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MFA FINANCIAL, INC. 10-Q 2009

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Unassociated Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
______________
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2009
 
OR
 
¨ 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ______________ to ______________
 
 
Commission File Number: 1-13991
 
MFA FINANCIAL, INC.
 (Exact name of registrant as specified in its charter)
 
______________
 
Maryland
(State or other jurisdiction of
incorporation or organization)
 
350 Park Avenue, 21st Floor, New York, New York
(Address of principal executive offices)
13-3974868
(I.R.S. Employer
Identification No.)
 
10022
(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     ü  No       
 
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 ___ No ___
 
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 [ü]
 
Accelerated filer [  ]
 
       
Non-accelerated filer [  ]
 
Smaller reporting company [  ]
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes        No   ü  
 
222,708,825 shares of the registrant’s common stock, $0.01 par value, were outstanding as of April 28, 2009.
 

 
TABLE OF CONTENTS
 
     
Page
PART I
FINANCIAL INFORMATION
       
Item 1.
Financial Statements
   
   
 
1
       
   
 
2
       
   
 
3
       
   
 
4
       
   
 
5
       
 
6
       
Item 2.
 
   
29
       
Item 3.
38
       
Item 4.
 
43
       
       
PART II
OTHER INFORMATION
       
Item 1.
 
44
       
Item 1A.    
 
44
       
Item 6.
 
44
       
 
46
 

 
MFA FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
 
   
March 31,
2009
   
December 31,
2008
 
(In Thousands, Except Per Share Amounts)
 
(Unaudited)
       
Assets:
           
  Investment securities at fair value (including pledged mortgage-backed
    securities (“MBS”) of $9,708,499 and $10,026,638 at March 31, 2009
    and December 31, 2008, respectively)  (Notes 2(b), 3, 5, 7, 8 and 14)
  $ 9,944,519     $ 10,122,583  
  Cash and cash equivalents (Notes 2(c), 7 and 8)
    405,567       361,167  
  Restricted cash (Notes 2(d), 5 and 8)
    78,819       70,749  
  Interest receivable (Note 4)
    48,139       49,724  
  Real estate, net (Note 6)
    11,264       11,337  
  Securities held as collateral, at fair value (Notes 7, 8 and 14)
    19,763       17,124  
  Goodwill (Note 2(f))
    7,189       7,189  
  Prepaid and other assets
    2,458       1,546  
     Total Assets
  $ 10,517,718     $ 10,641,419  
                 
Liabilities:
               
  Repurchase agreements (Notes 7 and 8)
  $ 8,772,641     $ 9,038,836  
  Accrued interest payable
    16,122       23,867  
  Mortgage payable on real estate (Note 6)
    9,270       9,309  
  Interest rate swap agreements (“Swaps”), at fair value (Notes 2(m), 5,
   8 and 14)
    226,470       237,291  
  Obligations to return cash and security collateral, at fair value (Notes
   8 and 14)
    29,763       22,624  
  Dividends and dividend equivalents payable (Note 10(b))
    -       46,351  
  Accrued expenses and other liabilities
    3,883       6,064  
     Total Liabilities
  $ 9,058,149     $ 9,384,342  
                 
Commitments and contingencies (Note 9)
               
                 
Stockholders' Equity:
               
   Preferred stock, $.01 par value; series A 8.50% cumulative redeemable;
    5,000 shares authorized; 3,840 shares issued and outstanding at
    March 31, 2009 and December 31, 2008 ($96,000 aggregate
    liquidation preference) (Note 10)
  $ 38     $ 38  
  Common stock, $.01 par value; 370,000 shares authorized;
    222,378 and 219,516 issued and outstanding at March 31, 2009
    and December 31, 2008, respectively (Note 10)
    2,224       2,195  
  Additional paid-in capital, in excess of par
    1,792,751       1,775,933  
  Accumulated deficit
    (159,182 )     (210,815 )
  Accumulated other comprehensive loss (Note 12)
    (176,262 )     (310,274 )
     Total Stockholders’ Equity
  $ 1,459,569     $ 1,257,077  
     Total Liabilities and Stockholders’ Equity
  $ 10,517,718     $ 10,641,419  
 
The accompanying notes are an integral part of the consolidated financial statements.
1

 
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
For the Three Months Ended March 31,
 
(In Thousands, Except Per Share Amounts)
 
2009
   
2008
 
   
(Unaudited)
 
Interest Income:
           
Investment securities (Note 3)
  $ 132,153     $ 125,065  
Cash and cash equivalent investments
    611       3,031  
      Interest Income
    132,764       128,096  
                 
      Interest Expense (Notes 5 and 7)
    72,137       93,472  
                 
      Net Interest Income
    60,627       34,624  
                 
Other Income/(Loss):
               
Net loss on sale of MBS (Note 3)
    -       (24,530 )
Other-than-temporary impairment on investments securities (Note 3)
    (1,549 )     (851 )
Revenue from operations of real estate (Note 6)
    383       414  
Loss on termination of Swaps, net (Note 5)
    -       (91,481 )
Miscellaneous other income, net
    44       92  
      Other Losses
    (1,122 )     (116,356 )
                 
Operating and Other Expense:
               
Compensation and benefits (Note 13)
    3,502       2,644  
Real estate operating expense and mortgage interest (Note 6)
    462       449  
Other general and administrative expense
    1,868       1,118  
      Operating and Other Expense
    5,832       4,211  
                 
Net Income/(Loss) Before Preferred Stock Dividends
    53,673       (85,943 )
Less:  Preferred Stock Dividends
    2,040       2,040  
      Net Income/(Loss) to Common Stockholders
  $ 51,633     $ (87,983 )
                 
Income/(Loss) Per Share of Common Stock–Basic and Diluted  (Note 11)
  $ 0.23     $ (0.61 )
 
The accompanying notes are an integral part of the consolidated financial statements.
2

 
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
 
   
For the
Three Months
Ended
March 31, 2009
 
(In Thousands, Except Per Share Amounts)
 
(Unaudited)
 
       
Preferred Stock, Series A 8.50% Cumulative Redeemable – Liquidation
  Preference $25.00 per Share:
     
Balance at December 31, 2008 and March 31, 2009 (3,840 shares)
  $ 38  
         
Common Stock, Par Value $0.01:
       
Balance at December 31, 2008 (219,516 shares)
    2,195  
  Issuance of common stock  (2,862 shares)
    29  
Balance at March 31, 2009 (222,378 shares)
    2,224  
         
Additional Paid-in Capital, in excess of Par:
       
Balance at December 31, 2008
    1,775,933  
  Issuance of common stock, net of expenses
    16,344  
  Share-based compensation expense
    474  
Balance at March 31, 2009
    1,792,751  
         
Accumulated Deficit:
       
Balance at December 31, 2008
    (210,815 )
  Net income
    53,673  
  Dividends declared on preferred stock
    (2,040 )
Balance at March 31, 2009
    (159,182 )
         
Accumulated Other Comprehensive Loss:
       
Balance at December 31, 2008
    (310,274 )
  Unrealized gains on investment securities, net
    123,191  
  Unrealized gains on Swaps
    10,821  
Balance at March 31, 2009
    (176,262 )
         
Total Stockholders' Equity at March 31, 2009
  $ 1,459,569  
 
The accompanying notes are an integral part of the consolidated financial statements.
3


MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

   
Three Months Ended
 
   
March 31,
 
(In Thousands)
 
2009
   
2008
 
   
(Unaudited)
 
Cash Flows From Operating Activities:
           
Net income/(loss)
  $ 53,673     $ (85,943 )
Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
               
