Business Context and Reporting Period
This unaudited Form 10-Q covers Ellington Residential Mortgage REIT (NYSE: EARN) for the quarter and nine-month periods ended September 30, 2021. The filing identifies the registrant as Ellington Residential Mortgage REIT, not Ellington Credit Co. The externally managed REIT acquires and manages primarily Agency residential mortgage-backed securities (RMBS), with smaller non-Agency RMBS and related mortgage investments. The company uses repurchase agreements and derivatives to finance assets and manage interest-rate risk.
Key Financial Metrics
| Metric | Three Months Ended September 30, 2021 | Nine Months Ended September 30, 2021 |
|---|---|---|
| Interest income | $5.5 million | $21.9 million |
| Interest expense | $0.6 million | $2.0 million |
| Net interest income | $4.9 million | $19.9 million |
| Total expenses | $1.4 million | $4.4 million |
| Other income (loss) | $(2.6) million | $(19.0) million |
| Net income (loss) | $0.9 million | $(3.6) million |
| GAAP earnings (loss) per share | $0.07 | $(0.28) |
| Core earnings | $4.0 million; $0.31 per share | $12.4 million; $0.99 per share |
For the third quarter, the reported net interest margin was 1.88%, excluding the catch-up premium amortization adjustment. For the nine-month period, the net interest margin was 1.95%, compared with 1.71% in the prior-year period. Core earnings are a non-GAAP measure and should not be viewed as a substitute for GAAP net income.
- Total assets were $1.367 billion at September 30, 2021, compared with $1.195 billion at December 31, 2020.
- Mortgage-backed securities at fair value were $1.218 billion, including $1.209 billion of Agency RMBS and $9.1 million of non-Agency RMBS.
- Shareholders’ equity was $158.9 million, compared with $166.4 million at year-end 2020. Book value per share was $12.28, compared with $13.48 at December 31, 2020.
- Cash and cash equivalents were $61.2 million. Management also reported approximately $31.7 million of other unencumbered assets.
- Net cash provided by operating activities was $21.7 million for the nine-month period. Investing activities used $50.9 million, while financing activities provided $32.2 million. Cash increased by $3.0 million from year-end 2020.
- Repurchase-agreement borrowings were $1.062 billion, with a weighted-average interest rate of 0.17% and a weighted-average remaining maturity of 161 days.
- The debt-to-equity ratio was 6.7:1 at September 30, 2021, versus 6.1:1 at December 31, 2020.
- Quarterly dividends declared totaled $0.30 per share; dividends declared for the first nine months totaled $0.88 per share.
Material Changes Versus Prior Comparable Period
- Third-quarter net income declined to $0.9 million from $8.1 million, primarily because securities and derivative results shifted from gains to losses and interest income decreased.
- Nine-month results shifted to a $3.6 million net loss from $12.7 million of net income. Other income changed from a $5.2 million gain to an $19.0 million loss.
- Net realized and unrealized securities losses were $2.9 million in the third quarter and $20.3 million for the nine-month period, compared with gains of $0.4 million and $29.1 million, respectively, in the prior-year periods.
- Derivative results were a $0.2 million gain for the quarter and a $1.3 million gain for the nine-month period, versus gains of $2.2 million and losses of $23.9 million, respectively, in the comparable 2020 periods.
- Interest income increased for the nine-month period to $21.9 million from $21.1 million, but declined in the third quarter to $5.5 million from $7.8 million. Lower portfolio yields and a negative $1.2 million catch-up premium amortization adjustment affected the quarter.
- Interest expense fell substantially for the nine-month period to $2.0 million from $9.2 million, reflecting lower short-term rates and financing spreads.
- The company issued 575,000 common shares in June 2021 and received $7.1 million of net proceeds. Total common shares outstanding increased to 12.94 million from 12.34 million at year-end 2020.
- The Agency RMBS portfolio increased to $1.197 billion from $1.051 billion at year-end 2020, while non-Agency RMBS declined to $9.1 million from $17.6 million.
Guidance, Outlook, Risks and Unusual Items
Management did not provide quantitative earnings guidance. It expects to continue actively managing Agency specified pools, varying its non-Agency RMBS allocation as opportunities change, and using derivatives and short positions to manage interest-rate exposure. Beginning in October 2021, the company shifted from quarterly to monthly dividend declarations; the board subsequently approved $0.10 per share monthly dividends payable in November and December 2021.
- Management identified interest-rate, prepayment, financing, liquidity, credit, counterparty, market-volatility, regulatory and COVID-19-related risks.
- Repurchase agreements are generally short term and secured by RMBS, creating maturity-mismatch, refinancing and margin-call risks. Cash collateral posted to repo counterparties was $45.6 million at September 30, 2021.
- The company had $53.2 million of aggregate amount at risk under repo agreements, $11.7 million under derivatives excluding TBAs, and approximately $4.3 million under forward-settling TBA transactions.
- A modeled immediate 100-basis-point increase in interest rates was estimated to reduce portfolio value by $17.4 million, or 10.93% of shareholders’ equity; the estimate is based on assumptions and may differ materially from actual results.
- Agency interest-only securities and other mortgage assets are particularly sensitive to prepayment speeds. Gross unrealized RMBS losses were $9.2 million at September 30, 2021.
- Level 3 assets totaled $11.5 million and depend on unobservable inputs, including projected prepayments, collateral losses, recoveries and option-adjusted spreads.
- The external management agreement provides for a management fee equal to 1.50% annually of defined shareholders’ equity and, in specified termination circumstances, a fee equal to 5% of defined shareholders’ equity.
- No material legal proceedings or significant contingencies were reported. Management stated that disclosure controls were effective as of September 30, 2021.
- The company is a REIT and generally must distribute at least 90% of taxable income to maintain qualification; failure to qualify could result in corporate-level taxation and other adverse consequences.
Important Facts for Investors to Verify
- Confirm that the intended issuer is Ellington Residential Mortgage REIT (EARN), because the request metadata names Ellington Credit Co.
- Reconcile GAAP net loss with core earnings and assess the effect of fair-value marks, derivative results and catch-up premium amortization.
- Review leverage, repo maturities, collateral requirements, haircuts and counterparty concentration, particularly as interest rates or RMBS prices change.
- Evaluate the sustainability of dividends relative to core earnings, taxable income, book value and liquidity.
- Assess exposure to prepayment speeds, Agency interest-only securities, lower-coupon RMBS, non-Agency credit risk and valuation-model assumptions.
- Review the external management fee, reimbursable expenses and potential termination fee, as well as the related-party nature of these arrangements.