collected. The difference between the cash flows expected to be collected and the carrying amount of the loans is referred to as the “accretable yield.” This amount is accreted as interest income over the life of the loans using an effective interest rate (level yield) methodology. Interest income recorded each period reflects the amount of accretable yield recognized and not the coupon interest payments received on the underlying loans. The difference between contractually required principal and interest payments and the cash flows expected to be collected is referred to as the “non-accretable difference,” and includes estimates of both the effect of prepayments and expected credit losses over the life of the underlying loans.

A decrease in expected cash flows in subsequent periods may indicate impairment at the pool and/or individual loan level thus requiring the establishment of an allowance for loan losses by a charge to the provision for loan losses. The allowance for loan losses represents the present value of cash flows expected at acquisition, adjusted for any increases due to changes in estimated cash flows, that are subsequently no longer expected to be received at the relevant measurement date. A significant increase in expected cash flows in subsequent periods first reduces any previously recognized allowance for loan losses and then will result in a recalculation in the amount of accretable yield. The adjustment of accretable yield due to a significant increase in expected

9

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


cash flows is accounted for prospectively as a change in estimate and results in reclassification from nonaccretable difference to accretable yield. (See Notes 4 and 19)

Residential Whole Loans at Fair Value

Certain of the Company’s residential whole loans are presented at fair value on its consolidated balance sheets as a result of a fair value election made at time of acquisition. Given the significant uncertainty associated with estimating the timing of and amount of cash flows associated with these loans that will be collected, and that the cash flows ultimately collected may be dependent on the value of the property securing the loan, the Company considers that accounting for these loans at fair value should result in a better reflection over time of the economic returns from these loans. The Company determines the fair value of its residential whole loans held at fair value after considering portfolio valuations obtained from a third-party who specializes in providing valuations of residential mortgage loans and trading activity observed in the market place. Subsequent changes in fair value are reported in current period earnings and presented in Net gain on residential whole loans held at fair value on the Company’s consolidated statements of operations.

Cash received reflecting coupon payments on residential whole loans held at fair value is not included in Interest Income, but rather is presented in Net gain on residential whole loans held at fair value on the Company’s consolidated statements of operations. (See Notes 4 and 18)

(eCash and Cash Equivalents
 
Cash and cash equivalents include cash on deposit with financial institutions and investments in money market funds, all of which have original maturities of three months or less.  Cash and cash equivalents may also include cash pledged as collateral to the Company by its repurchase agreement and/or Swap counterparties as a result of reverse margin calls (i.e., margin calls made by the Company).  The Company did not hold any cash pledged by its counterparties at March 31, 2016 or December 31, 2015.  The Company’s investments in overnight money market funds, which are not bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency, were $129.3 million and $120.4 million at March 31, 2016 and December 31, 2015, respectively.  (See Notes 10 and 18)
 
(f Restricted Cash
 
Restricted cash represents the Company’s cash held by its counterparties as collateral or otherwise in connection with the Company’s Swaps and/or repurchase agreements.  Restricted cash is not available to the Company for general corporate purposes, but may be applied against amounts due to counterparties to the Company’s repurchase agreements and/or Swaps, or may be returned to the Company when the related collateral requirements are exceeded or at the maturity of the Swap or repurchase agreement.  The Company had aggregate restricted cash held as collateral or otherwise in connection with its Swaps and repurchase agreements of $123.7 million and $71.5 million at March 31, 2016 and December 31, 2015, respectively.  (See Notes 6, 9, 10 and 18)
 
(gGoodwill
 
At March 31, 2016 and December 31, 2015, the Company had goodwill of $7.2 million, which represents the unamortized portion of the excess of the fair value of its common stock issued over the fair value of net assets acquired in connection with its formation in 1998.  Goodwill is tested for impairment at least annually, or more frequently under certain circumstances, at the entity level.  Through March 31, 2016, the Company had not recognized any impairment against its goodwill. Goodwill is included in Other assets on the Company’s consolidated balance sheets.

(h) Real Estate Owned (“REO”)
 
REO represents real estate acquired by the Company, including through foreclosure or deed in lieu of foreclosure, and is initially recorded at fair value less estimated selling costs. 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. (See Note 7)


10

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


(iDepreciation
 
Leasehold Improvements and Other Depreciable Assets
 
Depreciation is computed on the straight-line method over the estimated useful life of the related assets or, in the case of leasehold improvements, over the shorter of the useful life or the lease term.  Furniture, fixtures, computers and related hardware have estimated useful lives ranging from five to eight years at the time of purchase.
 
(jResecuritization and Other Debt Issuance Costs
 
Resecuritization related costs are costs associated with the issuance of beneficial interests by consolidated VIEs and incurred by the Company in connection with various resecuritization transactions completed by the Company.  Other debt issuance and related costs include costs incurred by the Company in connection with issuing Senior Notes and certain other repurchase agreement financings. These costs may include underwriting, rating agency, legal, accounting and other fees.  Such costs, which reflect deferred charges, are included on the Company’s consolidated balance sheets as a direct deduction from the corresponding debt liability. These deferred charges are amortized as an adjustment to interest expense using the effective interest method. For resecuritization financings, amortization is based upon the actual repayments of the associated beneficial interests issued to third parties. For Senior Notes and other repurchase agreement financings, such costs are amortized over the shorter of the period to the expected or stated legal maturity of the debt instruments. The Company periodically reviews the recoverability of these deferred costs and in the event an impairment charge is required, such amount will be included in Operating and Other Expense on the Company’s consolidated statements of operations.