Losses on sale of MBS, gross
    -       25,101  
Gains on sales of MBS, gross
    -       (571 )
Losses on early termination of Swaps
    -       91,481  
Other-than-temporary impairment charges
    1,549       851  
Amortization of purchase premium on MBS, net of accretion of discounts
    4,228       5,267  
Decrease in interest receivable
    1,585       1,456  
Depreciation and amortization on real estate
    94       117  
(Increase)/ decrease in other assets and other
    (746 )     198  
(Decrease)/ increase in accrued expenses and other liabilities
    (2,181 )     8,369  
(Decrease)/ increase in accrued interest payable
    (7,745 )     3,646  
Equity-based compensation expense
    474       342  
Negative amortization and principal accretion on investment securities
    (12 )     (238 )
   Net cash provided by operating activities
  $ 50,919     $ 50,076  
                 
Cash Flows From Investing Activities:
               
Principal payments on MBS and other investments securities
  $ 357,525     $ 395,632  
Proceeds from sale of MBS
    -       1,851,019  
Purchases of MBS and other investment securities
    (62,034 )     (2,089,356 )
Net additions to leasehold improvements, furniture, fixtures and real estate investment
    (218 )     (740 )
   Net cash provided by investing activities
  $ 295,273     $ 156,555  
                 
Cash Flows From Financing Activities:
               
Principal payments on repurchase agreements
  $ (16,630,370 )   $ (15,762,869 )
Proceeds from borrowings under repurchase agreements
    16,364,175       15,548,622  
Payments made on termination of Swaps
    -       (91,481 )
Payments made for margin calls on repurchase agreements and Swaps
    (74,360 )     (123,373 )
Cash received for reverse margin calls on repurchase agreements and Swaps
    70,820       94,835  
Proceeds from issuances of common stock
    16,373       253,074  
Dividends paid on preferred stock
    (2,040 )     (2,040 )
Dividends paid on common stock and dividend equivalent rights (“DERs”)
    (46,351 )     (18,005 )
Principal payments on mortgage loan
    (39 )     (37 )
   Net cash used by financing activities
  $ (301,792 )   $ (101,274 )
Net increase in cash and cash equivalents
  $ 44,400     $ 105,357  
Cash and cash equivalents at beginning of period
  $ 361,167     $ 234,410  
Cash and cash equivalents at end of period
  $ 405,567     $ 339,767  
 
The accompanying notes are an integral part of the consolidated financial statements.
4

 
MFA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
 
   
Three Months Ended
March 31,
 
(In Thousands)
 
2009
   
2008
 
   
(Unaudited)
 
             
Net income/(loss) before preferred stock dividends
  $ 53,673     $ (85,943 )
Other Comprehensive Income/(Loss):
               
  Unrealized gain on investment securities arising during the
    period, net
    121,786       8,836  
  Reclassification adjustment for MBS sales
    -       (8,241 )
  Reclassification adjustment for net losses included in net income/(loss)
    for other-than-temporary impairments
    1,405       301  
  Unrealized gain/(loss) on Swaps arising during the period, net
    10,821       (90,013 )
  Reclassification adjustment for net losses included in net income/(loss)
    from Swaps
    -       48,162  
      Comprehensive income/(loss) before preferred stock dividends
    187,685       (126,898 )
Dividends declared on preferred stock
    (2,040 )     (2,040 )
      Comprehensive Income/(Loss) to Common Stockholders
  $ 185,645     $ (128,938 )
 
The accompanying notes are an integral part of the consolidated financial statements.
5

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
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 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.  (See Note 10(b).)
 
On December 29, 2008, the Company filed Articles of Amendment with the State Department of Assessments and Taxation of Maryland changing its name from “MFA Mortgage Investments, Inc.” to “MFA Financial, Inc.”  The name change became effective on January 1, 2009.
 
2. Summary of Significant Accounting Policies>
 
(a) Basis of Presentation and Consolidation
The interim unaudited financial statements of the Company have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“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 such SEC rules and regulations.  Management believes, however, that the disclosures included in these interim financial statements are adequate to make the information presented not misleading.  The accompanying financial statements should be read in conjunction with the financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.  In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial condition of the Company at March 31, 2009 and results of operations for all periods presented have been made.  The results of operations for the three-month period ended March 31, 2009 should not be construed as indicative of the results to be expected for the full year.
 
The 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.  Actual results could differ from those estimates.  The consolidated financial statements of the Company include the accounts of all subsidiaries; significant intercompany accounts and transactions have been eliminated.
 
(b) MBS/Investment Securities
The Company’s MBS pledged as collateral against repurchase agreements and Swaps are included in investment securities on the Consolidated Balance Sheets with the fair value of the MBS pledged disclosed parenthetically.  (See Notes 3, 5, 7, 8 and 14.)
 
The Company’s investment securities are comprised primarily of Hybrid MBS (which are MBS secured by mortgages that have a fixed interest rate for a specified period, typically three to ten years, and, thereafter, generally reset annually) and adjustable-rate MBS (collectively, “ARM-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”).  To a lesser extent, the Company has investments in non-Agency MBS, which are not guaranteed by any agency of the U.S. Government.  The Company’s non-Agency MBS are primarily comprised of residential MBS that represent the senior most tranches within the MBS structure (“Senior MBS”).  The Company’s Senior MBS are rated by a nationally recognized rating agency, such as Moody’s Investors Services, Inc. (“Moody’s”), Standard & Poor’s Corporation (“S&P”) or Fitch, Inc. (collectively, “Rating Agencies”).  In addition, the Company may have investments in other mortgage-related securities and other investments, which may or may not be rated.  (See Note 3.)
 
The Company accounts for its investment securities in accordance with Statement of Financial Accounting Standards (“FAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“FAS 115”) which requires that investments in securities be designated as either “held-to-maturity,” “available-for-sale” or “trading” at the time of acquisition.  All of the Company’s investment securities are designated as available-for-sale and are carried at their fair value with unrealized gains and losses excluded from earnings and reported in other comprehensive (loss)/income, a component of Stockholders’ Equity.  (See Note 2(k).)
 
6

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
The Company determines the fair value of its investment securities based upon prices obtained from a third-party pricing service and broker quotes.  (See Note 14.)  The Company applies the guidance prescribed in Financial Accounting Standards Board (“FASB”) Staff Position (“FSP”) No. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments” (“FSP 115-1 and 124-1”).  (See Note 2(p).)
 
Although the Company generally intends to hold its investment securities until maturity, it may, from time to time, sell any of its securities as part of the overall management of its business.  Upon the sale of an investment security, any unrealized gain or loss is reclassified out of accumulated other comprehensive (loss)/income to earnings as a realized gain or loss using the specific identification method.
 
Interest income is accrued based on the outstanding principal balance of the investment securities and their contractual terms.  Premiums and discounts associated with Agency MBS and MBS rated AA and higher at the time of purchase are amortized into interest income over the life of such securities using the effective yield method, adjusted for actual prepayment activity in accordance with FAS No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases” (“FAS 91”).
 
Interest income on certain of the Company’s non-Agency MBS is recognized in accordance with Emerging Issues Task Force (“EITF”) of the FASB Consensus No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (“EITF 99-20”), as amended by FSP No. EITF 99-20-1 “Amendments to the Impairment Guidance of EITF 99-20” (“FSP EITF 99-20-1”).  Pursuant to EITF 99-20, cash flows from a security are estimated based on the holder’s best estimate of current information and events and the excess of the future cash flows over the investment is recognized as interest income under the effective yield method.
 
Under both FAS 91 for MBS purchased at a significant discount and EITF 99–20, as amended, management estimates, at the time of purchase, the future expected cash flows and determines the effective interest rate based on the estimated cash flows and the purchase price.  The cash flow projections are an estimate based on the Company’s observation of current information and events and include assumptions related to interest rates, prepayment rates and the timing and amount of credit losses.  The Company reviews and, if appropriate, makes adjustments to its cash flow projections at least quarterly and monitors these 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 interest income recognized on, and/or the carrying value of such securities.  (See Notes 2(o) and 3.)
 
