Ellington Residential Mortgage REIT (NYSE: EARN) — Fiscal Year 2023 Form 10-K
Reporting period: Year ended December 31, 2023; filed March 12, 2024. The supplied filing is for Ellington Residential Mortgage REIT, not Ellington Credit Co. It provides annual results rather than a separate fourth-quarter income statement.
Business Context
EARN is an externally managed Maryland REIT investing primarily in Agency RMBS, with additional investments in non-Agency RMBS, interest-only securities and corporate CLOs. It uses repurchase agreements and derivatives to finance assets and manage interest-rate exposure. The company has no employees and relies on Ellington and its affiliates for management, personnel, systems and operations.
- At December 31, 2023, the portfolio included $728.0 million of Agency RMBS, $18.7 million of Agency and non-Agency interest-only securities, $9.4 million of non-Agency RMBS and $17.4 million of corporate CLO investments.
- Invested capital was allocated approximately 89% to mortgage-related securities and 11% to corporate CLOs.
- The company remains subject to REIT distribution requirements and intends to maintain its exclusion from registration under the Investment Company Act.
Financial Highlights
| Metric | 2023 | 2022 |
|---|---|---|
| Interest income | $42.5 million | $35.0 million |
| Interest expense | $(45.3) million | $(14.8) million |
| Net interest income | $(2.7) million | $20.2 million |
| Total expenses | $5.5 million | $5.1 million |
| Net realized and unrealized gains/(losses) | $12.8 million | $(45.3) million |
| Net income/(loss) | $4.6 million | $(30.2) million |
| Basic and diluted EPS | $0.31 | $(2.29) |
| Adjusted Distributable Earnings | $13.0 million, or $0.87 per share | $13.8 million, or $1.05 per share |
| Net interest margin, excluding catch-up amortization | 1.43% | 1.58% |
| Shareholders’ equity | $136.2 million | $112.4 million |
| Book value per share | $7.32 | $8.40 |
| Cash and cash equivalents | $38.5 million | $34.8 million |
Debt, Liquidity and Cash Flow
- Repurchase-agreement borrowings were $729.5 million at year-end, compared with $842.5 million in 2022, with 19 counterparties and a weighted-average borrowing rate of 5.58% versus 3.70%.
- The debt-to-equity ratio declined to 5.4:1 from 7.5:1; adjusted for unsettled trades, it was 5.3:1 versus 7.6:1.
- Approximately 93% of borrowings were collateralized by Agency RMBS. The weighted-average contractual repo haircut was 5.7%.
- Cash flow from operating activities was $(10.0) million; investing activities provided $85.7 million; and financing activities used $72.0 million.
- The company raised $33.6 million of net equity proceeds during 2023 and paid $14.1 million of dividends.
- Other unencumbered assets totaled $22.9 million at year-end, compared with $2.9 million at December 31, 2022.
Material Changes Versus 2022
- Net income improved to $4.6 million from a $30.2 million loss, primarily because 2023 produced net gains on securities and derivatives, whereas 2022 had significant securities losses.
- Interest income increased, but higher short-term rates caused interest expense to rise sharply and net interest income to turn negative.
- Agency RMBS fair value declined 16% to $728.0 million, driven by paydowns and net sales. Non-Agency RMBS declined 25% to $9.4 million.
- The company began rotating capital into corporate CLOs during the second half of 2023, ending the year with $17.4 million of CLO investments.
- Book value per share fell 12.9% to $7.32 despite higher total equity, reflecting dividends, market effects and substantial equity issuance.
- Common shares issued increased materially, with 5.18 million shares issued in 2023, compared with 0.27 million in 2022.
- Adjusted Distributable Earnings declined to $0.87 per share from $1.05 per share, and economic return was negative 1.4% for 2023.
Outlook, Management Commentary and Risks
Management expects to continue targeting specified Agency pools and may increase allocations to CLO mezzanine debt and equity depending on market opportunities. Management characterized the market as exposed to elevated interest-rate, prepayment, financing and liquidity risks. The Federal Reserve maintained a 5.25%–5.50% federal funds target range from July through December 2023, while SOFR-based financing costs remained high.
- Interest-rate sensitivity analysis estimated that an immediate 100-basis-point increase in rates would reduce portfolio value by approximately $4.3 million, or 3.15% of equity; a 100-basis-point decrease was estimated to reduce value by $6.6 million, or 4.87%, under the stated assumptions.
- Short-term repo financing creates refinancing, margin-call and collateral-liquidation risk. The company had $11.2 million of net cash collateral posted to repo counterparties at year-end.
- Agency RMBS are exposed to changes in Fannie Mae, Freddie Mac and Ginnie Mae policies and guarantees. Non-Agency RMBS and CLOs carry greater credit and liquidity risk.
- CLO investments are concentrated in subordinated and equity tranches and may be affected by corporate defaults, rating migration, failed overcollateralization tests, limited liquidity and collateral-manager performance.
- Fair values for $19.0 million of Level 3 securities depended on unobservable inputs, including projected prepayments, losses, recoveries and discount rates.
- The company depends on Ellington, its key personnel, third-party servicers, financing counterparties and information systems. The filing states that two prior business-email-compromise incidents had no material impact and that no cybersecurity threat had materially affected the company as of the filing.
- The management agreement provides for a 1.50% annual management fee based on defined shareholders’ equity and generally requires a termination fee equal to 5% of defined shareholders’ equity if terminated or not renewed without cause.
- The board approved continuing monthly dividends of $0.08 per share for payments in February, March and April 2024. Future dividends remain discretionary and depend on earnings, liquidity, financial condition, REIT requirements and other factors.
Important Facts for Investors to Verify
- Confirm the issuer identity: the filing is for Ellington Residential Mortgage REIT, ticker EARN, rather than Ellington Credit Co.
- Review the full quarterly results and supplemental disclosures because this Form 10-K does not separately present fourth-quarter revenue, profit or cash flow.
- Assess whether higher financing costs continue to pressure net interest income and dividend coverage.
- Reconcile the decline in book value per share with equity issuance, dividends, realized gains and unrealized valuation changes.
- Monitor repo maturities, haircuts, margin requirements, counterparty exposure and available unencumbered liquidity.
- Evaluate the growing CLO allocation, including tranche seniority, collateral quality, concentration, ratings and cash-flow diversion triggers.
- Review Level 3 valuation assumptions and the sensitivity of fair value to prepayments, credit losses, recoveries and interest rates.
- Verify future ATM issuance, dilution, remaining authorization and the effect of the management agreement and related-party reimbursements.