(kRepurchase Agreements and Other Advances
 
Repurchase Agreements

The Company finances the holdings of a significant portion of its MBS and CRT securities with repurchase agreements.  Under repurchase agreements, the Company sells securities to a lender and agrees to repurchase the same securities in the future for a price that is higher than the original sale price.  The difference between the sale price that the Company receives and the repurchase price that the Company pays represents interest paid to the lender.  Although legally structured as sale and repurchase transactions, the Company accounts for repurchase agreements as secured borrowings. Under its repurchase agreements, the Company pledges its securities as collateral to secure the borrowing, which is equal in value to a specified percentage of the fair value of the pledged collateral, while the Company retains beneficial ownership of the pledged collateral.  At the maturity of a repurchase financing, unless the repurchase financing is renewed with the same counterparty, the Company is required to repay the loan including any accrued interest and concurrently receives back its pledged collateral from the lender.  With the consent of the lender, the Company may renew a repurchase financing at the then prevailing financing terms.  Margin calls, whereby a lender requires that the Company pledge additional securities or cash as collateral to secure borrowings under its repurchase financing with such lender, are routinely experienced by the Company when the value of the MBS pledged as collateral declines as a result of principal amortization and prepayments or due to changes in market interest rates, spreads or other market conditions.  The Company also may make margin calls on counterparties when collateral values increase.
 
The Company’s repurchase financings typically have terms ranging from one month to six months at inception, but may also have longer or shorter terms.  Should a counterparty decide not to renew a repurchase financing at maturity, the Company must either refinance elsewhere or be in a position to satisfy the obligation.  If, during the term of a repurchase financing, a lender should default on its obligation, the Company might experience difficulty recovering its pledged assets which could result in an unsecured claim against the lender for the difference between the amount loaned to the Company plus interest due to the counterparty and the fair value of the collateral pledged by the Company to such lender, including accrued interest receivable or such collateral.  (See Notes 9, 10 and 18)
 
In addition to the repurchase agreement financing arrangements discussed above, as part of its financing strategy for Non-Agency MBS, the Company has entered into contemporaneous repurchase and reverse repurchase agreements with a single counterparty.  Under a typical reverse repurchase agreement, the Company buys securities from a borrower for cash and agrees to sell the same securities in the future for a price that is higher than the original purchase price.  The difference between the purchase price the Company originally paid and the sale price represents interest received from the borrower.  In contrast, the contemporaneous repurchase and reverse repurchase transactions effectively resulted in the Company pledging Non-Agency MBS as collateral to the counterparty in connection with the repurchase agreement financing and obtaining U.S. Treasury securities as

11

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


collateral from the same counterparty in connection with the reverse repurchase agreement.  No net cash was exchanged between the Company and counterparty at the inception of the transactions.  Securities obtained and pledged as collateral are recorded as an asset on the Company’s consolidated balance sheets.  Interest income is recorded on the reverse repurchase agreement and interest expense is recorded on the repurchase agreement on an accrual basis.  Both the Company and the counterparty have the right to make daily margin calls based on changes in the value of the collateral obtained and/or pledged.  The Company’s liability to the counterparty in connection with this financing arrangement is recorded on the Company’s consolidated balance sheets and disclosed as “Obligation to return securities obtained as collateral, at fair value.”  (See Note 2(c))

Federal Home Loan Bank (“FHLB”) Advances

FHLB advances are secured financing transactions and are carried at their contractual amounts. The ability to borrow from the FHLB is subject to the Company’s continued creditworthiness, pledging of sufficient eligible collateral to secure advances, and compliance with certain agreements with the FHLB. The amount of collateral pledged to the FHLB to secure advances is subject to periodic adjustment based on changes in the fair value of the collateral. Accrued interest payable on FHLB advances is included in Other liabilities on the Company’s consolidated balance sheets. (See Notes 9, 10 and 18)

In addition, as a condition to membership in the FHLB, the Company’s wholly-owned subsidiary, MFA Insurance, Inc. (“MFA Insurance”) is required to purchase and hold a certain amount of FHLB stock, which is based, in part, upon the outstanding principal balance of advances from the FHLB. FHLB stock is considered a non-marketable investment, is carried at cost and is subject to recoverability testing under applicable accounting standards. This stock can only be redeemed or sold at its par value, and only to the FHLB. Accordingly, when evaluating FHLB stock for impairment, the Company considers the ultimate recoverability of the par value rather than recognizing temporary declines in value. FHLB stock is included in Other assets on the Company’s consolidated balance sheets.
 
(lEquity-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.  With respect to awards granted in 2009 and prior years, the Company applied a zero forfeiture rate for these awards, as they were granted to a limited number of employees, and historical forfeitures have been minimal.  Forfeitures, or an indication that forfeitures are expected to occur, may result in a revised forfeiture rate and would be accounted for prospectively as a change in estimate.
 
During 2010, the Company granted certain restricted stock units (“RSUs”) that vested after either two or four years of service and provided that certain criteria were met, which were based on a formula that included changes in the Company’s closing stock price over a two- or four-year period and dividends declared on the Company’s common stock during those periods.  From 2011 through 2013, the Company granted certain RSUs that vested annually over a one or three-year period, provided that certain criteria were met, which were based on a formula tied to the Company’s achievement of average total stockholder return during that three-year period.  During 2014, 2015 and the first quarter of 2016, the Company made grants of RSUs certain of which cliff vest after a three-year period and certain of which cliff vest after a three-year period, subject to the achievement of certain performance criteria based on a formula tied to the Company’s achievement of average total stockholder return during that three-year period. The features in these awards related to the attainment of total stockholder return over a specified period constitute a “market condition” which impacts the amount of compensation expense recognized for these awards.  Specifically, the uncertainty regarding the achievement of the market condition was reflected in the grant date fair valuation of the RSUs, which in addition to estimates regarding the amount of RSUs expected to be forfeited during the associated service period, determined the amount of compensation expense recognized.  The amount of compensation expense recognized was not dependent on whether the market condition was or will be achieved, while differences in actual forfeiture experience relative to estimated forfeitures results in adjustments to the timing and amount of compensation expense recognized.
 