(c) Cash and Cash Equivalents
Cash and cash equivalents include cash on deposit with financial institutions and investments in high quality overnight 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.  The Company held $10.0 million and $5.5 million of cash pledged by its counterparties at March 31, 2009 and December 31, 2008, respectively.  At March 31, 2009, all of the Company’s cash investments were in high quality overnight money market funds, such that their carrying amount is deemed to be their fair value.  (See Note 8.)
 
(d) Restricted Cash
Restricted cash represents the Company’s cash held by counterparties as collateral against the Company’s Swaps and/or repurchase agreements.  Restricted cash, which earns interest, is not available to the Company for general corporate purposes, but may be applied against amounts due to Swap or repurchase agreement counterparties or returned to the Company when the collateral requirements are exceeded or, at the maturity of the Swap or repurchase agreement.  The Company had restricted cash, held as collateral against its repurchase agreements and Swaps, of $78.8 million and $70.7 million at March 31, 2009 and December 31, 2008, respectively.  (See Notes 5, 7 and 8.)
 
7

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
(e) Credit Risk/Other-Than-Temporary Impairment
The Company limits its exposure to credit losses on its investment portfolio by requiring that at least 50% of its investment portfolio consist of Hybrids and adjustable-rate MBS that are either (i) Agency MBS or (ii) rated in one of the two highest rating categories by at least one Rating Agency.  The remainder of the Company’s investment portfolio may consist of direct or indirect investments in: (i) other types of MBS and residential mortgage loans; (ii) other mortgage and real estate-related debt and equity; (iii) other yield instruments (corporate or government); and (iv) other types of assets approved by the Company’s Board of Directors (the “Board”) or a committee thereof.  At March 31, 2009, all of the Company’s MBS were secured by pools of first lien mortgages on residential properties.  At March 31, 2009, 92.7% of the Company’s assets consisted of Agency MBS and related receivables, 2.3% were Senior MBS and related receivables and 4.6% were cash, cash equivalents and restricted cash; combined these assets comprised 99.6% of the Company’s total assets.  The Company’s remaining assets consisted of an investment in real estate, securities held as collateral, goodwill, prepaid and other assets and other non-Agency MBS.
 
The Company recognizes impairments on its investment securities in accordance with the FSP 115-1 and 124-1, which, among other things, specifically addresses: (i) the determination as to when an investment is considered impaired; (ii) whether that impairment is other-than-temporary; (iii) the measurement of an impairment loss; (iv) accounting considerations subsequent to the recognition of an other-than-temporary impairment; and (v) certain required disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.
 
The Company assesses its investment securities for other-than-temporary impairment on at least a quarterly basis.  When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either “temporary” or “other-than-temporary.”  If it is determined that impairment is other-than-temporary, then the impairment is recognized in earnings reflecting the entire difference between the investment's cost basis and its fair value at the balance sheet date of the reporting period for which the assessment is made.  The measurement of the impairment is not permitted to include partial recoveries subsequent to the balance sheet date.  Following the recognition of an other-than-temporary impairment, the fair value of the investment becomes the new cost basis of the investment and may not be adjusted for subsequent recoveries in fair value through earnings.  Because management’s assessments are based on factual information as well as subjective information available at the time of assessment, the determination as to whether an other-than-temporary impairment exists and, if so, the amount considered other-than-temporarily impaired, or not impaired, is subjective and, therefore, the timing and amount of other-than-temporary impairments constitute material estimates that are susceptible to significant change.  (See Note 3.)
 
Upon a decision to sell an impaired available-for-sale investment security on which the Company does not expect the fair value of the investment to fully recover prior to the expected time of sale, the investment shall be deemed other-than-temporarily impaired in the period in which the decision to sell is made.  Even if the inability to collect is not probable, the Company may recognize an other-than-temporary impairment charge if, for example, the Company does not have the intent and ability to hold a security until its fair value has recovered.  (See Notes 2(o)  and 2(p).)
 
Certain of the Company’s non-Agency MBS were purchased at a discount to par value, with a portion of such discount considered credit protection against future credit losses.  The initial credit protection (i.e., discount) on these MBS may be adjusted over time, based on the performance of the investment or, if applicable, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors.  If the performance of these securities is more favorable than forecasted, a portion of the amount designated as credit discount may be accreted into interest income over time.  Conversely, if the performance of these securities is less favorable than forecasted, impairment charges and write-downs of such securities to a new cost basis could result.
 
The Company accounts for its goodwill in accordance with FAS No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”) which provides, among other things, how entities are to account for goodwill and other intangible assets that arise from business combinations or are otherwise acquired.  FAS 142 requires that goodwill be tested for impairment annually or more frequently under certain circumstances.  At March 31, 2009 and December 31, 2008, 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 at the entity level.  Through March 31, 2009, the Company had not recognized any impairment against its goodwill.
 
8

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
(g) Real Estate
At March 31, 2009, the Company indirectly held 100% of the ownership interest in Lealand Place, a 191-unit apartment property located in Lawrenceville, Georgia (“Lealand”), which is consolidated with the Company.  This property was acquired through a tax-deferred exchange under Section 1031 of the Internal Revenue Code of 1986, as amended (the “Code”).  (See Note 6.)
 
The property, capital improvements and other assets held in connection with this investment are carried at cost, net of accumulated depreciation and amortization.  Maintenance, repairs and minor improvements are expensed in the period incurred, while real estate assets, except land, and capital improvements are depreciated over their useful life using the straight-line method.
 
(h) Repurchase Agreements
The Company finances the acquisition of its MBS 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 structured as a sale and repurchase, under its repurchase agreements, the Company pledges its securities as collateral to secure a loan 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 agreement, the Company is required to repay the loan and concurrently receives back its pledged collateral from the lender.  With the consent of the lender, the Company may renew a repurchase agreement 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 agreements with such lender, are routinely experienced by the Company as the value of the MBS pledged as collateral declines as the MBS principal is repaid, or if the fair value of the MBS pledged as collateral declines due to changes in market interest rates, spreads or other market conditions.  To date, the Company had satisfied all of its margin calls and has never sold assets to meet any margin calls.  (See Notes 7 and 8.)
 
The Company’s repurchase agreements typically have terms ranging from one month to three months at inception, with some having longer terms.  Should a counterparty decide not to renew a repurchase agreement at maturity, the Company must either refinance elsewhere or be in a position to satisfy the obligation.  If, during the term of a repurchase agreement, a lender should file for bankruptcy, 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 to such lender.  The Company generally seeks to diversify its exposure by entering into repurchase agreements with multiple counterparties with a maximum loan from any lender of no more than three times the Company’s stockholders’ equity.  At March 31, 2009, the Company had outstanding balances under repurchase agreements with 20 separate lenders with a maximum net exposure (the difference between the amount loaned to the Company, including interest payable, and the fair value of securities pledged by the Company as collateral, including accrued interest on such securities) to any single lender of $133.8 million, or 9.2% of stockholders’ equity, related to repurchase agreements.  (See Note 7.)
 
(i) Equity Based Compensation
The Company accounts for its stock-based compensation in accordance with FAS No. 123R, “Share-Based Payment,” (“FAS 123R”).  The Company uses the Black-Scholes-Merton option model to value its stock options.  There are limitations inherent in this model, as with all other models currently used in the market place to value stock options.  For example, the Black-Scholes-Merton option model was not designed to value stock options which contain significant restrictions and forfeiture risks, such as those contained in the stock options that have been granted by the Company.  Significant assumptions are made in order to determine the Company’s option value, all of which are subjective.  The fair value of the Company’s stock options are expensed using the straight-line method.
 
