Ellington Financial Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Ellington Financial is an externally managed mortgage and credit investor, with portfolios spanning Agency and non-Agency mortgage securities, mortgage and consumer loans, CLOs, commercial real estate debt, and derivatives. It intends to qualify as a REIT. The company cautions that results are not necessarily indicative of full-year performance; results also are not fully comparable with 2019 because investment-company accounting was discontinued prospectively beginning January 1, 2019.
Financial results and position
- Income: Interest income was $52.1 million, up from $36.0 million; interest expense was $22.1 million, up from $17.6 million. Net interest income increased to $30.0 million from $18.4 million.
- Profitability: GAAP net loss was $128.3 million, versus net income of $16.5 million in Q1 2019. Net loss attributable to common stockholders was $129.4 million, or $3.04 per share, versus net income of $15.4 million, or $0.52 per share. The loss was driven principally by $133.7 million of unrealized losses on securities and loans and $22.4 million of realized and unrealized derivative losses. Management’s non-GAAP Core Earnings were $23.3 million, or $0.46 per common share, compared with $14.4 million, or $0.45 per share.
- Margins and costs: Management reported a 3.11% net interest margin excluding the catch-up premium amortization adjustment and including interest-rate swap costs, compared with 2.94% a year earlier. Average secured cost of funds declined to 2.58% from 3.52% in Q1 2019. Total expenses were $10.2 million, versus $9.2 million.
- Cash flow: Operating activities provided $28.9 million; investing activities provided $428.5 million; financing activities used $392.9 million. Cash, cash equivalents, and restricted cash increased $64.4 million to $136.9 million.
- Balance sheet and liquidity: Total assets were $3.78 billion, down from $4.34 billion at year-end; total liabilities were $2.97 billion, down from $3.47 billion. Total equity was $809.5 million, versus $868.7 million. Cash and cash equivalents were $136.7 million, and management reported approximately $279.2 million of unencumbered assets.
- Debt and leverage: Total recourse and non-recourse borrowings were $2.85 billion, including $2.03 billion of repurchase agreements, other secured borrowings, and $86.0 million of senior notes. Debt-to-equity declined to 3.5:1 from 3.8:1; recourse debt-to-equity was 2.5:1. Book value per common share, after deducting preferred liquidation preference, was $15.06.
- Dividends and capital: Common dividends declared for Q1 totaled $0.45 per share, down from $0.55 in Q1 2019. A January common-stock offering raised $95.3 million net from 5.29 million shares. The company repurchased 288,172 shares for $3.0 million.
Material changes versus comparable periods
- GAAP results reversed from profit to substantial loss amid COVID-19-related market dislocations, sharp spread widening, and fair-value declines in credit assets.
- Long Agency RMBS fair value fell 48%, to $1.016 billion from $1.937 billion, as the company reduced the portfolio to bolster liquidity and lower leverage. The long credit portfolio declined 1%, to approximately $2.0 billion.
- Net interest income rose year over year, reflecting a larger average portfolio, while average financing costs fell. Interest expense nevertheless increased due to higher average borrowings.
- Cash and cash equivalents rose from $72.3 million at year-end, while total assets and borrowings declined. The company raised equity in January and reduced repurchase-agreement borrowings during March.
Outlook, risks, and unusual items
- COVID-19: Management said the pandemic caused extreme market volatility, illiquidity, asset-price declines, and higher-than-usual margin calls; all margin calls through quarter-end were met. Repo rollovers were completed, at times with higher haircuts or borrowing rates. Some unencumbered loans could not be financed on acceptable terms during the quarter.
- Credit and valuation risks: The company recorded $40.7 million of expected future credit losses on securities and $10.7 million on loans, primarily reflecting adverse changes in expected cash flows associated with the pandemic. Management anticipated potential principal losses, particularly if shutdowns were prolonged. Subsequent to quarter-end, forbearance and deferment requests and delinquencies increased. Many assets are Level 3 or otherwise rely on models and less observable inputs, increasing fair-value uncertainty.
- Liquidity and financing risks: Short-term repo maturities, margin calls, changing collateral haircuts, and counterparties’ asset valuations could pressure liquidity or force asset sales. Management believed available capital and financing were sufficient for anticipated needs, but warned that inability to finance Agency RMBS or further market declines could materially strain liquidity.
- Dividends: Future common and preferred dividends remain subject to board discretion, liquidity, earnings, covenants, and REIT requirements. After quarter-end, the board approved common dividends of $0.08 per share for May and June payments, below the $0.15 monthly Q1 declarations.
- Other: Management reported no material legal proceedings, no material impact from the CARES Act on the Q1 tax provision, and effective disclosure controls as of March 31, 2020. No quantified earnings or full-year financial guidance is provided in the supplied filing text.
Investor verification priorities
- Track subsequent delinquencies, forbearance, defaults, and realized credit losses across residential, commercial, consumer, and corporate exposures.
- Verify liquidity, repo renewals, collateral haircuts, margin requirements, and whether unencumbered assets can be financed on acceptable terms.
- Assess fair-value assumptions and exposure to less-liquid Level 3 assets, especially CLOs, CMBS, non-Agency RMBS, and mortgage loans.
- Reconcile GAAP losses with management’s Core Earnings measure and review the sustainability of the reduced common dividend.
- Monitor leverage, book value per share, and the effects of portfolio sales and equity issuance on per-share value.