Ellington Residential Mortgage REIT (EARN) — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022; filed May 12, 2022. The filing identifies the registrant as Ellington Residential Mortgage REIT, a Maryland REIT externally managed by Ellington Residential Mortgage Management LLC. Its portfolio primarily comprises Agency residential mortgage-backed securities (RMBS), with smaller non-Agency RMBS and related hedges.
Key Financial Metrics
| Metric | Q1 2022 | Comparable period or prior year-end |
|---|---|---|
| Interest income | $6.5 million | $6.5 million in Q1 2021 |
| Net interest income | $5.4 million | $5.8 million in Q1 2021 |
| Net income (loss) | $(17.5) million | $0.1 million in Q1 2021 |
| Basic and diluted EPS | $(1.33) | $0.01 in Q1 2021 |
| Core earnings | $3.9 million, or $0.30 per share | $3.8 million, or $0.31 per share in Q1 2021 |
| Net interest margin | 1.76% | 1.96% in Q1 2021 |
| Total assets | $1.51 billion | $1.60 billion at December 31, 2021 |
| Shareholders’ equity | $132.9 million | $154.2 million at December 31, 2021 |
| Book value per share | $10.14 | $11.76 at December 31, 2021 |
| RMBS at fair value | $1.09 billion | $1.31 billion at December 31, 2021 |
| Repurchase agreement borrowings | $1.21 billion at a 0.39% weighted-average rate | $1.06 billion at a 0.18% rate at December 31, 2021 |
| Cash and cash equivalents | $16.2 million | $69.0 million at December 31, 2021 |
Cash Flow, Liquidity and Leverage
- Operating activities provided $6.9 million of cash, while investing activities used $201.8 million.
- Net financing cash flow was $142.0 million, primarily reflecting $963.8 million of repo borrowings and $817.5 million of repayments.
- Cash decreased by $52.8 million during the quarter to $16.2 million. Management reported cash, cash equivalents and other liquidity of approximately $29.9 million, plus approximately $11.3 million of other unencumbered assets.
- Total debt-to-equity increased to 9.1:1 from 6.9:1; adjusted for unsettled purchases and sales, the ratio was 8.3:1.
- The company had repo financing with 15 counterparties. RMBS pledged as collateral had a fair value of approximately $1.2 billion, and net cash collateral posted was approximately $78.0 million.
- Quarterly dividends declared were $0.30 per share, totaling $3.9 million. Subsequent monthly dividends of $0.10 and $0.08 per share were approved for May and June 2022, respectively.
Material Changes Versus Prior Comparable Period
- GAAP results shifted from a $0.1 million profit in Q1 2021 to a $17.5 million loss, primarily because of substantial mark-to-market losses on securities.
- Net realized and unrealized securities losses were $64.7 million, including approximately $70.1 million of losses on Agency securities. These losses were partially offset by $43.1 million of net realized and unrealized derivative gains.
- Interest expense increased to $1.1 million from $0.8 million as short-term rates and repo borrowing costs rose. The adjusted average cost of funds, including swaps and short Treasury positions, increased to 0.62% from 0.45%.
- Despite lower GAAP earnings, core earnings were broadly stable at $3.9 million versus $3.8 million, while core earnings per share declined to $0.30 from $0.31 because of a larger share base.
- RMBS fair value declined by $217.2 million, while gross unrealized RMBS losses increased to $50.6 million from $12.4 million at year-end.
- Interest-rate hedging expanded materially. Net derivative assets increased to $33.3 million from $5.5 million, and average interest-rate swap notional increased to $524.0 million from $422.9 million in 2021.
Outlook, Commentary and Risks
Management attributed the quarter’s losses to sharply higher interest rates, widening Agency RMBS spreads, increased volatility, and duration extension. The Federal Reserve raised the federal funds target range to 0.25%–0.50% in March 2022 and signaled further increases and balance-sheet runoff. Management expects to continue actively adjusting Agency and non-Agency RMBS allocations, leverage and hedges in response to market conditions.
- Key risks include interest-rate risk, prepayment risk, credit risk in non-Agency RMBS, repo refinancing and margin-call risk, counterparty risk, liquidity risk and valuation uncertainty.
- The company uses fair-value accounting for most securities and derivatives; reported earnings can therefore be significantly affected by market prices and model assumptions.
- Portfolio liquidity is exposed to the maturity mismatch between longer-lived RMBS and generally shorter-term repo financing, typically with maturities of up to 364 days.
- Management stated that available capital resources should be sufficient for anticipated short- and long-term liquidity needs, but the filing provides no assurance that financing will remain available on acceptable terms.
- The management agreement provides for a termination fee equal to 5% of defined shareholders’ equity in specified circumstances, and expense reimbursements to the external manager are not subject to a dollar limit.
- No material legal proceedings or significant contingencies were reported, although the company and its affiliates may receive regulatory inquiries in the ordinary course.
- The company reported effective disclosure controls as of March 31, 2022 and no material changes in internal control over financial reporting.
Investor Verification Items
- Reconcile GAAP net losses with core earnings and assess the sustainability of the 1.76% net interest margin as repo costs rise.
- Verify the company’s exposure to further increases in interest rates, including the disclosed sensitivity of total portfolio value to 50- and 100-basis-point shifts.
- Monitor repo borrowing maturities, collateral requirements, margin calls, counterparty concentration and the increase in leverage.
- Evaluate the liquidity impact of cash declining to $16.2 million and the company’s reliance on repo financing.
- Review the valuation assumptions for Level 3 RMBS, particularly projected prepayments, collateral losses, recoveries and discount rates.
- Confirm the ability to maintain dividend distributions while book value, liquidity and GAAP equity remain under pressure.
- Track the transition from LIBOR to SOFR and any effects on derivative contracts, financing costs and hedging effectiveness.