Pursuant to FAS 123R, compensation expense for restricted stock awards, restricted stock units (“RSUs”) and stock options is recognized over the vesting period of such awards, based upon the fair value of such awards at the grant date.  Payments pursuant to DERs, which are attached to certain awards are charged to stockholders’ equity when declared.  Equity based awards for which there is no risk of forfeiture are expensed upon grant, or at such time that there is no longer a risk of forfeiture.  The Company applies a zero forfeiture rate for its equity based awards, given that such awards have been granted to a limited number of employees, and that historical forfeitures have been minimal.  Should information arise indicating that forfeitures may occur, the forfeiture rate would be revised and accounted for as a change in estimate.
 
9

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Forfeiture provisions for dividends and DERs on unvested equity instruments on the Company’s equity based awards vary by award.  To the extent that equity awards do not vest and grantees are not required to return such payments to the Company, additional compensation expense is recorded at the time an award is forfeited.  There were no forfeitures of any equity based compensation awards during the quarters ended March 31, 2009 and 2008.  (See Note 13.)
 
(j) Earnings per Common Share (“EPS”)
Basic EPS is computed by dividing net income/(loss) allocable to common stockholders by the weighted average number of shares of common stock outstanding during the period, which also includes participating securities representing unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents.  Diluted EPS is computed by dividing net income available to holders of common stock by the weighted average shares of common stock and common equivalent shares outstanding during the period.  For the diluted EPS calculation, common equivalent shares outstanding includes the weighted average number of shares of common stock outstanding adjusted for the effect of dilutive unexercised stock options and RSUs outstanding 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 for unvested stock options and RSUs, are used to repurchase shares of the Company’s outstanding common stock at the average market price during the reported period.  No common share equivalents are included in the computation of any diluted per share amount for a period in which a net operating loss is reported.
 
The Company’s adoption of FSP No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“EITF 03-6-1”) on January 1, 2009 did not have a material impact on the Company’s EPS for current or prior periods.  (See Notes 2(o) and 11.)
 
(k) Comprehensive Income/Loss
The Company’s comprehensive income/(loss) includes net income/(loss), the change in net unrealized gains/(losses) on its investment securities and hedging instruments, adjusted by realized net gains/(losses) included in net income/(loss) for the period and is reduced by dividends declared on the Company’s preferred stock.
 
(l) U.S. Federal Income Taxes
The Company has elected to be taxed as a REIT under the provisions of the Code and the corresponding provisions of state law.  The Company expects to operate in a manner that will enable it to continue to be taxed as a REIT.  A REIT is not subject to tax on its earnings to the extent that it distributes its REIT taxable income to its stockholders.  As such, no provision for current or deferred income taxes has been made in the accompanying consolidated financial statements.
 
(m) Derivative Financial Instruments/Hedging Activity
The Company utilizes derivative financial instruments to manage a portion of its interest rate risk and does not enter into derivative transactions for speculative or trading purposes.  These derivative financial instruments were comprised of Swaps for the periods presented and are accounted for in accordance with FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“FAS 133”).  The Company’s Swaps are designated as cash flow hedges against the benchmark interest rate risk associated with its borrowings.  No cost is incurred at the inception of a Swap, under which the Company agrees to pay a fixed rate of interest and receive a variable interest rate, generally based on one-month or three-month London Interbank Offered Rate (“LIBOR”), on the notional amount of the Swap.  The Company documents its risk-management policies, including objectives and strategies, as they relate to its hedging activities, and upon entering into hedging transactions, documents the relationship between the hedging instrument and the hedged liability.  The Company assesses, both at inception of a hedge and on an on-going basis, whether or not the hedge is “highly effective,” in accordance with FAS 133.
 
The Company discontinues hedge accounting on a prospective basis and recognizes changes in the 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.  Swaps are carried on the Company’s balance sheet at fair value, as assets, if their fair value is positive, or as liabilities, if their fair value is negative.  Since the Company’s Swaps are designated as “cash flow hedges,” changes in their fair value is recorded in other comprehensive (loss)/income provided that the hedge is effective.  A change in fair value for any ineffective amount of the Company’s Swaps would be recognized in earnings.  The Company has not recognized any change in the value of its existing Swaps through earnings as a result of ineffectiveness of the hedge, except that the Company has recognized 100% of all gains and losses realized on Swaps that have been terminated early, as all of the associated hedges were deemed ineffective.  (See Notes 5, 8 and 14.)
 
10

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
FASB Interpretation (“FIN”) No. 39-1, “Amendment of FIN No. 39” (“FIN 39-1”), defines “right of setoff” and specifies the conditions that must be met for a derivative contract to qualify for this right of setoff.  FIN 39-1 also addresses the applicability of a right of setoff to derivative instruments and clarifies the circumstances in which it is appropriate to offset amounts recognized for those instruments in the balance sheet.  In addition, FIN 39-1 permits offsetting of fair value amounts recognized for multiple derivative instruments executed with the same counterparty under a master netting arrangement and fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) arising from the same master netting arrangement as the derivative instruments.  The Company’s adoption of FIN 39-1 on January 1, 2008 did not have any impact on its consolidated financial statements, as the Company does not offset cash collateral receivables or payables against its net derivative positions.
 
(n) Fair Value Measurements and The Fair Value Option for Financial Assets and Financial Liabilities
On January 1, 2008, the Company adopted FAS No. 157, “Fair Value Measurements” (“FAS 157”), which defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements.  Changes to previous practice resulting from the application of FAS 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements.  FAS 157 clarified that the exchange price is the 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.  FAS 157 provides a consistent definition of fair value which focuses on exit price and prioritizes, the use of market-based inputs over entity-specific inputs when determining fair value.  In addition, FAS 157 provides a framework for measuring fair value, and establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date.  (See Notes 2(p) and 14.)
 
On October 10, 2008, the FASB issued FSP No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSP 157-3”).  FSP 157-3 clarifies the application of FAS 157 in a market that is not active and provides an example to illustrate key consideration in determining the fair value of a financial asset when the market for that financial asset is not active.  The issuance of FSP 157-3 did not have any impact on the Company’s determination of fair value for its financial assets.
 
FAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“FAS 159”), permits entities to elect to measure many financial instruments and certain other items at fair value.  Unrealized gains and losses on items for which the fair value option has been elected will be recognized in earnings at each subsequent reporting date.  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.  The adoption of FAS 159 on January 1, 2008 did not have any impact on the Company’s consolidated financial statements, as it did not elect the fair value option on any of its assets or liabilities.
 
(o) Adoption of New Accounting Standards and Interpretations
Accounting for Transfers of Financial Assets and Repurchase Financing Transactions
On January 1, 2009, the Company adopted FSP No. 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP 140-3”), which provides guidance on accounting for transfers of financial assets and repurchase financings.  FSP 140-3 presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (i.e., a linked transaction) under FAS No. 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“FAS 140”).  However, if certain criteria, as described in FSP 140-3, are met, the initial transfer and repurchase financing shall not be evaluated as a linked transaction and shall be evaluated separately under FAS 140.  If the linked transaction does not meet the requirements for sale accounting, the linked transaction shall generally be accounted for as a forward contract, as opposed to the current presentation, where the purchased asset and the repurchase liability are reflected separately on the balance sheet.  The adoption of FSP 140-3 had no impact on the Company’s financial statements, as the Company did not enter into any linked transactions.
 
