Ellington Residential Mortgage REIT — Form 10-Q Summary
Reporting period: Three months ended March 31, 2016. The filing identifies the registrant as Ellington Residential Mortgage REIT, although the request metadata refers to Ellington Credit Co. The company is an externally managed Maryland REIT investing primarily in Agency residential mortgage-backed securities, with a smaller non-Agency RMBS portfolio, financed largely through repurchase agreements.
Financial performance and key metrics
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Interest income | $9.7 million | $10.3 million |
| Interest expense | $2.1 million | $1.3 million |
| Net interest income | $7.6 million | $9.0 million |
| Total expenses | $1.4 million | $1.4 million |
| Other income (loss) | $(6.5) million | $(3.9) million |
| Net income (loss) | $(0.2) million | $3.7 million |
| GAAP diluted EPS | $(0.03) | $0.40 |
| Core earnings | $4.9 million, or $0.53 per share | $6.0 million, or $0.66 per share |
| Core earnings excluding catch-up premium amortization | $4.6 million, or $0.50 per share | $6.5 million, or $0.71 per share |
- Cash and cash equivalents were $41.2 million at March 31, 2016, compared with $40.2 million at December 31, 2015.
- Total assets were $1.39 billion, down from $1.56 billion at year-end 2015. Shareholders’ equity was $140.4 million, down from $144.9 million.
- Mortgage-backed securities at fair value totaled $1.17 billion, including $1.15 billion of Agency RMBS and $27.6 million of non-Agency RMBS.
- Repurchase agreement borrowings were $1.13 billion, compared with $1.22 billion at December 31, 2015. The weighted-average borrowing rate was 0.66% at quarter-end and the average cost of funds during the quarter was 0.62%.
- Debt-to-equity declined to 8.1:1 from 8.4:1; adjusted for unsettled trades, the ratio was 7.7:1 versus 8.1:1.
- Net cash provided by operating activities was $10.8 million. Investing activities provided $83.4 million, while financing activities used $93.2 million. Cash increased by $1.1 million during the quarter.
- The company declared a $0.45 per-share dividend, compared with $0.55 per share in the prior-year quarter.
- Book value per share declined to $15.39 from $15.86 at December 31, 2015.
Material changes versus the prior comparable period
- Net income declined to a small loss from $3.7 million of income, primarily because net interest income decreased and derivative losses increased.
- Net realized and unrealized losses on financial derivatives were $18.1 million, compared with $15.8 million in Q1 2015. These losses were largely driven by interest rate swaps and TBA positions as interest rates declined and swap spreads moved adversely.
- Net realized and unrealized gains on securities were $11.6 million, broadly comparable with $11.9 million in Q1 2015. Agency RMBS generated approximately $13.7 million of aggregate realized and unrealized gains, while the interest-rate hedging portfolio, including U.S. Treasury securities, generated approximately $20.4 million of losses.
- Interest income decreased because of lower average holdings and lower yields on non-Agency RMBS. Interest expense increased because repo borrowing rates rose and the company used more short U.S. Treasury positions for hedging.
- Core earnings decreased to $4.9 million from $6.0 million, and core earnings per share declined to $0.53 from $0.66.
- The Agency RMBS portfolio declined in fair value to $1.15 billion from $1.21 billion. The non-Agency portfolio declined to $27.6 million from $31.4 million.
- Specified-pool prepayment rates increased to 7.1% from 6.5% in the preceding quarter. Net Agency premium increased to approximately 5.6% from 4.1%, indicating greater exposure to prepayment-related valuation risk.
- The company repurchased 17,920 common shares for $0.2 million under its $10 million repurchase program.
Guidance, outlook, commentary, and risks
- Management expects to continue emphasizing specified Agency pools, particularly higher-coupon pools, while selectively investing in reverse mortgage pools, Agency ARMs, Agency IOs, and non-Agency RMBS.
- Management described substantial market volatility, wider Agency and credit-sector spreads, sharply lower interest rates, and increased prepayment activity during the quarter. The Federal Reserve maintained a federal funds target range of 0.25% to 0.50% and signaled gradual future increases.
- Management believes liquidity is sufficient to meet anticipated short- and long-term requirements. Liquidity sources include cash, investment cash flows, securities sales, repo financing, and potential equity offerings.
- The principal risks are interest-rate volatility, prepayment speeds, mortgage-credit performance, valuation uncertainty, leverage, repo refinancing and margin-call requirements, counterparty concentration, and changes in Federal Reserve, GSE, REIT, or Investment Company Act regulation.
- Repo financing is short-term relative to the expected lives of the mortgage assets, creating refinancing and maturity-mismatch risk. Collateral posted under repo borrowings had a fair value of approximately $1.2 billion, and the company had posted $6.7 million of net cash collateral and $1.0 million of additional securities due to margin calls.
- Derivative liabilities increased materially to $18.3 million from $4.7 million at year-end, while total net derivative fair value moved to a $16.6 million liability from a $2.5 million liability.
- Fair values for certain securities rely on third-party valuations, discounted cash-flow models, prepayment assumptions, loss estimates, recovery assumptions, and other unobservable inputs. Reported values could change materially if these assumptions change.
- The company reported no material legal proceedings, no material changes to previously disclosed risk factors, and no significant contingencies known to management. Its disclosure controls were determined to be effective.
- The company intends to maintain REIT status and generally distribute taxable income. Failure to qualify as a REIT could result in corporate-level taxation and loss of REIT status for up to four subsequent taxable years.
Important facts for investors to verify
- Confirm the correct issuer identity because the filing names Ellington Residential Mortgage REIT, not Ellington Credit Co.
- Reconcile GAAP net loss and EPS with the non-GAAP core earnings measures and assess the effect of derivative valuation losses.
- Review repo counterparties, maturities, haircuts, collateral requirements, margin-call exposure, and the 8.1:1 debt-to-equity ratio.
- Assess sensitivity to interest-rate movements: management estimated total portfolio value changes of approximately $(2.5) million and $(9.2) million for 50- and 100-basis-point rate decreases, and $(2.2) million and $(9.1) million for corresponding increases.
- Evaluate the sustainability of the $0.45 per-share dividend relative to core earnings, GAAP earnings, taxable income, and book value.
- Review prepayment assumptions, Agency premium exposure, specified-pool composition, and the valuation of Agency IO and non-Agency RMBS positions.
- Consider counterparty, regulatory, GSE-policy, REIT-qualification, and Investment Company Act risks described in the filing.