The Company has awarded dividend equivalents that may be granted as a separate instrument or may be a right associated with the grant of another equity-based award.  Compensation expense for separately awarded dividend equivalents is based on the grant date fair value of such awards and is recognized over the vesting period.  Payments pursuant to these dividend equivalents are charged to Stockholders’ Equity.  Payments pursuant to dividend equivalents that are attached to equity based awards are charged to Stockholders’ Equity to the extent that the attached equity awards are expected to vest.  Compensation expense is recognized for payments made for dividend equivalents to the extent that the attached equity awards do not or are not expected to vest and grantees are not required to return payments of dividends or dividend equivalents to the Company.  (See Notes 2(m) and 17)

12

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


 
(mEarnings 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 other securities that participate in dividends, such as the Company’s unvested restricted stock and RSUs that have non-forfeitable rights to dividends and dividend equivalents attached to/associated with RSUs and vested stock options to arrive at total common equivalent shares.  In applying the two-class method, earnings are allocated to both shares of common stock and securities that participate in dividends based on their respective weighted-average shares outstanding for the period.  For the diluted EPS calculation, common equivalent shares are further adjusted for the effect of dilutive unexercised stock options and RSUs outstanding that are unvested and have dividends that are subject to forfeiture using the treasury stock method.  Under the treasury stock method, common equivalent shares are calculated assuming that all dilutive common stock equivalents are exercised and the proceeds, along with future compensation expenses associated with such instruments, are used to repurchase shares of the Company’s outstanding common stock at the average market price during the reported period.  (See Note 16)
 
(nComprehensive 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 de-designated derivative hedging instruments and is reduced by dividends declared on the Company’s preferred stock and issuance costs of redeemed preferred stock.
 
(oU.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. In order to maintain its status as a REIT, the Company must, among other things, distribute at least 90% of its REIT taxable income (excluding net long-term capital gains) to stockholders in the timeframe permitted by the Code.  As long as the Company maintains its status as a REIT, the Company will not be subject to regular federal income tax to the extent that it distributes 100% of its REIT taxable income (including net long-term capital gains) to its stockholders within the permitted timeframe.  Should this not occur, the Company would be subject to federal taxes at prevailing corporate tax rates on the difference between its REIT taxable income and the amounts deemed to be distributed for that tax year.  As the Company’s objective is to distribute 100% of its REIT taxable income to its stockholders within the permitted timeframe, no provision for current or deferred income taxes has been made in the accompanying consolidated financial statements.  Should the Company incur a liability for corporate income tax, such amounts would be recorded as REIT income tax expense on the Company’s consolidated statements of operations. Furthermore, if the Company fails to distribute during each calendar year, or by the end of January following the calendar year in the case of distributions with declaration and record dates falling in the last three months of the calendar year, at least the sum of (i) 85% its REIT ordinary income for such year, (ii) 95% of its REIT capital gain income for such year, and (iii) any undistributed taxable income from prior periods, the Company would be subject to a 4% nondeductible excise tax on the excess of the required distribution over the amounts actually distributed. To the extent that the Company incurs interest, penalties or related excise taxes in connection with its tax obligations, including as a result of its assessment of uncertain tax positions, such amounts will be included in Operating and Other Expense on the Company’s consolidated statements of operations.

In addition, the Company has elected to treat certain of its subsidiaries as a TRS. In general, a TRS may hold assets and engage in activities that the Company cannot hold or engage in directly and generally may engage in any real estate or non-real estate-related business. Generally, a TRS is subject to U.S. federal, state and local corporate income taxes. Since a portion of the Company’s business may be conducted through one or more TRS, its income earned by TRS may be subject to corporate income taxation. To maintain the Company’s REIT election, no more than 25% (or, for 2018 and subsequent taxable years, 20%) of the value of a REIT’s assets at the end of each calendar quarter may consist of stock or securities in TRS. For purposes of the determination of U. S. federal and state income taxes, the Company’s subsidiaries that elected to be treated as a TRS record current or deferred income taxes based on differences (both permanent and timing) between the determination of their taxable income and net income under GAAP. No deferred tax benefit was recorded by the Company for the three months ended March 31, 2016 and 2015, as a valuation allowance for the full amount of the associated deferred tax asset was recognized as its recovery is not considered more likely than not.

13

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016



 Based on its analysis of any potential uncertain tax positions, the Company concluded that it does not have any material uncertain tax positions that meet the relevant recognition or measurement criteria as of March 31, 2016, December 31, 2015, or March 31, 2015. The Company filed its 2014 tax return prior to September 15, 2015. The Company’s tax returns for tax years 2010 through 2014 are open to examination.

(pDerivative Financial Instruments
 
The Company may use a variety of derivative instruments to economically hedge a portion of its exposure to market risks, including interest rate risk and prepayment risk. The objective of the Company’s risk management strategy is to reduce fluctuations in net book value over a range of interest rate scenarios. In particular, the Company attempts to mitigate the risk of the cost of its variable rate liabilities increasing during a period of rising interest rates. The Company’s derivative instruments are currently comprised of Swaps, which are designated as cash flow hedges against the interest rate risk associated with its borrowings. Prior to 2015, the Company’s derivative financial instruments also included Linked Transactions, which were not designated as hedging instruments. New accounting guidance that was effective for the Company on January 1, 2015 prospectively eliminated the use of Linked Transaction accounting (See Note 6).

Swaps
 
The Company documents its risk-management policies, including objectives and strategies, as they relate to its hedging activities and the relationship between the hedging instrument and the hedged liability for all Swaps designated as hedging transactions.  The Company assesses, both at inception of a hedge and on a quarterly basis thereafter, whether or not the hedge is “highly effective.”
 
Swaps are carried on the Company’s consolidated balance sheets at fair value, as assets, if their fair value is positive, or as liabilities, if their fair value is negative.  Changes in the fair value of the Company’s Swaps designated in hedging transactions are recorded in OCI provided that the hedge remains effective.  Changes in fair value for any ineffective amount of a Swap are recognized in earnings.  The Company has not recognized any change in the value of its existing Swaps designated as hedges through earnings as a result of hedge ineffectiveness.