11

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
Amendments to the Impairment Guidance of EITF 99-20
On January 12, 2009, the FASB issued FSP EITF 99-20-1, which amends the impairment guidance in EITF 99-20 to achieve a more consistent determination of whether an other-than-temporary impairment has occurred for all beneficial interests within the scope of EITF 99-20.  FSP EITF 99-20-1 eliminates the requirement that a holder’s best estimate of cash flows be based upon those that “a market participant” would use and instead requires that an other–than–temporary impairment be recognized as a realized loss through earnings when it its “probable” there has been an adverse change in the holder’s estimated cash flows from cash flows previously projected.  This change is consistent with the impairment models contained in FAS 115.  FSP EITF 99-20-1 emphasizes that the holder must consider all available information relevant to the collectibility of the security, including information about past events, current conditions and reasonable and supportable forecasts, when developing the estimate of future cash flows.  Such information generally should include the remaining payment terms of the security, prepayments speeds, financial condition of the issuer, expected defaults, and the value of any underlying collateral.  The holder should also consider industry analyst reports and forecasts, sector credit ratings, and other market data that are relevant to the collectibility of the security.  The Company’s adoption of FSP EITF 99-20-1 on December 31, 2008 did not have a material impact on the Company’s financial statements.
 
Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities
On January 1, 2009, the Company adopted EITF 03-6-1, which provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method.  EITF 03-6-1 requires that all previously reported EPS data is retrospectively adjusted to conform with the provisions of EITF 03-6-1.  The Company’s adoption of EITF 03-6-1 on January 1, 2009 did not have a material impact on the Company’s historical or current period EPS amounts.
 
(p) Recently Issued Accounting Standards
On April 9, 2009, the FASB issued FSP No. FAS 107-1 and Accounting Principles Board (“APB”) 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP 107-1 and APB 28-1”), FSP No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP 157-4”) and FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP 115-2 and 124-2”).  The key provisions of these FSPs, which are intended to provide additional guidance for interim fair value disclosures, fair value measurements and the determination of other-than-temporary impairments, are summarized as follows:
 
FSP 107-1 and APB 28-1:  FSP 107-1 and APB 28-1 amends FAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures in the body or in the accompanying notes to financial statements for interim reporting periods and in financial statements for annual reporting periods for the fair value of all financial instruments for which it is practicable to estimate that value, whether recognized or not recognized in the balance sheet.  This FSP also amends APB opinion No. 28, “Interim Financial Reporting,” to require entities to disclose the methods and significant assumptions used to estimate the fair value of financial instruments and describe changes in methods and significant assumptions in both interim and annual financial statements.  FSP 107-1 and APB 28-1 is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009 only if an entity also elects to early adopt FSP 157-4 and FSP 115-2 and 124-2.  The Company did not elect early adoption of this FSP for the quarter ended March 31, 2009 and does not expect that its adoption during the quarter ending June 30, 2009 will have a material impact on its consolidated financial statements.
 
FSP 157-4:  FSP 157-4 provides additional guidance for estimating fair value in accordance with FAS 157, when the volume and level of activity for the asset or liability have significantly decreased and also provides guidance on identifying circumstances that indicate a transaction is not orderly.  FSP 157-4 emphasizes that even if there has been a significant decrease in the volume and level of activity for the asset or liability and regardless of the valuation technique(s) used, the objective of a fair value measurement remains the same.  Fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions.  Among other things, FSP 157-4 amends FAS 157 to require that a reporting entity disclose in interim and annual periods the inputs and valuation technique(s) used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period.  FSP 157-4 is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  If a reporting entity elects to adopt early either FSP 115-2 and 124-2 or FSP 107-1 and APB 28-1, the reporting entity also is required to adopt early FSP 157-4.  Additionally, if a reporting entity elects to early adopt FSP 157-4, FSP 115-2 and 124-2 and FSP 107-1 and APB 28-1 must also be adopted early.  Revisions resulting from a change in valuation technique or its application shall be accounted for as a change in accounting estimate.  The Company did not elect early adoption of FSP 157-4 during the quarter ended March 31, 2009 and does not expect that its adoption during the quarter ending June 30, 2009 will have a material impact on its consolidated financial statements.
 
12

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
FSP 115-2 and 124-2:  The objective of an other-than-temporary impairment analysis under existing GAAP is to determine whether the holder of an investment in a debt or equity security, for which changes in fair value are not regularly recognized in earnings (such as for securities classified as held-to-maturity or available-for-sale), should recognize a loss in earnings when the investment is impaired.  An investment is impaired if the fair value of the investment is less than its amortized cost basis.  The objective of FSP 115-2 and 124-2, which amends exiting other-than-temporary impairment guidance for debt securities, is to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements.  Specifically, the recognition guidance contained in FSP 115-2 and 124-2 applies to debt securities classified as available-for-sale and held-to-maturity that are subject to other-than-temporary impairment guidance within FAS 115, FSP 115-1 and 124-1, FSP EITF 99-20-1 and American Institute of Certified Public Accountants Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer.  Among other provisions, FSP 115-2 and 124-2 requires entities to:  (1) split other-than-temporary impairment charges between credit losses (i.e., the loss based on the entity’s estimate of the decrease in cash flows, including those that result from expected voluntary prepayments), which are charged to earnings, and the remainder of the impairment charge (non-credit component) to other comprehensive income, net of applicable income taxes; (2) disclose information for interim and annual periods that enables financial statement users to understand the types of available-for-sale and held-to-maturity debt and equity securities held, including information about investments in an unrealized loss position for which an other-than-temporary impairment has or has not been recognized, and (3) disclose for interim and annual periods information that enables users of financial statements to understand the reasons that a portion of an other-than-temporary impairment of a debt security was not recognized in earnings and the methodology and significant inputs used to calculate the portion of the total other-than-temporary impairment that was recognized in earnings.  FSP 115-2 and 124-2 is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009.  If an entity elects to adopt early either FSP FAS 157-4 or FSP FAS 107-1 and APB 28-1, it would also be required to adopt early this FSP 115-2 and 124-2.  Additionally, if an entity elects to early adopt FSP 115-2 and 124-2, it is required to adopt FSP 157-4 and FSP 107-1 and APB 28-1.  For debt securities held at the beginning of the interim period of adoption for which an other-than-temporary impairment was previously recognized, if an entity does not intend to sell and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the entity shall recognize the cumulative effect of initially applying this FSP as an adjustment to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income and the impact of adoption accounted for as a change in accounting principles, with applicable disclosures provided.  The Company did not elect early adoption of FSP 115-2 and 124-2 during the quarter ended March 31, 2009 and does not expect that its adoption during the quarter ending June 30, 2009 will have a material impact on its consolidated financial statements.
 
(q) Reclassifications
Certain prior period amounts have been reclassified to conform to the current period presentation.
 
