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No. of Recommendations: 6
MFA Financial (NYSE: MFA) was the twenty-sixth stock mentioned in this post: http://boards.fool.com/probably-time-to-resume-reviews-32756... , which makes it next up for reviews.

A mortgage REIT, MFA Financial is one of the riskiest companies in our household's portfolio. It makes its money on the interest rate spread between what it can borrow at and what it can clear from owning mortgage debts. Particularly with the recent flat interest rate curves, that has been a risky business, and MFA Financial is a case where we got lucky rather than were particularly smart with the initial investment. Rising interest rates are also risky as the company may find its borrowing costs increasing as the value of its existing assets declines.

Dividends: As a REIT, MFA Financial must pay at least 90% of its earnings as dividends. Its current payout ratio is just over 100% of earnings. Its dividend currently sits at $0.20 per share per quarter, a level it has maintained for several years but is off its high. Given its business, a fluctuating dividend shouldn't be all that surprising, but its high yield is a reflection of the high risk of the dividend and of the risks that a rough interest rate environment can have on the future survivability of the business.

Balance Sheet: MFA Financial's balance sheet is still a bit more leveraged than I like, but it seems to have reduced its debt to equity ratio to just above 2.1 since the last time I reviewed it ( http://boards.fool.com/total-portfolio-review-part-xxx-mfa-3... ), which is a good thing in today's interest rate environment. Its current ratio is down to 0.4, however, which is likely an artifact of the changes in interest rates. I'm not thrilled with its balance sheet, but I'm willing to hold on, even though I wouldn't feel comfortable adding to our position.

Valuation: MFA Financial currently trades at about 0.9 times its book value, which seems fair given the high risk nature of its business and the leverage on its balance sheet. I don't expect it to ever really trade much above 1 times its book value, as it doesn't retain much in the way of earnings and a high stock price turns into an invitation to issue more shares as an alternative or an adjunct to borrowing to raise capital.

Next Steps: Mortgage REITs are a risky enough business model that I wouldn't ever commit a huge portion of my portfolio to it, but if the company survives the transition to higher rates, things should get better for it. That's still not a good reason to increase our stake in MFA Financial, but it could ease the pressure to sell. As a result, we expect to hold onto the shares of MFA Financial we own, but we'd be willing to sell, particularly if those shares got too far above book value or if the mortgage market, mortgage default rate, or yield curve got uncomfortably painful.

Regards,
-Chuck

Inside Value Home Fool
Disclosure: My wife owns shares of MFA Financial.
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