The Company discontinues hedge accounting on a prospective basis and recognizes changes in fair value through earnings when:  (i) it is determined that the derivative is no longer effective in offsetting cash flows of a hedged item (including forecasted transactions); (ii) it is no longer probable that the forecasted transaction will occur; or (iii) it is determined that designating the derivative as a hedge is no longer appropriate.

Although permitted under certain circumstances, the Company does not offset cash collateral receivables or payables against its net derivative positions.  (See Notes 6, 10 and 18)

Linked Transactions

Prior to 2015, it was presumed that the initial transfer of a financial asset (i.e., the purchase of an MBS by the Company) and contemporaneous repurchase financing of such security with the same counterparty were considered part of the same arrangement, or a “linked transaction,” unless certain criteria were met. The two components of a linked transaction (security purchase and repurchase financing) were not reported separately but were evaluated on a combined basis and reported as a forward (derivative) contract and were presented as “Linked Transactions” on the Company’s consolidated balance sheets.  Changes in the fair value of the assets and liabilities underlying Linked Transactions and associated interest income and expense were reported as “Unrealized net gains/(losses) and net interest income from Linked Transactions” on the Company’s consolidated statements of operations and were not included in OCI.  However, if certain criteria were met, the initial transfer (i.e., the purchase of a security by the Company) and repurchase financing were not treated as a Linked Transaction and would have been evaluated and reported separately as an MBS purchase and MBS repurchase financing.  When or if a transaction was no longer considered to be linked, the security and repurchase financing were reported on a gross basis.  In this case, the fair value of the MBS at the time the transactions were no longer considered linked became the cost basis of the MBS, and the income recognition yield for such MBS was calculated prospectively using this new cost basis.

New accounting guidance that was effective for the Company on January 1, 2015 prospectively eliminated the use of Linked Transaction accounting as described above. This resulted in changes subsequent to January 1, 2015 to the presentation of assets

14

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


and liabilities, and revenues and expenses of Non-Agency MBS and associated repurchase agreements that had been accounted for as Linked Transactions prior to that date. The changes include the presentation of Non-Agency MBS and associated repurchase agreements as separate assets and liabilities, rather than on a combined basis on the Company’s consolidated balance sheets. In addition, starting in 2015, interest income related to the securities and interest expense related to the associated repurchase agreements are separately presented and included in the determination of the Company’s net interest income on its consolidated statement of operations. Further, the previous treatment of Linked Transactions as forward (derivative) instruments recorded at fair value at the end of each period, with changes in fair value included in net income, was discontinued and effective January 1, 2015 MBS that were previously accounted for as components of Linked Transactions are accounted for on a consistent basis with other MBS held by the Company as AFS securities.  (See Note 6)

(qFair Value Measurements and the Fair Value Option for Financial Assets and Financial Liabilities
 
The Company’s presentation of fair value for its financial assets and liabilities is determined within a framework that stipulates that the fair value of a financial asset or liability is an exchange price in an orderly transaction between market participants to sell the asset or transfer the liability in the market in which the reporting entity would transact for the asset or liability, that is, the principal or most advantageous market for the asset or liability.  The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability.  This definition of fair value focuses on exit price and prioritizes the use of market-based inputs over entity-specific inputs when determining fair value.  In addition, the framework for measuring fair value establishes a three-level hierarchy for fair value measurements based upon the observability of inputs to the valuation of an asset or liability as of the measurement date. 

In addition to the financial instruments that it is required to report at fair value, the Company has elected the fair value option for certain of its residential whole loans and CRT securities at time of acquisition. Subsequent changes in the fair value of these loans and CRT securities are reported in Net gain on residential whole loans held at fair value and Other income, net respectively on the Company’s consolidated statements of operations.  A decision to elect the fair value option for an eligible financial instrument, which may be made on an instrument by instrument basis, is irrevocable. (See Notes 2(d), 4 and 18)

 (rVariable Interest Entities
 
An entity is referred to as a VIE if it meets at least one of the following criteria:  (i) the entity has equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support of other parties; or (ii) as a group, the holders of the equity investment at risk lack (a) the power to direct the activities of an entity that most significantly impact the entity’s economic performance; (b) the obligation to absorb the expected losses; or (c) the right to receive the expected residual returns; or (iii) have disproportional voting rights and the entity’s activities are conducted on behalf of the investor that has disproportionally 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 resecuritization transactions which result in the Company consolidating the VIEs that were created to facilitate the transactions and to which the underlying assets in connection with the resecuritizations were transferred.  In determining the accounting treatment to be applied to these resecuritization transactions, the Company concluded that the entities used to facilitate these transactions were VIEs and that they should be consolidated.  If the Company had determined that consolidation was not required, it would have then assessed whether the transfer of the underlying assets would qualify as a sale or should be accounted for as secured financings under GAAP.
 
Prior to the completion of its initial resecuritization transaction in October 2010, the Company had not transferred assets to VIEs or Qualifying Special Purpose Entities (“QSPEs”) and other than acquiring MBS issued by such entities, had no other involvement with VIEs or QSPEs.  (See Note 19)

The Company also includes in 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.

15

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016



(sOffering Costs Related to Issuance and Redemption of Preferred Stock

Offering costs related to issuance of preferred stock are recorded as a reduction in Additional paid-in capital, a component of Stockholders’ Equity, at the time such preferred stock is issued. On redemption of preferred stock, any excess of the fair value of the consideration transferred to the holders of the preferred stock over the carrying amount of the preferred stock in the Company’s consolidated balance sheets is included in the determination of Net Income Available to Common Stock and Participating Securities in the calculation of EPS.
 
(tNew Accounting Standards and Interpretations
 
Accounting Standards Adopted in 2016

Interest - Imputation of Interest - Simplifying the Presentation of Debt Issuance Costs

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03, Simplifying the Presentation of Debt Issuance Costs (or ASU 2015-03).  The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with the presentation of debt issued at a discount. The recognition and measurement guidance of debt issuance costs are not affected by the amendments in this ASU. ASU 2015-03 requires retrospective application and was effective for the Company for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. While the Company’s adoption of ASU 2015-03 beginning on January 1, 2016, did not have a material impact on the Company’s financial position, it did result in changes, subsequent to adoption, to the presentation of assets and liabilities prior to that date. On adoption of the new standard on January 1, 2016, the Company reclassified debt issuance costs of $3.3 million related to Senior Notes, $1.3 million related to repurchase agreements and $189,000 related to its Securitized debt from Other assets and present them as a reduction in the corresponding liability on its consolidated balance sheet.

