Ellington Residential Mortgage REIT — FY2017 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2017, with quarterly information for the fourth quarter. The filing identifies the registrant as Ellington Residential Mortgage REIT (NYSE: EARN), not “Ellington Credit Co.”
Business context
The company is an externally managed Maryland REIT that invests primarily in Agency residential mortgage-backed securities (RMBS), with smaller allocations to non-Agency RMBS and other mortgage-related assets. It uses repurchase agreements and derivatives, including interest-rate swaps, TBAs, Treasury securities and futures, to finance and hedge the portfolio. Ellington Residential Mortgage Management LLC manages the company; the company has no employees. The Blackstone Funds owned approximately 20% of common shares at year-end.
Key financial metrics
| Metric | FY2017 | FY2016 | Change |
|---|---|---|---|
| Net interest income | $30.1 million | $24.2 million | +24% |
| Net income | $10.8 million | $11.9 million | -9% |
| Net income per share | $0.93 | $1.31 | Lower |
| Core earnings | $22.1 million | $15.6 million | +41% |
| Adjusted core earnings | $20.9 million | $17.7 million | +18% |
| Adjusted core earnings per share | $1.80 | $1.94 | Lower |
| Weighted-average portfolio yield | 3.10% | 2.71% | Higher |
| Net interest margin | 1.63% | 1.60% | Higher |
| Adjusted net interest margin | 1.55% | 1.77% | Lower |
| Management and operating expenses | $5.7 million | $5.0 million | +14% |
| Cash dividends declared per share | $1.57 | $1.65 | Lower |
Fourth-quarter 2017 net income was $0.8 million, or $0.06 per share, compared with $2.0 million, or $0.22 per share, in the fourth quarter of 2016. Fourth-quarter dividends were $0.37 per share.
Balance sheet, portfolio and leverage
- Total assets increased to $1.887 billion from $1.429 billion.
- Mortgage-backed securities at fair value increased to $1.686 billion from $1.227 billion, primarily through increased Agency RMBS investments.
- At year-end, the portfolio included approximately $1.656 billion of Agency RMBS, $18.0 million of non-Agency RMBS and $12.2 million of Agency interest-only securities.
- Shareholders’ equity increased to $192.7 million from $141.7 million, supported by approximately $59.1 million of net common-share issuance and $10.8 million of net income, partly offset by $18.9 million of declared dividends.
- Repurchase-agreement borrowings increased to $1.597 billion from $1.198 billion. The debt-to-equity ratio was 8.3:1 versus 8.5:1.
- Cash and cash equivalents were $56.1 million, compared with $33.5 million at year-end 2016.
- Average repo borrowing costs rose to 1.21% from 0.71%; total average cost of funds, including swaps and short Treasuries, rose to 1.47% from 1.11%.
Cash flow and capital activity
- Operating activities provided $60.2 million of cash.
- Investing activities used $477.9 million, primarily reflecting portfolio purchases and financing-related activity.
- Financing activities provided $440.3 million, including $59.1 million of net common-share proceeds and net repo borrowings.
- Cash increased by $22.6 million during the year.
- The company sold 3.23 million shares in a follow-on offering and issued 964,968 shares under a $100 million at-the-market program.
Material changes versus the prior comparable period
- Portfolio growth and equity issuance increased interest income and net interest income, but higher short-term rates materially increased financing expense.
- Net realized and unrealized losses on securities were $7.2 million, compared with $1.7 million in 2016. Agency RMBS losses reflected underperformance of shorter-duration and higher-coupon pools.
- Net realized and unrealized derivative losses were $6.5 million, compared with $5.6 million in 2016, largely because short TBA positions lost value in a low-volatility, muted-prepayment environment.
- Agency RMBS generated a $9.0 million net realized and unrealized loss, while non-Agency RMBS generated a $2.5 million gain.
- Book value per share declined to $14.45 from $15.52. Reported economic return was 3.2%, or 6.1% excluding the dilutive effect of share offerings.
- The expense ratio improved to 3.3% from 3.5%, but management fees increased to $2.7 million from $2.1 million because of the larger equity base.
Outlook, risks and unusual items
Management expected Federal Reserve balance-sheet runoff and rising short-term rates to continue influencing Agency RMBS pricing, repo costs and hedging results. It expected accelerated Federal Reserve tapering to place downward pressure on TBA prices, potentially benefiting the company’s TBA short positions. Management continued to favor specified Agency pools with attractive relative yields and favorable prepayment characteristics, while retaining flexibility to increase non-Agency RMBS exposure if valuations became more attractive.
- Primary risks include rising interest rates, yield-curve flattening, prepayment volatility, asset-price declines, credit losses on non-Agency RMBS, liquidity constraints and margin calls.
- All debt financing was through short-term repurchase agreements, creating refinancing and maturity-mismatch risk. Year-end repo borrowings had a weighted-average remaining maturity of 43 days.
- The company posted $18.7 million of net cash collateral and $2.5 million of additional securities in connection with margin calls at year-end.
- The company’s REIT status and exclusion from Investment Company Act registration impose operational and asset-composition constraints. Failure to maintain either status could result in material tax, restructuring or asset-sale consequences.
- The company is externally managed under a fee arrangement equal to 1.50% of defined shareholders’ equity. Termination or non-renewal by the company generally requires a termination fee equal to 5% of defined shareholders’ equity.
- An Ellington affiliate received an SEC subpoena in January 2017 concerning loan origination, analysis, securitization and servicing matters. Management stated that no material legal proceeding was currently known, but future regulatory action cannot be ruled out.
- Subsequent to year-end, the board authorized a new repurchase program for up to 1.2 million shares. Through March 9, 2018, 216,881 shares had been repurchased for $2.4 million. The board also approved a first-quarter 2018 dividend of $0.37 per share.
- On March 13, 2018, the company entered into a fifth amended and restated management agreement, including provisions allowing independent trustees to waive specified fee reductions.
Most important facts for investors to verify
- Confirm the issuer identity and ticker: the supplied filing is for Ellington Residential Mortgage REIT, NYSE: EARN.
- Reconcile reported net income, core earnings, adjusted core earnings and dividends; the $1.57 annual dividend exceeded reported GAAP earnings per share of $0.93.
- Assess sensitivity to repo-rate increases, short-term refinancing, margin calls and the 8.3:1 debt-to-equity ratio.
- Review the composition, duration, prepayment exposure and fair-value assumptions of the heavily Agency RMBS portfolio.
- Evaluate the effect of TBA and derivative hedges, which produced losses in 2017 despite partially offsetting interest-rate exposure.
- Monitor book value per share, share issuance and repurchase activity, and the potential dilution or accretion from capital actions.
- Review REIT qualification, Investment Company Act compliance, management fees, termination provisions and the SEC inquiry involving an Ellington affiliate.