13

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
3. Investment Securities
 
At March 31, 2009 and December 31, 2008, the Company’s investment securities portfolio consisted primarily of pools of Agency ARM-MBS.  The Company’s non-Agency MBS, 99.9% of which were comprised of Senior MBS, are reported below based on the lowest rating issued by a Rating Agency at the date presented.  The Company may pledge its MBS as collateral against its repurchase agreements and Swaps.  (See Note 8.)  The following tables present certain information about the Company's investment securities at March 31, 2009 and December 31, 2008:
 
March 31, 2009
 
(In Thousands)
 
Principal/ Current Face
   
Purchase Premiums
   
Purchase Discounts (1)
   
Amortized Cost (2)
   
Carrying Value/
Fair Value
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Net Unrealized Gain/(Loss)
 
Agency MBS:
                                               
   Fannie Mae
  $ 8,669,095     $ 111,010     $ (1,370 )   $ 8,778,735     $ 8,958,157     $ 194,608     $ (15,186 )   $ 179,422  
   Freddie Mac
    675,524       10,202       -       702,441       712,077       10,512       (876 )     9,636  
   Ginnie Mae
    28,731       510       -       29,241       29,139       68       (170 )     (102 )
  Total Agency MBS
    9,373,350       121,722       (1,370 )     9,510,417       9,699,373       205,188       (16,232 )     188,956  
Non-Agency Senior MBS:
                                                         
   Rated AAA
    128,448       1,400       (19,248 )     110,600       81,213       901       (30,288 )     (29,387 )
   Rated AA
    5,916       -       (3,032 )     2,884       3,017       133       -       133  
   Rated A
    120,499       16       (4,605 )     115,910       63,435       182       (52,657 )     (52,475 )
   Rated BBB
    51,547       273       (14,044 )     37,776       29,048       706       (9,434 )     (8,728 )
   Rated BB
    60,180       60       (8,648 )     51,592       26,231       362       (25,723 )     (25,361 )
   Rated B
    68,594       91       (12,220 )     56,465       33,409       360       (23,416 )     (23,056 )
   Rated CCC
    18,566       -       (10,116 )     8,450       8,575       418       (293 )     125  
  Total Senior MBS
    453,750       1,840       (71,913 )     383,677       244,928       3,062       (141,811 )     (138,749 )
Other Non-Agency MBS
    2,152       -       (79 )     217       218       1       -       1  
    Total MBS
  $ 9,829,252     $ 123,562     $ (73,362 )   $ 9,894,311     $ 9,944,519     $ 208,251     $ (158,043 )   $ 50,208  
   
December 31, 2008
 
(In Thousands)
 
Principal/ Current Face
   
Purchase Premiums
   
Purchase Discounts (1)
   
Amortized Cost (2)
   
Carrying Value/
Fair Value
   
Gross Unrealized Gains
   
Gross Unrealized Losses
   
Net Unrealized Gain/(Loss)
 
Agency MBS:
                                                               
   Fannie Mae
  $ 8,986,206     $ 115,106     $ (1,401 )   $ 9,099,911     $ 9,156,030     $ 78,148     $ (22,029 )   $ 56,119  
   Freddie Mac
    714,110       10,753       -       732,248       732,719       3,462       (2,991 )     471  
   Ginnie Mae
    30,017       532       -       30,549       29,864       -       (685 )     (685 )
  Total Agency MBS
    9,730,333       126,391       (1,401 )     9,862,708       9,918,613       81,610       (25,705 )     55,905  
Non-Agency Senior MBS:
                                                         
   Rated AAA
    106,191       1,487       (7,290 )     100,388       71,418       961       (29,931 )     (28,970 )
   Rated AA
    29,064       352       -       29,416       17,767       -       (11,649 )     (11,649 )
   Rated A
    115,213       -       (1,845 )     113,368       67,346       269       (46,291 )     (46,022 )
   Rated BBB
    10,524       91       (2,705 )     7,910       4,999       66       (2,977 )     (2,911 )
   Rated BB
    79,700       -       (626 )     79,074       41,075       -       (37,999 )     (37,999 )
   Rated CCC
    1,852       -       (931 )     921       989       68       -       68  
  Total Senior MBS
    342,544       1,930       (13,397 )     331,077       203,594       1,364       (128,847 )     (127,483 )
Other Non-Agency MBS
    2,161       -       (197 )     1,781       376       -       (1,405 )     (1,405 )
     Total MBS
  $ 10,075,038     $ 128,321     $ (14,995 )   $ 10,195,566     $ 10,122,583     $ 82,974     $ (155,957 )   $ (72,983 )
 
(1)  Purchase discounts included $38.8 million and $5.9 million of discounts designated as credit reserves at March 31, 2009 and December 31, 2008, respectively. These credit discounts are not expected to be accreted into interest income.
(2) Includes principal payments receivable, which are not included in the Principal/Current Face.  Amortized cost is reduced by other-than-temporary impairments recognized, such that the amortized cost for other-than-temporarily impaired securities is equal to their fair value at the impairment date, and therefore is not equal to the current face net of purchase premiums or discounts.
 
14

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
 
Non-Agency MBS:>  The Company’s non-Agency MBS, which includes Senior MBS, are certificates that are secured by pools of residential mortgages, which are not guaranteed by the U.S. Government, any federal agency or any federally chartered corporation.  Non-Agency MBS may be rated from AAA to CC by one or more of the Rating Agencies or may be unrated (i.e., not assigned a rating by any Rating Agency).  The rating indicates the opinion of the Rating Agency as to the credit worthiness of the investment, indicating the obligor’s ability to meet its financial commitment on the obligation.  The Company’s non-Agency MBS are primarily comprised of Senior MBS which are the senior most tranches from their respective securitizations.  The loans collateralizing the Company’s Senior MBS include Hybrids and, to a lesser extent, adjustable-rate mortgages.
 
Certain of the Company’s non-Agency MBS were purchased at a discount to par value.  The portion of such discount that is considered credit protection against future credit losses is designated as a credit reserve and is not accreted into interest income.  Discounts designated as credit reserves may be adjusted over time, based on review of the investment or, if applicable, its underlying collateral, actual and projected cash flow from such collateral, economic conditions and other factors.  If the performance of these securities is more favorable than forecasted, a portion of the discount initially designated as a credit reserve may be accreted into interest income over time.  Conversely, if the performance of these securities is less favorable than forecasted, other-than-temporary impairment charges and write-downs of such securities to a new cost basis could result.  The Company had unearned discounts of $73.4 million, of which $38.8 million were designated as credit reserves, at March 31, 2009 and $15.0 million, of which $5.9 million were designated as credit reserves, at December 31, 2008.
 
The following table presents information about the Company’s investment securities that were in an unrealized loss position at March 31, 2009:
 
   
Unrealized Loss Position For:
       
   
Less than 12 Months
   
12 Months or more
   
Total
 
(In Thousands)
 
Fair
Value
   
Unrealized losses
   
Number of Securities
   
Fair
Value
   
Unrealized losses
   
Number of Securities
   
Fair
Value
   
Unrealized losses
 
Agency MBS:
                                               
  Fannie Mae
  $ 27,700     $ 78       33     $ 516,687     $ 15,108       102     $ 544,387     $ 15,186  
  Freddie Mac
    22,226       89       8       32,748       787       27       54,974       876  
  Ginnie Mae
    10,467       40       5       9,026       130       7       19,493       170  
  Total Agency MBS
    60,393       207       46       558,461       16,025       136       618,854       16,232  
Non-Agency MBS:
                                                               
  Rated AAA
    7,865       734       3       57,534       29,554       9       65,399       30,288  
  Rated A
    -       -       -       57,598       52,657       2       57,598       52,657  
  Rated BBB
    4,803       259       2       13,531        9,175       1       18,334       9,434  
  Rated BB
    1,048       225       1       19,879        25,498       2       20,927       25,723  
  Rated B
    7,141       748       2       21,370       22,668       2       28,511       23,416  
  Rated CCC
    1,388       293       1       -       -       -       1,388       293  
  Total Non-Agency MBS
    22,245       2,259       9       169,912       139,552       16       192,157       141,811  
    Total MBS
  $ 82,638     $ 2,466       55     $ 728,373     $ 155,577       152     $ 811,011     $ 158,043  
 
During the three months ended March 31, 2009, the Company recognized aggregate other-than-temporary impairments of $1.5 million against five of its non-Agency MBS, none of which were Senior MBS.  These non-Agency MBS had an amortized cost of $1.7 million prior to recognizing the impairments and, an aggregate carrying value of $218,000 after recognizing the other-than-temporary impairments.  All of the Company’s remaining MBS, including MBS that were in an unrealized loss position, were performing in accordance with their terms.  During the three months ended March 31, 2008, the Company recognized an impairment charge $851,000 against an unrated investment security, which had an amortized cost of $1.9 million prior to recognizing the impairment.
 