Consolidation - Amendments to the Consolidation Analysis

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis (or ASU 2015-02).  The amendments in this ASU change the way reporting enterprises evaluate whether (a) they should consolidate limited partnerships and similar entities, (b) fees paid to a decision maker or service provider are variable interests in a VIE, and (c) variable interests in a VIE held by related parties of the reporting enterprise require the reporting enterprise to consolidate the VIE. It also eliminates the VIE consolidation model based on majority exposure to variability that applied to certain investment companies and similar entities. At the effective date, all previous consolidation analyses that the guidance affects must be reconsidered. ASU 2015-02 was effective for the Company for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015.  The Company’s adoption of ASU 2015-02 on January 1, 2016 did not have an impact on the Company’s consolidated financial statements.


16

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


3.                   MBS and CRT Securities
 
Agency and Non-Agency MBS

The Company’s MBS are comprised of Agency MBS and Non-Agency MBS which include MBS issued prior to 2008 (“Legacy Non-Agency MBS”). These MBS are secured by:  (i) hybrid mortgages (“Hybrids”), which have interest rates that are fixed for a specified period of time and, thereafter, generally adjust annually to an increment over a specified interest rate index; (ii) adjustable-rate mortgages (“ARMs”); (iii) mortgages that have interest rates that reset more frequently (collectively, “ARM-MBS”); and (iv) 15 year and longer-term fixed rate mortgages. In addition, the Company’s MBS are also comprised of MBS secured by re-performing/non-performing loans (“RPL/NPL MBS”), where the cash flows of the bond may not reflect the contractual cash flows of the underlying collateral. The Company’s RPL/NPL MBS are structured with a contractual coupon step-up feature where the coupon steps-up 300 basis points at 36 months from issuance or sooner. The Company pledges a significant portion of its MBS as collateral against its borrowings under repurchase agreements, FHLB advances and Swaps.  (See Note 10)
 
Agency MBS:  Agency MBS are guaranteed as to principal and/or interest by a federally chartered corporation, such as Fannie Mae or Freddie Mac, or an agency of the U.S. Government, such as Ginnie Mae.  The payment of principal and/or interest on Ginnie Mae MBS is explicitly backed by the full faith and credit of the U.S. Government.  Since the third quarter of 2008, Fannie Mae and Freddie Mac have been under the conservatorship of the Federal Housing Finance Agency, which significantly strengthened the backing for these government-sponsored entities.
 
Non-Agency MBS (including Non-Agency MBS transferred to consolidated VIEs):  The Company’s Non-Agency MBS are secured by pools of residential mortgages which are not guaranteed by an agency of the U.S. Government or any federally chartered corporation.  Credit risk associated with Non-Agency MBS is regularly assessed as new information regarding the underlying collateral becomes available and based on updated estimates of cash flows generated by the underlying collateral.
 
CRT Securities

CRT securities are debt obligations issued by Fannie Mae and Freddie Mac. While the coupon payments are paid by Fannie Mae or Freddie Mac on a monthly basis, the payment of principal is dependent on the performance of loans in a reference pool of MBS securitized by Fannie Mae or Freddie Mac. As principal on loans in the reference pool are paid, principal payments on the securities are made and the principal balances of the securities are reduced. Consequently, CRT securities mirror the payment and prepayment behavior of the mortgage loans in the reference pool. As an investor in a CRT security, the Company may incur a loss if certain defined credit events occur, including if the loans in the reference pool experience delinquencies exceeding specified thresholds. The Company assesses the credit risk associated with CRT securities by assessing the current and expected future performance of the associated reference pool. The Company pledges a significant portion of its CRT securities as collateral against its borrowings under repurchase agreements.  (See Note 10)



17

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


The following tables present certain information about the Company’s MBS and CRT securities at March 31, 2016 and December 31, 2015:
 
March 31, 2016
(In Thousands)
 
Principal/ Current
Face
 
Purchase
Premiums
 
Accretable
Purchase
Discounts
 
Discount
Designated
as Credit Reserve and 
OTTI (1)
 
Amortized
Cost (2)
 
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Net
Unrealized
Gain/(Loss)
Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
3,512,731

 
$
132,452

 
$
(57
)
 
$

 
$
3,645,126

 
$
3,684,575

 
$
54,304

 
$
(14,855
)
 
$
39,449

Freddie Mac
 
816,393

 
31,343

 

 

 
848,854

 
851,230

 
7,358

 
(4,982
)
 
2,376

Ginnie Mae
 
8,740

 
155

 

 

 
8,895

 
9,078

 
183

 

 
183

Total Agency MBS
 
4,337,864

 
163,950

 
(57
)
 

 
4,502,875

 
4,544,883

 
61,845

 
(19,837
)
 
42,008

Non-Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Expected to Recover Par (3)(4)
 
2,774,846

 
66

 
(28,004
)
 

 
2,746,908

 
2,747,272

 
19,377

 
(19,013
)
 
364

Expected to Recover Less than Par (3)
 
3,876,544

 

 
(253,327
)
 
(757,564
)
 
2,865,653

 
3,353,485

 
499,855

 
(12,023
)
 
487,832

Total Non-Agency MBS (5)
 
6,651,390

 
66

 
(281,331
)
 
(757,564
)
 
5,612,561

 
6,100,757

 
519,232

 
(31,036
)
 
488,196

Total MBS
 
10,989,254

 
164,016

 
(281,388
)
 
(757,564
)
 
10,115,436

 
10,645,640

 
581,077

 
(50,873
)
 
530,204

CRT securities (6)
 
222,085

 

 
(6,466
)
 

