Business Context and Reporting Period
The filing is Ellington Residential Mortgage REIT’s unaudited Form 10-Q for the quarter and six-month period ended June 30, 2018. The provided metadata identifies Ellington Credit Co, but the filing registrant is Ellington Residential Mortgage REIT. The company is an externally managed Maryland REIT investing primarily in Agency residential mortgage-backed securities (RMBS), with smaller positions in non-Agency RMBS and related derivatives.
The company uses repurchase agreements to finance Agency RMBS and derivatives, including interest-rate swaps, TBAs, swaptions, futures, and short U.S. Treasury positions, to manage interest-rate risk.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2018 | Six Months Ended June 30, 2018 |
|---|---|---|
| Interest income | $14.1 million | $27.5 million |
| Interest expense | $7.7 million | $14.9 million |
| Net interest income | $6.4 million | $12.6 million |
| Total expenses | $1.4 million | $2.9 million |
| Other income (loss) | $(3.2) million | $(11.8) million |
| Net income (loss) | $1.8 million | $(2.2) million |
| Basic and diluted EPS | $0.14 | $(0.17) |
| Dividends declared per share | $0.37 | $0.74 |
- Total assets were $1.748 billion at June 30, 2018, compared with $1.887 billion at December 31, 2017.
- Mortgage-backed securities at fair value were $1.580 billion, consisting primarily of $1.568 billion of Agency RMBS and $12.0 million of non-Agency RMBS.
- Shareholders’ equity was $174.2 million, compared with $192.7 million at year-end 2017. Book value per share was $13.70 versus $14.45 at December 31, 2017.
- Cash and cash equivalents were $41.4 million, down from $56.1 million at year-end 2017.
- Repurchase-agreement borrowings were $1.537 billion, with a weighted-average interest rate of 2.09% and 42 weighted-average remaining days to maturity.
- Total debt-to-equity was 8.8:1; adjusted for unsettled purchases and sales, it was 8.6:1.
- Six-month operating cash flow was $24.1 million and investing cash flow was $37.9 million. Financing activities used $76.7 million, producing a $14.7 million decrease in cash.
- The reported second-quarter net interest margin was 1.28%; excluding the catch-up premium amortization adjustment, adjusted net interest margin was 1.17%.
- Second-quarter Core Earnings were $5.1 million, or $0.40 per share; Adjusted Core Earnings were $4.6 million, or $0.36 per share. These are non-GAAP measures.
Material Changes Versus Comparable Periods
- Second-quarter net income increased modestly from $1.6 million in 2017 to $1.8 million in 2018, primarily because derivative gains reduced the other loss compared with the prior year.
- Six-month results reversed from net income of $3.7 million in 2017 to a net loss of $2.2 million in 2018.
- Six-month net interest income declined to $12.6 million from $16.0 million, despite higher interest income, because interest expense more than doubled as borrowings and funding rates increased.
- Six-month securities-related realized and unrealized losses were $35.5 million, partly offset by $23.7 million of derivative gains. In the prior-year period, securities losses were $1.6 million and derivative losses were $8.1 million.
- For the quarter, the RMBS portfolio declined 3.1% from March 31, 2018 to $1.580 billion. Agency RMBS prices declined as interest rates increased, while hedges generated gains.
- Average repo funding cost increased to 1.96% in the second quarter from 1.63% in the first quarter and 1.09% in the second quarter of 2017.
- The company repurchased 628,167 common shares during the six-month period for $7.0 million, reducing shares outstanding to 12.7 million at June 30, 2018.
- The quarterly dividend declined to $0.37 per share from $0.40 per share in the prior-year quarter.
Guidance, Outlook, Risks, and Unusual Items
- Management expects available cash, portfolio cash flows, repo financing, and available credit to satisfy anticipated short- and long-term liquidity requirements; no formal earnings or dividend guidance was provided.
- Management intends to continue emphasizing Agency specified pools selected for yield, prepayment characteristics, and potential trading gains. It may increase non-Agency RMBS allocations if more attractive entry points develop.
- Interest-rate conditions remained challenging: the Federal Reserve raised the federal funds target range to 1.75%–2.00%, LIBOR increased, and the yield curve flattened.
- Management reported muted Agency RMBS prepayments and continued to focus on managing prepayment exposure. Fixed-rate specified-pool prepayment rates increased to 8.2% from 7.0% in the first quarter.
- Key risks include rising funding costs, repo refinancing and margin-call risk, high leverage, interest-rate volatility, RMBS valuation changes, prepayment risk, non-Agency credit risk, counterparty exposure, and changes in Federal Reserve or government-sponsored enterprise policies.
- A 50-basis-point parallel increase in interest rates was estimated to reduce portfolio market value by $4.4 million, or 2.54% of equity; a 100-basis-point increase was estimated to reduce it by $16.2 million, or 9.30%. Management cautioned that these model-based estimates may differ materially from actual results.
- The company had no material legal proceedings recorded, but an Ellington affiliate continued responding to an SEC subpoena concerning a loan originator, related loans, analyses, securitizations, and servicing. The filing states that no material proceeding was known to be contemplated at the reporting date.
- One repo counterparty, Wells Fargo Bank, N.A., represented $19.2 million of amount at risk, equal to 11.0% of shareholders’ equity. The company reported no material recorded liabilities for indemnification arrangements.
- The company’s management agreement provides for a 1.50% annual management fee based on shareholders’ equity and, under specified circumstances, a termination fee equal to 5% of defined shareholders’ equity.
Important Facts for Investors to Verify
- Confirm that the intended issuer is Ellington Residential Mortgage REIT rather than Ellington Credit Co.
- Reconcile GAAP net income and book-value changes with non-GAAP Core Earnings and Adjusted Core Earnings.
- Assess whether the 8.8:1 leverage ratio and $1.537 billion of short-term repo borrowings remain appropriate under higher-rate or stressed-market conditions.
- Review the sensitivity of securities valuations, funding costs, and dividends to further interest-rate increases and prepayment changes.
- Monitor the SEC inquiry involving an Ellington affiliate and any potential consequences for the company or its external manager.
- Verify the sustainability of the $0.37-per-share dividend relative to taxable income, Core Earnings, liquidity, and book value.
- Review valuation assumptions for Level 3 assets, including projected prepayments, losses, recoveries, and discount rates.