Ellington Financial Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; filed March 13, 2020. EFC is an externally managed mortgage and specialty-finance company investing in mortgage, consumer and corporate credit assets, Agency and non-Agency securities, and related derivatives. The company converted to a corporation effective March 1, 2019, elected corporate taxation effective January 1, 2019, and expected to elect REIT status for 2019 when filing its tax return.
Financial performance and condition
| Metric | 2019 |
|---|---|
| Interest income / interest expense | $159.9 million / $78.5 million |
| Net interest income | $81.4 million |
| Total other income | $11.8 million; securities and loans gains of $41.7 million were partly offset by derivative losses of $36.3 million |
| Net income / attributable to common stockholders | $63.2 million / $56.5 million |
| Basic and diluted earnings per common share | $1.76 |
| Core Earnings, a non-GAAP measure | $64.6 million; $58.2 million attributable to common stockholders, or $1.82 per share |
| Net interest margin | 2.80%, excluding the Catch-up Premium Amortization Adjustment and including specified swap costs; 3.12% in 2018 |
| Cash flow from operations | $79.2 million provided |
| Cash, cash equivalents and restricted cash | $72.5 million at year-end |
| Total assets / total liabilities | $4.34 billion / $3.47 billion |
| Debt-to-equity / recourse debt-to-equity | 3.8:1 / 2.6:1 |
| Book value per common share | $18.48 |
Investments in securities, loans, unconsolidated entities and real estate owned totaled approximately $3.96 billion at fair value. The credit portfolio was $2.03 billion, including real estate owned; residential mortgage loans represented 46.1% of that portfolio. Long Agency RMBS totaled $1.94 billion. Repo borrowings were $2.45 billion, and other secured borrowings were approximately $744.7 million. The $86 million Senior Notes carry a 5.50% coupon and mature in September 2022.
Operating cash flow and financing proceeds did not cover investment activity: investing activities used $1.66 billion, while financing activities provided $1.61 billion. Cash increased by $27.4 million over the year. Common dividends declared totaled $1.81 per share for 2019; the Series A preferred stock has a 6.750% fixed dividend through October 2024, then a floating rate tied to three-month LIBOR.
Fourth-quarter detail: net interest income was $24.1 million; net income was $14.3 million, of which $11.1 million was attributable to common stockholders; common EPS was $0.31.
Material changes versus the prior comparable period
- Interest income rose to $159.9 million from $131.0 million in 2018, while interest expense rose to $78.5 million from $56.7 million. Average cost of funds increased to 3.18% from 2.81%; the weighted-average borrowing rate at year-end declined to 2.67% from 3.39%.
- Management reported strong results from loan-related strategies, CMBS, non-Agency RMBS and secondary CLOs. CLO equity, interest-rate hedges and credit hedges detracted; foreign-currency hedges generated net gains.
- The Agency RMBS portfolio nearly doubled from $975 million at year-end 2018 to $1.94 billion at year-end 2019; long credit grew from $1.48 billion to $2.03 billion. Capital raised in two common-stock offerings and an inaugural preferred-stock offering helped fund portfolio growth.
- Common equity offerings in July and November generated approximately $156.3 million in net proceeds; the October preferred offering generated approximately $111.0 million. A further common-stock offering raised $95.3 million in January 2020.
- Comparisons require caution: beginning January 1, 2019, EFC prospectively discontinued investment-company accounting under ASC 946, changed presentation and consolidation, and continued fair-value accounting for eligible assets and liabilities. The company states that the 2019 and prior-period financial statements are not directly comparable. 2018 reported a $46.7 million increase in shareholders’ equity from operations under the prior presentation, not a directly comparable 2019 net-income measure.
Outlook, risks and unusual items
Management described an opportunistic strategy, intending to shift allocations as credit and liquidity conditions change. It highlighted continued investment in non-QM and residential transition loans, small-balance commercial mortgage loans, consumer assets and Agency RMBS. No quantified earnings, return or dividend guidance is provided.
- Interest-rate declines during 2019 supported Agency RMBS gains but contributed to hedge losses and sharply faster prepayments. Fixed-rate specified-pool prepayment rates reached 19.9% in the fourth quarter, versus 7.5% in the fourth quarter of 2018. Management also cited potential net-interest-margin pressure, refinancing and prepayment risk, and exposure to yield-curve changes.
- Financing is substantially dependent on short-term repos subject to rollover, collateral haircuts and margin calls. Approximately 86% of year-end repo borrowings had stated remaining maturities of 90 days or less. Market-value declines or reduced lender availability could force asset sales or impair liquidity.
- Credit risk includes non-performing and re-performing mortgages, non-QM loans, commercial real estate, consumer loans, lower-rated CLOs and other subordinated or illiquid investments. California accounted for 46.6% of residential mortgage unpaid principal balance; Florida accounted for 31.7% of commercial mortgage unpaid principal balance.
- Fair values for material Level 3 assets depend on management estimates, third-party pricing and assumptions such as yields, collateral defaults, recoveries, prepayments and resolution timing. Changes in these judgments affect reported earnings and equity.
- REIT qualification and the company’s Investment Company Act exclusions impose asset, income, distribution and structural constraints. Failure to satisfy applicable requirements could trigger taxes, forced portfolio changes or material operating restrictions. The filing also identifies LIBOR transition, counterparty, servicing, regulatory, cyber and external-manager conflicts as risks.
- Unusual reporting items include the accounting and corporate conversion, REIT restructuring, two non-QM securitizations during 2019, and a $28.7 million impairment charge on securities’ cost basis. The company reported no material legal proceedings and stated that it was compliant with Senior Note covenants at year-end.
Management said available cash, portfolio cash flows and anticipated credit access should meet short- and long-term liquidity needs, while warning that inability to finance Agency RMBS or significant margin calls could strain liquidity. COVID-19 was cited as a potential risk in the filing; the report does not quantify its impact on EFC’s 2019 results.
Important facts for investors to verify
- Review the 2019 audited statements and footnotes for the effects of the ASC 946 accounting change, including consolidation, fair-value estimates and comparability with 2018.
- Check the company’s actual REIT election and ongoing compliance, including asset and income tests, distribution requirements and TRS limits.
- Assess repo renewal terms, near-term maturities, collateral requirements, counterparty concentration and liquidity under stressed market conditions.
- Examine credit performance and geographic concentrations in residential and commercial loans, consumer assets and lower-rated CLO investments, including impairment and delinquency disclosures.
- Compare GAAP earnings, Core Earnings and cash available for distributions; assess the impact of common and preferred issuance, preferred dividend obligations and external-manager fees.