 
215,619

 
215,803

 
1,668

 
(1,484
)
 
184

Total MBS and CRT securities
 
$
11,211,339

 
$
164,016

 
$
(287,854
)
 
$
(757,564
)
 
$
10,331,055

 
$
10,861,443

 
$
582,745

 
$
(52,357
)
 
$
530,388


December 31, 2015
(In Thousands)
 
Principal/ Current
Face
 
Purchase
Premiums
 
Accretable
Purchase
Discounts
 
Discount
Designated
as Credit Reserve and 
OTTI (1)
 
Amortized
Cost (2)
 
Fair Value
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Net
Unrealized
Gain/(Loss)
Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
3,690,020

 
$
139,243

 
$
(59
)
 
$

 
$
3,829,204

 
$
3,865,485

 
$
62,111

 
$
(25,830
)
 
$
36,281

Freddie Mac
 
851,087

 
32,680

 

 

 
884,798

 
877,109

 
6,906

 
(14,595
)
 
(7,689
)
Ginnie Mae
 
9,296

 
164

 

 

 
9,460

 
9,650

 
190

 

 
190

Total Agency MBS
 
4,550,403

 
172,087

 
(59
)
 

 
4,723,462

 
4,752,244

 
69,207

 
(40,425
)
 
28,782

Non-Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Expected to Recover Par (3)(4)
 
2,906,878

 
73

 
(31,576
)
 

 
2,875,375

 
2,878,532

 
23,300

 
(20,143
)
 
3,157

Expected to Recover Less than Par (3)
 
4,054,615

 

 
(280,606
)
 
(787,541
)
 
2,986,468

 
3,542,285

 
564,031

 
(8,214
)
 
555,817

Total Non-Agency MBS (5)
 
6,961,493

 
73

 
(312,182
)
 
(787,541
)
 
5,861,843

 
6,420,817

 
587,331

 
(28,357
)
 
558,974

Total MBS
 
11,511,896

 
172,160

 
(312,241
)
 
(787,541
)
 
10,585,305

 
11,173,061

 
656,538

 
(68,782
)
 
587,756

CRT securities (6)
 
192,000

 

 
(5,689
)
 

 
186,311

 
183,582

 
418

 
(3,147
)
 
(2,729
)
Total MBS and CRT securities
 
$
11,703,896

 
$
172,160

 
$
(317,930
)
 
$
(787,541
)
 
$
10,771,616

 
$
11,356,643

 
$
656,956

 
$
(71,929
)
 
$
585,027

 
(1)
Discount designated as Credit Reserve and amounts related to OTTI are generally not expected to be accreted into interest income.  Amounts disclosed at March 31, 2016 reflect Credit Reserve of $736.4 million and OTTI of $21.2 million.  Amounts disclosed at December 31, 2015 reflect Credit Reserve of $766.0 million and OTTI of $21.5 million.
(2)
Includes principal payments receivable of $1.1 million and $1.0 million at March 31, 2016 and December 31, 2015, respectively, which are not included in the Principal/Current Face.
(3)
Based on managements current estimates of future principal cash flows expected to be received.
(4)
At March 31, 2016 RPL/NPL MBS had a $2.515 billion Principal/Current face, $2.514 billion amortized cost and $2.496 billion fair value. At December 31, 2015, RPL/NPL MBS had a $2.648 billion Principal/Current face, $2.645 billion amortized cost and $2.626 billion fair value.
(5)
At March 31, 2016 and December 31, 2015, the Company expected to recover approximately 89% and 89%, respectively, of the then-current face amount of Non-Agency MBS.
(6)
Amounts disclosed at March 31, 2016 includes CRT securities with a fair value of $92.9 million for which the fair value option has been elected. Such securities have gross unrealized gains of approximately $1.4 million, gross unrealized losses of approximately $132,000 and net unrealized gains of approximately $1.2 million at March 31, 2016. Amounts disclosed at December 31, 2015 includes CRT securities with a fair value of $62.2 million for which the fair value option has been elected. Such securities have gross unrealized gains of approximately $332,000, gross unrealized losses of approximately $555,000 and net unrealized losses of approximately $223,000 at December 31, 2015.
 


18

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016



Unrealized Losses on MBS and CRT Securities

The following table presents information about the Company’s MBS and CRT securities that were in an unrealized loss position at March 31, 2016:
 
Unrealized Loss Position For:
 
 
Less than 12 Months
 
12 Months or more
 
Total
 
Fair Value
 
Unrealized Losses
 
Number of Securities
Fair Value
 
Unrealized Losses
 
Number of Securities
Fair Value
 
Unrealized Losses
(Dollars in Thousands)
Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Fannie Mae
 
$
566,376

 
$
4,507

 
95

 
$
976,991

 
$
10,348

 
129

 
$
1,543,367

 
$
14,855

Freddie Mac
 
4,523

 
1

 
1

 
517,333

 
4,981

 
92

 
521,856

 
4,982

Total Agency MBS
 
570,899

 
4,508

 
96

 
1,494,324

 
15,329

 
221

 
2,065,223

 
19,837

Non-Agency MBS:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Expected to Recover Par (1)
 
1,841,079

 
15,689

 
55

 
181,507

 
3,324

 
10

 
2,022,586

 
19,013

Expected to Recover Less than Par (1)
 
276,920

 
7,233

 
43

 
67,129

 
4,790

 
15

 
344,049

 
12,023

Total Non-Agency MBS
 
2,117,999

 
22,922

 
98

 
248,636

 
8,114

 
25

 
2,366,635

 
31,036

Total MBS
 
2,688,898

 
27,430

 
194

 
1,742,960

 
23,443

 
246

 
4,431,858

 
50,873

CRT securities (2)
 
95,402

 
1,071

 
23

 
4,588

 
413

 
1

 
99,990

 
1,484

Total MBS and CRT securities
 
$
2,784,300

 
$
28,501

 
217

 
$
1,747,548

 
$
23,856

 
247

 
$
4,531,848

 
$
52,357


(1)
Based on management’s current estimates of future principal cash flows expected to be received.  
(2)
Amounts disclosed at March 31, 2016 includes CRT securities with a fair value of $24.7 million for which the fair value option has been elected. Such securities have unrealized losses of $132,000 at March 31, 2016.