15

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
The Company believes that the impairments on its remaining MBS are temporary and are primarily related to an overall widening of market spreads for many types of fixed income products, reflecting, among other things, reduced liquidity in the market.  At March 31, 2009, the Company believed it had the ability and intended to continue to hold each of its Agency and non-Agency MBS in unrealized loss positions until recovery, which may be at their maturity.  In assessing the Company’s ability to hold its impaired MBS, it considers the significance of each investment and the amount of impairment, as well as the Company’s current and anticipated leverage capacity and liquidity position.  The Company did not sell any investment securities during the quarter ended March 31, 2009 and did not have plans to sell any securities that were in an unrealized loss position.
 
At March 31, 2009, the Company’s Agency MBS portfolio had net unrealized gains of $189.0 million, comprised of gross unrealized gains of $205.2 million and gross unrealized losses of $16.2 million and, its non-Agency MBS had net unrealized losses of $138.7 million, comprised of gross unrealized losses of $141.8 million and gross unrealized gains of $3.1 million.  All of the unrealized gains on the Company’s Senior MBS were related to the Senior MBS acquired by the Company through its wholly-owned subsidiary MFResidential Assets I, LLC (“MFR”), while $139.6 million of the gross unrealized losses were related to non-Agency MBS purchased prior to 2008.  It is anticipated that pending government actions aimed at increasing market liquidity are likely to make leverage for non-Agency MBS more readily available during 2009, thereby increasing the potential for appreciation on the Company’s non-Agency MBS.  At March 31, 2009, the Company had borrowings under repurchase agreements of $84.0 million (less than 1.0% of repurchase borrowings) against its non-Agency MBS portfolio.  At March 31, 2009, the Company estimated that the recovery period for its non-Agency MBS was approximately 18 months.  The Company determined that it had the ability and intent to continue to hold these securities until recovery, such that the impairment on each of its non-Agency MBS at March 31, 2009 was considered temporary.
 
The Company’s intent and ability to continue to hold its available-for-sale securities in an unrealized loss position until recovery, which may be at their maturity, is based on its reasonable judgment of the specific facts and circumstances at the time such assessment is made.  In making this assessment, the Company reviews and considers its contractual collateral requirements, investment and leverage strategies, current and targeted liquidity position, current and anticipated market conditions, as well as the expected cash flows from such securities and, the nature and credit quality of the underlying assets collateralizing such securities.  The Company’s assessment of its ability and intent to continue to hold its securities may change over time, given, among other things, the dynamic nature of markets and other variables.  Future sales or changes in the Company’s assessment of its ability and/or intent to hold impaired investment securities could result in the Company recognizing other-than-temporary impairment charges or realizing losses on sales of MBS in the future.  (See Note 2(p).)
 
In response to tightening of market credit conditions in March 2008, the Company adjusted its balance sheet strategy decreasing its target range for its debt-to-equity multiple.  In order to reduce its borrowings, the Company sold MBS with an amortized cost of $1.876 billion and realized aggregate net losses of $24.5 million, comprised of gross losses of $25.1 million and gross gains of $571,000.  Given the continued uncertainty in the financial markets and the Company’s purchases of Senior MBS on an unleveraged basis, the Company continues to maintain low leverage.
 
The following table presents the impact of the Company’s investment securities on its other comprehensive income for the three months ended March 31, 2009 and 2008:
 
   
Three Months Ended
March 31,
 
(In Thousands)
 
2009
   
2008
 
Accumulated other comprehensive income/(loss) from
 investment securities:
           
Unrealized (loss)/gain on investment securities at  beginning of period
  $ (72,983 )   $ 29,232  
Unrealized gain on investment securities arising during the period, net
    121,786       8,836  
Reclassification adjustment for MBS sales
    -       (8,241 )
Reclassification adjustment for net losses included in net income for
 other-than-temporary impairments
    1,405       301  
Balance at the end of period
  $ 50,208     $ 30,128  
 
16

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
The Company’s net yield on its MBS portfolio was 5.23% and 5.62% for the three months ended March 31, 2009 and March 31, 2008, respectively.  The following table presents components of interest income on the Company’s investment securities portfolio for the three months ended March 31, 2009 and 2008:

   
Three Months Ended
March 31,
 
(In Thousands)
 
2009
   
2008
 
Coupon interest on MBS
  $ 136,381     $ 130,282  
Premium amortization
    (4,758 )     (5,358 )
Discount accretion
    530       91  
Interest income on MBS, net
    132,153       125,015  
Interest on income notes
    -       50  
  Total
  $ 132,153     $ 125,065  

 
The following table presents certain information about the Company’s MBS that will reprice or amortize based on contractual terms, which do not consider prepayment assumptions, at March 31, 2009:
 
   
March 31, 2009
 
Months to Coupon Reset or Contractual Payment
 
Fair Value
   
% of Total
   
WAC (1)
 
(Dollars in Thousands)
                 
Within one month
  $ 439,101       4.4 %     3.95 %
One to three months
    122,968       1.2       5.07  
Three to 12 Months
    450,879       4.5       4.91  
One to two years
    1,023,017       10.3       5.37  
Two to three years
    1,631,263       16.5       6.05  
Three to five years
    1,859,137       18.7       5.52  
Five to 10 years
    4,418,154       44.4       5.54  
  Total
  $ 9,944,519       100.0 %     5.50 %
(1) "WAC" is the weighted average coupon rate on the Company’s MBS, which is higher than the net yield that will be earned on such MBS. The net yield is primarily reduced by net premium amortization and the contractual delay in receiving payments, which delay varies by issuer.
 

 
4. Interest Receivable
 
The following table presents the Company’s interest receivable by investment category at March 31, 2009 and December 31, 2008:
 
(In Thousands)
 
March 31,
2009
   
December 31,
2008
 
MBS interest receivable:
           
   Fannie Mae
  $ 39,651     $ 41,370  
   Freddie Mac
    6,244       6,587  
   Ginnie Mae
    124       136  
   Non-Agency Senior MBS
    2,089       1,596  
   Other non-Agency MBS
    9       9  
     Total interest receivable on MBS
    48,117       49,698  
   Money market investments
    22       26  
     Total interest receivable
  $ 48,139     $ 49,724  
 
17

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
5. Swaps
 
As part of the Company’s interest rate risk management process, it periodically hedges a portion of its interest rate risk by entering into derivative financial instrument contracts.  At and during the three months ended March 31, 2009, the Company’s derivatives were entirely comprised of Swaps, which have the effect of modifying the interest rate repricing characteristics of the Company’s repurchase agreements and cash flows for such liabilities.
 
The following table presents the fair value of derivative instruments and their location in the Company’s Consolidated Balance Sheets at March 31, 2009 and December 31, 2008:
 
         
Derivates Designated as Hedging Instruments Under FAS 133
Balance Sheet Location
 
March 31, 2009
   
December 31, 2008
 
(In Thousands)
             
Swaps
Liabilities-Swaps, at fair value
  $ (226,470 )   $ (237,291 )

 
Consistent with market practice, the Company has agreements with its Swap counterparties that provide for collateral based on the fair values of its derivative contracts.  Through this margining process, either the Company or its Swap counterparty may be required to pledge cash or securities as collateral.  Collateral requirements vary by counterparty and change over time based on the market value, notional amount and remaining term of the Swap.  Certain Swaps may provide for cross collateralization with repurchase agreements with the same counterparty.
 
