Ellington Financial LLC — 2015 Form 10-K
Business context and reporting period. This annual report covers the year ended December 31, 2015; the filing also provides unaudited fourth-quarter results. Ellington is an externally managed specialty finance company investing primarily in mortgage-related assets, with additional investments in CLOs, consumer loans, ABS, distressed corporate debt and related derivatives. The filing identifies the registrant as Ellington Financial LLC.
Key financial metrics
| Metric | 2015 | 2014 |
|---|---|---|
| Investment income | $104.6 million | $93.9 million |
| Net investment income | $66.2 million | $58.8 million |
| Net increase in equity from operations | $38.4 million; $38.1 million attributable to shareholders | $59.9 million; $59.2 million attributable to shareholders |
| Shareholders’ equity per share | $22.10; diluted $21.80 | $23.38; diluted $23.09 |
| Cash and cash equivalents at year-end | $183.9 million | $114.1 million |
| Total assets / total liabilities at year-end | $3.0 billion / $2.3 billion | $3.9 billion / $3.2 billion |
| Reverse-repo borrowings at year-end | $1.174 billion | $1.669 billion |
| Debt-to-equity ratio | 1.59:1 | 2.12:1 |
| Net interest margin, including interest-rate swap payments | 4.39% | 4.52% |
| Dividends per common share | $2.30 | $2.96 |
For fourth-quarter 2015, net investment income was $13.5 million and net increase in shareholders’ equity from operations was $1.8 million, or $0.05 per share. The quarter included $11.6 million of net realized and unrealized losses on investments, derivatives and foreign currency. The board subsequently declared a $0.50-per-share fourth-quarter dividend, payable March 15, 2016.
Cash provided by operating activities was $654.2 million in 2015, compared with cash used of $604.2 million in 2014. These cash-flow figures reflect substantial purchases, sales and financing activity in the investment portfolio and should not be read as conventional operating cash generation alone. No conventional sales revenue or gross-profit measure is reported; investment income is the relevant income measure.
Material changes versus 2014
- Net income attributable to shareholders fell to $38.1 million from $59.2 million, principally because investment and derivative results moved from a net gain to a net loss, despite higher net investment income.
- Net realized and unrealized results across investments, derivatives and foreign currency were a $27.7 million loss, versus a $1.2 million gain in 2014. Investment results included losses in distressed corporate debt, net short TBAs, Agency RMBS and CLOs; derivative losses were substantially smaller than in 2014.
- The Credit portfolio was rebalanced: long Credit investments declined to $600.5 million from $880.4 million. U.S. non-Agency RMBS fell to $217.8 million from $530.3 million, while consumer loans and ABS grew to $112.5 million from $20.4 million. Management also expanded non-QM loan purchases and mortgage-originator investments.
- Agency RMBS holdings fell to $962.6 million from $1.218 billion. The company sold assets late in the year to raise cash and reduce leverage amid market volatility.
- Net asset value-based total return was 5.14%, down from 8.77%; market-price total return was negative 4.56%, compared with positive 0.15% in 2014. Diluted book value per share declined to $21.80 from $23.09.
- The annual dividend declined to $2.30 per share from $2.96; quarterly dividends were reduced from $0.77 early in 2014 to $0.50 for the final two quarters of 2015.
Outlook, management commentary and risks
Management described 2015 as a volatile year, with widening credit spreads, sharply variable interest rates and concerns about global growth. It said credit hedges and newer, less interest-rate-sensitive asset classes partly offset portfolio pressure. Management intended to keep adjusting asset allocations, maintain a core Agency RMBS position, preserve liquidity and pursue Credit opportunities selectively. The filing gives no quantified earnings or return guidance.
- Funding and liquidity: Most financing is short-term reverse repos subject to collateral haircuts and margin calls. At year-end, $1.105 billion of $1.174 billion in borrowings was due within one year; the weighted-average remaining term was 100 days. Falling collateral values, financing non-renewal or higher funding costs could force asset sales.
- Market and portfolio risks: Credit losses, spread widening, interest-rate changes, prepayments and foreign exchange movements can affect asset values and income. Hedging may be imperfect, costly or subject to counterparty and collateral risks. The filing’s sensitivity analysis estimates a $7.4 million portfolio-value decline for an immediate 100-basis-point rate increase, under stated assumptions; actual results may differ materially.
- Valuation uncertainty: $487.0 million of investments were classified as Level 3 at year-end and valued using significant unobservable inputs. Changes to assumptions or market liquidity can alter reported fair values and earnings.
- Commitments and contingencies: The company reported $95.2 million of purchase commitments in its contractual-obligations table and a separate open-ended commitment to purchase at least $182.9 million of eligible residential mortgage loans under a flow agreement. It also guaranteed a mortgage-originator warehouse facility, with a stated maximum guarantee of $7.5 million, and participated in a separate facility involving a $10 million interest. The borrower under that separate facility was performing at year-end.
- Structure and governance: The company depends on its external manager and is exposed to related-party and allocation conflicts. Maintaining partnership tax treatment and exclusions from Investment Company Act registration constrains investment choices. No material legal proceedings were reported; regulatory inquiries involving Ellington or affiliates remain a disclosed risk.
Important facts for investors to verify
- Review the full audited statements and notes for the composition, maturity and collateral terms of reverse-repo financing, and distinguish operating cash-flow movements from portfolio trading and financing flows.
- Assess whether the lower dividend and declining diluted book value are supported by sustainable investment income, cash availability and current portfolio valuations.
- Check Level 3 valuation assumptions, especially projected collateral losses, prepayments, recoveries and resolution timelines, and the sensitivity of reported equity to those assumptions.
- Confirm the status and potential funding needs of loan-purchase commitments, mortgage-originator facilities, guarantees and other contingent exposures.
- Monitor margin-call capacity, financing renewals, counterparty concentration, the effectiveness and cost of hedges, and compliance with partnership-tax and Investment Company Act requirements.
PricewaterhouseCoopers LLP gave an unqualified opinion on the consolidated financial statements and reported effective internal control over financial reporting as of December 31, 2015.