At March 31, 2016, the Company did not intend to sell any of its investments that were in an unrealized loss position, and it is “more likely than not” that the Company will not be required to sell these securities before recovery of their amortized cost basis, which may be at their maturity.  With respect to Non-Agency MBS held by consolidated VIEs, the ability of any entity to cause the sale to a third-party by the VIE prior to the maturity of these Non-Agency MBS is either specifically precluded or is limited to specified events of default, none of which has occurred to date.
 
Gross unrealized losses on the Company’s Agency MBS were $19.8 million at March 31, 2016.  Agency MBS are issued by Government Sponsored Entities (“GSEs”) and enjoy either the implicit or explicit backing of the full faith and credit of the U.S. Government. While the Company’s Agency MBS are not rated by any rating agency, they are currently perceived by market participants to be of high credit quality, with risk of default limited to the unlikely event that the U.S. Government would not continue to support the GSEs. Given the credit quality inherent in Agency MBS, the Company does not consider any of the current impairments on its Agency MBS to be credit related. In assessing whether it is more likely than not that it will be required to sell any impaired security before its anticipated recovery, which may be at its maturity, the Company considers for each impaired security, the significance of each investment, the amount of impairment, the projected future performance of such impaired securities, as well as the Company’s current and anticipated leverage capacity and liquidity position. Based on these analyses, the Company determined that at March 31, 2016 any unrealized losses on its Agency MBS were temporary.

Unrealized losses on the Company’s Non-Agency MBS (including Non-Agency MBS transferred to consolidated VIEs) were $31.0 million at March 31, 2016, of which $17.8 million were RPL/NPL MBS and $13.2 million were Legacy Non-Agency MBS at March 31, 2016. Based upon the most recent evaluation, the Company does not consider these unrealized losses to be indicative of OTTI and does not believe that these unrealized losses are credit related, but are rather a reflection of current market yields and/or market place bid-ask spreads.  The Company has reviewed its Non-Agency MBS that are in an unrealized loss position to identify those securities with losses that are other-than-temporary based on an assessment of changes in expected cash flows for such securities, which considers recent bond performance and, where possible, expected future performance of the underlying collateral.
  

19

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


The Company did not recognize any credit-related OTTI losses through earnings related to its MBS during the three months ended March 31, 2016. The Company recognized credit-related OTTI losses through earnings related to its Non-Agency MBS of $407,000 during the three months ended March 31, 2015.

Non-Agency MBS on which OTTI is recognized have experienced, or are expected to experience, credit-related adverse cash flow changes.  The Company’s estimate of cash flows for these Non-Agency MBS is based on its review of the underlying mortgage loans securing these MBS.  The Company considers information available about the structure of the securitization, including structural credit enhancement, if any, and the past and expected future performance of underlying mortgage loans, including timing of expected future cash flows, prepayment rates, default rates, loss severities, delinquency rates, percentage of non-performing loans, FICO scores at loan origination, year of origination, LTVs, geographic concentrations, as well as Rating Agency reports, general market assessments, and dialogue with market participants.  Changes in the Company’s evaluation of each of these factors impacts the cash flows expected to be collected at the OTTI assessment date. For Non-Agency MBS purchased at a discount to par that were assessed for and had no OTTI recorded this period, such cash flow estimates indicated that the amount of expected losses decreased compared to the previous OTTI assessment date. These positive cash flow changes are primarily driven by recent improvements in LTVs due to loan amortization and home price appreciation, which, in turn, positively impacts the Company’s estimates of default rates and loss severities for the underlying collateral. In addition, voluntary prepayments (i.e., loans that prepay in full with no loss) have generally trended higher for these MBS which also positively impacts the Company’s estimate of expected loss. Overall, the combination of higher voluntary prepayments and lower LTVs supports the Company’s assessment that such MBS are not other-than-temporarily impaired.

The following table presents the composition of OTTI charges recorded by the Company for the three months ended March 31, 2016 and 2015:
 
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2016
 
2015
Total OTTI losses
 
$

 
$
(395
)
OTTI reclassified from OCI
 

 
(12
)
OTTI recognized in earnings
 
$

 
$
(407
)

The following table presents a roll-forward of the credit loss component of OTTI on the Company’s Non-Agency MBS for which a non-credit component of OTTI was previously recognized in OCI.  Changes in the credit loss component of OTTI are presented based upon whether the current period is the first time OTTI was recorded on a security or a subsequent OTTI charge was recorded.
 
 
 
Three Months Ended 
 March 31,
(In Thousands)
 
2016
 
2015
Credit loss component of OTTI at beginning of period
 
$
36,820

 
$
36,115

Additions for credit related OTTI not previously recognized
 

 
395

Subsequent additional credit related OTTI recorded
 

 
12

Credit loss component of OTTI at end of period
 
$
36,820

 
$
36,522



20

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


Purchase Discounts on Non-Agency MBS
 
The following tables present the changes in the components of the Company’s purchase discount on its Non-Agency MBS between purchase discount designated as Credit Reserve and OTTI and accretable purchase discount for the three months ended March 31, 2016 and 2015:

 
 
Three Months Ended 
 March 31, 2016
 
Three Months Ended 
 March 31, 2015
(In Thousands)
 
Discount
Designated as
Credit Reserve and OTTI
 
Accretable
Discount (1) 
Discount
Designated as
Credit Reserve and OTTI
 
 Accretable Discount (1)
Balance at beginning of period
 
$
(787,541
)
 
$
(312,182
)
 
$
(900,557
)
 
$
(399,564
)
Cumulative effect adjustment on adoption of revised accounting standard for repurchase agreement financing
 

 

 
(15,543
)
 
1,832

Accretion of discount
 

 
21,406

 

 
24,800

Realized credit losses
 
18,050

 