Certain of the Company’s Swaps include financial covenants, which, if breached, could cause an event of default or early termination event to occur under such agreements.  If the Company were to cause an event of default or trigger an early termination event pursuant to one of its Swaps, the counterparty to such agreement may have the option to terminate all of its outstanding Swaps with the Company and, if applicable, any close-out amount due to the counterparty upon termination of the Swaps would be immediately payable by the Company.  The Company was in compliance with all of its financial covenants through March 31, 2009.
 
The Company had MBS with a fair value of $170.3 million and $171.0 million pledged as collateral against its Swaps at March 31, 2009 and December 31, 2008, respectively.  The Company had restricted cash of $64.0 million and $70.7 million pledged against its Swaps at March 31, 2009 and December 31, 2008, respectively.  (See Note 8.)
 
The use of hedging instruments exposes the Company to counterparty credit risks in the event of a default by a Swap counterparty, as the Company may not receive payments to which it is entitled under its Swap agreements, and may have difficulty receiving back its assets pledged as collateral against such Swaps.  If, during the term of the Swap, a Counterparty should file for bankruptcy, the Company may experience difficulty recovering its pledged assets which could result in the Company having an unsecured claim against such counterparty’s assets for the difference between the fair value of the Swap and the fair value of the collateral pledged to such counterparty. At March 31, 2009, all of the Company’s Swap counterparties were rated A or better by a Rating Agency.
 
The following table presents the impact of the Company’s Swaps on its accumulated other comprehensive loss for the three months ended March 31, 2009 and 2008:
 
   
For the Three Months Ended March 31,
 
(In Thousands)
 
2009
   
2008
 
Accumulated other comprehensive loss from Swaps:
           
Balance at beginning of period
  $ (237,291 )   $ (99,733 )
Unrealized gain/(loss) on Swaps arising during the
  period, net
    10,821       (90,013 )
Reclassification adjustment for net losses included in
  net income from Swaps
    -       48,162  
Balance at the end of period
  $ (226,470 )   $ (141,584 )
 
18

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
At March 31, 2009, all of the Company’s Swaps were deemed effective and no Swaps were terminated during the three months ended March 31, 2009.  During the three months ended March 31, 2008, the Company terminated 48 Swaps with an aggregate notional amount of $1.637 billion and, in connection therewith, repaid the repurchase agreements hedged by such Swaps.  These transactions resulted in the Company recognizing net losses of $91.5 million.  To date, except for gains and losses realized on Swaps terminated early and deemed ineffective, the Company has not recognized any change in the value of its Swaps in earnings as a result of the hedge or a portion thereof being ineffective.
 
The following table presents the net impact of the Company’s Swaps on its interest expense and the weighted average interest rate paid and received for such Swaps for the three months ended March 31, 2009 and 2008:
   
For the Three Months Ended March 31,
 
(Dollars In Thousands)
 
2009
   
2008
 
Interest expense attributable to Swaps
  $ 27,048     $ 9,331  
Weighted average Swap rate paid
    4.20 %     4.58 %
Weighted average Swap rate received
    1.17 %     3.84 %

At March 31, 2009, the Company had Swaps with an aggregate notional amount of $3.740 billion, including $300.0 million notional for forward-starting Swaps, which had gross unrealized losses of $226.5 million and extended 28 months on average with a maximum term of approximately six years.
 
The following table presents information about the Company’s Swaps at March 31, 2009 and December 31, 2008:

   
March 31, 2009
   
December 31, 2008
 
Maturity (1)
 
Notional Amount
   
Weighted Average Fixed-Pay Interest Rate
   
Weighted Average Variable Interest Rate (2)
   
Notional Amount
   
Weighted Average Fixed Pay Interest Rate
   
Weighted Average Variable Interest Rate (2)
 
(Dollars In Thousands)
                                   
Active Swaps:
                                   
Within 30 days
  $ 73,330       3.93 %     0.92 %   $ 78,348       3.92 %     2.36 %
Over 30 days to 3 months
    146,988       4.10       0.98       151,697       4.12       1.48  
Over 3 months to 6 months
    205,991       4.06       0.96       220,318       4.04       1.78  
Over 6 months to 12 months
    502,117       4.22       0.88       513,070       4.24       1.50  
Over 12 months to 24 months
    841,980       4.18       0.91       821,162       4.13       1.68  
Over 24 months to 36 months
    580,796       4.14       0.91       642,595       4.12       1.61  
Over 36 months to 48 months
    735,259       4.37       0.86       833,302       4.40       1.43  
Over 48 months to 60 months
    155,189       4.02       0.86       169,351       4.01       1.99  
Over 60 months
    198,361       4.27       0.76       240,212       4.21       1.77  
      3,440,011       4.20       0.89       3,670,055       4.19       1.62  
Forward Starting Swaps (3)
    300,000       4.39       0.50       300,000       4.39       0.44  
     Total
  $ 3,740,011       4.22 %     0.86 %   $ 3,970,055       4.21 %     1.53 %
(1)  Each maturity category reflects contractual amortization and/or maturity of notional amounts.
(2)  Reflects the benchmark variable rate due from the counterparty at the date presented, which rate adjusts monthly or quarterly based on one-month or three-month LIBOR, respectively.  For forward starting Swaps, the rate presented  reflects the rate that would be receivable if the Swap were active.
(3)  $150.0 million of forward starting Swaps becomes active in July 2009, and $150.0 million becomes active in August 2009.
 
19

MFA FINANCIAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
 
6. Real Estate
 
The Company’s investment in real estate at March 31, 2009 and December 31, 2008, which is consolidated with the Company, was comprised of an indirect 100% ownership interest in Lealand, a 191-unit apartment property located in Lawrenceville, Georgia.  The following table presents the summary of assets and liabilities of Lealand at March 31, 2009 and December 31, 2008:

(In Thousands)
 
March 31, 2009
   
December 31, 2008
 
Real Estate Assets and Liabilities:
           
  Land and buildings, net of accumulated depreciation
  $ 11,264     $ 11,337  
  Cash, prepaids and other assets
    127       144  
  Mortgage payable (1)
    (9,270 )     (9,309 )
  Accrued interest and other payables
    (196 )     (168 )
    Real estate assets, net
  $ 1,925     $ 2,004  
 
(1)  The mortgage collateralized by Lealand is non-recourse, subject to customary non-recourse exceptions, which generally means that the lender’s final source of repayment in the event of default is foreclosure of the property securing such loan.  This mortgage has a fixed interest rate of 6.87%, contractually matures on February 1, 2011 and is subject to a penalty if prepaid.  The Company has a loan to Lealand which had a balance of $185,000 at March 31, 2009 and December 31, 2008.  This loan and the related interest accounts are eliminated in consolidation.
 
The following table presents the summary results of operations for Lealand for the three months ended March 31, 2009 and 2008:
 
   
Three Months Ended
March 31,
 
(In Thousands)
 
2009
   
2008
 
Revenue from operations of real estate
  $ 383     $ 414  
Mortgage interest expense
    (155 )     (163 )
Other real estate operations expense
    (251 )     (205 )
Depreciation expense
    (56 )     (81 )
   Loss from real estate operations, net
  $ (79 )   $ (35 )

 
7. Repurchase Agreements
 
The Company’s repurchase agreements bear interest that are LIBOR-based and are collateralized by the Company’s MBS and cash.  At March 31, 2009, the Company’s repurchase agreements had a weighted average remaining contractual term of approximately three months and an effective repricing period of 14 months, including the impact of related Swaps.  At December 31, 2008, the Company’s repurchase agreements had a weighted average remaining contractual term of approximately four months and an effective repricing period of 16 months, including the impact of related Swaps.
 
The following table presents contractual repricing information about the Company’s repurchase agreements, which does not reflect the impact of related Swaps that hedge existing and forecasted repurchase agreements, at March 31, 2009 and December 31, 2008:
 
   
March 31, 2009
   
December 31, 2008
 
         
Weighted