Ellington Financial LLC — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. The filing identifies the registrant as Ellington Financial LLC. It is an externally managed specialty finance company investing primarily in mortgage-related assets and derivatives.
Financial performance and position
Amounts are in U.S. dollars; financial statement figures are generally in millions unless noted.
| Metric | Q1 2014 / March 31, 2014 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $21.5 million | $18.4 million in Q1 2013 |
| Net investment income | $14.1 million | $10.6 million in Q1 2013 |
| Net realized and unrealized gains | $8.8 million, including $8.8 million on investments, derivatives and foreign currency | $30.2 million in Q1 2013 |
| Increase in equity from operations | $22.8 million consolidated; $22.6 million attributable to shareholders; $0.88 per share | $40.7 million consolidated; $40.3 million attributable to shareholders; $1.94 per share in Q1 2013 |
| Net interest margin | 4.31% | 4.35% in Q1 2013; includes swap payments in cost of funds, but excludes certain hedge costs |
| Total assets / total liabilities | $2,924.0 million / $2,293.9 million | $2,975.2 million / $2,349.1 million at December 31, 2013 |
| Total equity / shareholder equity | $630.1 million / $623.0 million | $626.0 million / $620.4 million at December 31, 2013 |
| Cash and cash equivalents | $170.4 million | $183.5 million at December 31, 2013 |
| Reverse repo borrowings and debt-to-equity | $1,175.9 million; 1.87:1 | $1,236.2 million at year-end; 1.98:1 |
| Common equity per share | $24.49 | $24.40 at December 31, 2013; diluted book value per share was $24.10 versus $23.99 |
| Dividends | $0.77 per share for Q1, approved May 6, payable June 16, 2014 | $0.77 per share in Q1 2013 plus a $0.75 special dividend |
Net cash from operating activities was $66.3 million, compared with cash used of $26.5 million in Q1 2013. Financing activities used $79.5 million, primarily reflecting net reverse-repo repayments and dividends; cash declined by $13.1 million during the quarter. Total expenses were $7.4 million, down from $7.8 million, despite higher interest and management fees; no incentive fee was incurred in Q1 2014.
Material changes and portfolio
- Shareholder operating results fell year over year, primarily because investment gains were lower; net investment income increased, and derivative losses were smaller than in Q1 2013.
- The non-Agency portfolio (including mortgage loans and other ABS) declined to $631.8 million fair value from $694.0 million at year-end, as the company sold assets into a rally and realized gains. Agency RMBS were $886.3 million versus $893.0 million.
- Net short TBAs decreased to $592.3 million from $715.1 million. Total interest-rate hedges, measured by notional value, increased to $1.7 billion from $1.3 billion.
- Distressed small-balance commercial loans increased to 12 loans valued at $39.0 million from five loans valued at $18.9 million. European non-dollar RMBS totaled $26.1 million; CLO investments totaled $47.5 million.
- Level 3 assets were $679.2 million, including private-label securities, mortgage loans and other less readily observable valuations. Fair values rely in part on third-party indicative quotes and management models and assumptions.
Outlook, risks and unusual items
- Management was generally positive on non-Agency MBS but cautioned that tighter credit spreads and possible increases in long-term rates could pressure valuations. It expected to increase residential non-performing loan investment activity during the rest of 2014 and anticipated opportunities in European distressed assets, CMBS, CLOs and commercial loans.
- Management expected continued Federal Reserve tapering and seasonal mortgage production could weigh on Agency RMBS. It favored specified pools and expected to continue active trading and hedging. The filing gives no numerical earnings or return guidance.
- Key risks include interest-rate, prepayment, credit and valuation risk; reliance on short-term repo financing; margin calls and refinancing/rollover needs; and counterparty concentration. At quarter-end, 28.8% of reverse repos matured within 30 days and 87.1% within 90 days. Financing availability could be affected by bank capital regulation.
- Approximately 73.8% of outstanding borrowings related to Agency RMBS. The company held $170.4 million cash, but stated that inability to finance Agency assets could cause significant liquidity strain and force asset sales. A substantial increase in prepayments or declines in collateral values could also increase liquidity needs.
- Approximately $20.0 million of commercial mortgage loans were non-performing. Management noted that fair-value estimates are inherently uncertain and sensitive to assumptions including prepayments, defaults, losses and recovery timing.
- No material legal proceedings were reported; the company noted that regulatory inquiries involving the manager or affiliates could lead to further investigation. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether net investment income and the $0.77 quarterly dividend remain supported by portfolio income after financing, management and hedging costs.
- How much of reported operating performance depends on realized gains, unrealized marks and Level 3 valuation assumptions.
- Repo renewal, haircut, margin-call and counterparty exposure, particularly given short maturities and reliance on secured financing.
- Portfolio sensitivity to rate moves, prepayments, housing conditions and credit losses, and the effectiveness and cost of hedges.
- Execution and performance of the planned expansion into residential non-performing loans and other distressed assets.