 
19,624

 

Purchases
 
(4,294
)
 
1,606

 
(34
)
 
(3,410
)
Sales
 
12,020

 
12,040

 
1,049

 
9,969

Net impairment losses recognized in earnings
 

 

 
(407
)
 

Transfers/release of credit reserve
 
4,201

 
(4,201
)
 
22,335

 
(22,335
)
Balance at end of period
 
$
(757,564
)
 
$
(281,331
)
 
$
(873,533
)
 
$
(388,708
)

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

Impact of AFS Securities on AOCI
 
The following table presents the impact of the Company’s AFS securities on its AOCI for the three months ended March 31, 2016 and 2015:
 
 
Three Months Ended March 31,
(In Thousands)
2016
 
2015
AOCI from AFS securities:
 
 

 
 

Unrealized gain on AFS securities at beginning of period
 
$
585,250

 
$
813,515

Unrealized gain on Agency MBS, net
 
13,226

 
12,885

Unrealized (loss)/gain on Non-Agency MBS, net
 
(58,840
)
 
26,150

Cumulative effect adjustment on adoption of revised accounting standard for repurchase agreement financing
 

 
4,537

Reclassification adjustment for MBS sales included in net income
 
(10,485
)
 
(6,423
)
Reclassification adjustment for OTTI included in net income
 

 
(407
)
Change in AOCI from AFS securities
 
(56,099
)
 
36,742

Balance at end of period
 
$
529,151

 
$
850,257

 
Sales of MBS
 
During the three months ended March 31, 2016, the Company sold certain Non-Agency MBS for $32.0 million realizing gross gains of $9.7 million.  During the three months ended March 31, 2015, the Company sold certain Non-Agency MBS for $10.8 million, realizing gross gains of $6.4 million. The Company has no continuing involvement with any of the sold MBS.


21

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


 Interest Income on MBS and CRT Securities
 
The following table presents the components of interest income on the Company’s MBS and CRT securities for the three months ended March 31, 2016 and 2015
 
 
Three Months Ended March 31,
(In Thousands)
 
2016
 
2015
Agency MBS
 
 
 
 
Coupon interest
 
$
32,132

 
$
40,743

Effective yield adjustment (1)
 
(8,135
)
 
(9,070
)
Interest income
 
$
23,997

 
$
31,673

 
 
 
 
 
Legacy Non-Agency MBS
 
 
 
 
Coupon interest
 
$
40,309

 
$
49,356

Effective yield adjustment (2)
 
19,913

 
24,406

Interest income
 
$
60,222

 
$
73,762

 
 
 
 
 
RPL/NPL MBS
 
 
 
 
Coupon interest
 
$
24,370

 
$
19,185

Effective yield adjustment (2)
 
1,560

 
344

Interest income
 
$
25,930

 
$
19,529

 
 
 
 
 
CRT securities
 
 
 
 
Coupon interest
 
$
2,356

 
$
1,202

Effective yield adjustment (2)
 
336

 
158

Interest income
 
$
2,692

 
$
1,360

 
(1)  Includes amortization of premium paid net of accretion of purchase discount.  For Agency MBS, interest income is recorded at an effective yield, which reflects net premium amortization based on actual prepayment activity.
(2)  The effective yield adjustment is the difference between the net income calculated using the net yield, which is based on management’s estimates of the amount and timing of future cash flows, less the current coupon yield.

4.    Residential Whole Loans

Included on the Company’s consolidated balance sheets at March 31, 2016 and December 31, 2015, are approximately $1.024 billion and $895.1 million, respectively, of residential whole loans arising from the Company’s 100% equity interest in certificates issued by certain trusts established to acquire the loans. Based on its evaluation of these interests and other factors, the Company has determined that the trusts are required to be consolidated for financial reporting purposes.

Residential Whole Loans at Carrying Value

Residential whole loans at carrying value totaled approximately $376.2 million and $271.8 million at March 31, 2016 and December 31, 2015, respectively. The carrying value reflects the original investment amount, plus accretion of interest income, less principal and interest cash flows received. The carrying value is reduced by any allowance for loan losses established subsequent to acquisition.

The Company recorded an allowance for loan losses of approximately $1.1 million on its residential whole loan pools held at carrying value as of March 31, 2016. For the three months ended March 31, 2016 and March 31, 2015, a net (reversal of)/provision for loan losses of approximately $(37,000) and $327,000 was recorded, respectively, which is included in Operating and Other expense on the Company’s consolidated statements of operations.


22

MFA FINANCIAL, INC.
NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2016


The following table presents the activity in the Company’s allowance for loan losses on its residential whole loan pools at carrying value for the three months ended March 31, 2016 and 2015:

 (In Thousands)
 
Three Months Ended
 
 
March 31, 2016
 
March 31, 2015
Balance at the beginning of period
 
$
1,165

 
$
137

(Reversal of)/Provisions for loan losses
 
(37
)
 
327

Balance at the end of period
 
$
1,128

 
$
464


The following table presents information regarding estimates of the contractually required payments, the cash flows expected to be collected, and the estimated fair value of the residential whole loans held at carrying value acquired by the Company for the three months ended March 31, 2016 and 2015:

 (In Thousands)
 
Three Months Ended
 
 
March 31, 2016
 
March 31, 2015
Contractually required principal and interest
 
$
199,092

 
$
78,799

Contractual cash flows not expected to be collected (non-accretable yield)
 
(28,663
)
 
(13,357
)
Expected cash flows to be collected
 
170,429

 
65,442

Interest component of expected cash flows (accretable yield)
 
(58,509
)
 
(26,840
)
Fair value at the date of acquisition
 
$
111,920

 
$
38,602


The following table presents accretable yield activity for the Company’s residential whole loans held at carrying value for the three months ended March 31, 2016 and 2015:

 (In Thousands)
 
Three Months Ended
 
 
March 31, 2016
 
March 31, 2015
Balance at beginning of period
 
$
175,271

 
$
133,012

  Additions
 
58,509