Ellington Residential Mortgage REIT — Q3 2017 Form 10-Q Summary
Filing period: Quarter and nine months ended September 30, 2017. The filing identifies the registrant as Ellington Residential Mortgage REIT, a Maryland REIT externally managed by Ellington Residential Mortgage Management LLC. The company invests primarily in Agency residential mortgage-backed securities (RMBS), with smaller non-Agency RMBS and related hedging instruments. The filing text does not identify the registrant as “Ellington Credit Co.”
Financial position and key metrics
| Metric | Q3 2017 / September 30, 2017 | Comparable period or prior date |
|---|---|---|
| Total assets | $1.934 billion | $1.429 billion at December 31, 2016 |
| Mortgage-backed securities | $1.743 billion fair value | $1.227 billion at December 31, 2016 |
| Agency RMBS | $1.722 billion fair value | $1.208 billion at December 31, 2016 |
| Non-Agency RMBS | $20.6 million fair value | $19.4 million at December 31, 2016 |
| Cash and cash equivalents | $50.3 million | $33.5 million at December 31, 2016 |
| Repurchase agreement borrowings | $1.642 billion; weighted average rate 1.32% | $1.198 billion; 0.88% at December 31, 2016 |
| Shareholders’ equity | $196.8 million | $141.7 million at December 31, 2016 |
| Book value per share | $14.76 | $15.52 at December 31, 2016; $14.71 at June 30, 2017 |
| Debt-to-equity ratio | 8.3:1 | 8.5:1 at December 31, 2016, adjusted for unsettled trades |
Revenue, profit, cash flow and margins
| Metric | Three months ended September 30, 2017 | Three months ended September 30, 2016 | Nine months ended September 30, 2017 | Nine months ended September 30, 2016 |
|---|---|---|---|---|
| Interest income | $12.9 million | $7.1 million | $36.1 million | $24.3 million |
| Interest expense | $(5.7) million | $(2.3) million | $(12.9) million | $(6.6) million |
| Net interest income | $7.1 million | $4.8 million | $23.2 million | $17.7 million |
| Total expenses | $1.5 million | $1.3 million | $4.2 million | $3.9 million |
| Net income | $6.3 million | $6.6 million | $10.0 million | $9.9 million |
| Net income per share | $0.48 | $0.73 | $0.91 | $1.09 |
| Dividends declared per share | $0.40 | $0.40 | $1.20 | $1.25 |
For Q3, the portfolio weighted-average yield was 2.86%, average cost of funds including swaps and Treasury shorts was 1.56%, and net interest margin was 1.30%, compared with 1.56% net interest margin in Q2 2017. Excluding the $0.7 million negative catch-up premium amortization adjustment, adjusted net interest margin was 1.45%.
Q3 Core Earnings were $5.0 million, or $0.38 per share, and Adjusted Core Earnings were $5.6 million, or $0.43 per share. For the nine months, Core Earnings were $17.2 million, or $1.56 per share, and Adjusted Core Earnings were $15.5 million, or $1.41 per share. These are non-GAAP measures and are supplemental to, not substitutes for, GAAP net income.
Operating activities generated $35.4 million of cash during the nine months, while investing activities used $509.5 million. Financing activities provided $490.9 million, including $59.1 million of net common-share issuance proceeds and net repo borrowings. Cash increased by $16.8 million to $50.3 million.
Material changes versus prior periods
- Common shares outstanding increased to 13.34 million from 9.13 million at December 31, 2016. The company raised $45.0 million net in a May 2017 follow-on offering and $14.0 million net through its ATM program during the first nine months.
- The RMBS portfolio expanded from $1.227 billion at year-end 2016 to $1.743 billion at September 30, 2017, primarily through leveraged deployment of equity proceeds.
- Interest income and net interest income increased substantially because of the larger asset base and higher Agency RMBS holdings.
- Interest expense nearly doubled year over year as average repo borrowings increased and funding costs rose. Q3 average repo cost increased to 1.31% from 0.71% in Q3 2016.
- Net income per share declined despite relatively stable aggregate net income because of the materially larger share count and higher hedging losses.
- Nine-month other income changed to an $9.0 million loss from a $3.9 million loss in the prior-year period. Derivative losses were $11.8 million in 2017 versus $27.3 million in 2016, while securities gains declined to $2.8 million from $23.4 million.
- The specified-pool constant prepayment rate was 9.6% in Q3 2017, compared with 8.2% in Q2 2017 and 14.1% in Q3 2016.
Outlook, commentary, risks and unusual items
- Management intended to remain focused primarily on Agency specified pools, with selective exposure to Agency ARMs, reverse mortgages, Agency interest-only securities and non-Agency RMBS. Management stated that it may increase non-Agency RMBS exposure if more attractive entry points develop.
- The Federal Reserve began balance-sheet normalization in October 2017. Management noted a flattening yield curve, historically low volatility, tight credit spreads and continued uncertainty around monetary policy.
- Management expects available cash, investment cash flows, repo financing and equity proceeds to satisfy anticipated liquidity needs, but the company remains dependent on short-term repo financing and collateral maintenance.
- Primary risks include interest-rate movements, repo refinancing and margin-call risk, prepayment risk, valuation uncertainty, leverage, derivative losses, non-Agency credit risk, changes in Agency mortgage market policy, and REIT and Investment Company Act qualification requirements.
- At September 30, 2017, collateral pledged under repos had a fair value of approximately $1.7 billion. Net cash collateral posted for repo margin calls was approximately $15.0 million, plus $2.6 million of additional securities.
- Interest-rate sensitivity modeling estimated a $14.5 million decrease in portfolio fair value for an immediate 100-basis-point rate increase, or approximately 7.4% of shareholders’ equity. Management cautioned that actual results could differ materially because the analysis depends on model assumptions.
- The company reported no material legal proceedings or recorded liabilities for indemnification arrangements. An Ellington affiliate had received an SEC subpoena relating primarily to loan origination, analysis, securitization and servicing matters; the affiliate was cooperating, but the filing could not assure that further investigation or proceedings would not materially affect the company or its affiliates.
- Management stated that disclosure controls and procedures were effective as of September 30, 2017, with no material changes to internal control over financial reporting.
Most important facts for investors to verify
- Confirm the issuer identity and ticker because the supplied metadata names Ellington Credit Co., while the filing is for Ellington Residential Mortgage REIT.
- Assess the sustainability of the $0.40 quarterly dividend against Core Earnings, Adjusted Core Earnings and changing repo costs.
- Monitor leverage, repo maturities, collateral haircuts, margin calls and counterparty concentration.
- Review the sensitivity of book value and earnings to interest rates, prepayments, Agency RMBS spreads and derivative positioning.
- Evaluate the effects of the substantial 2017 equity issuance on per-share earnings and book value.
- Review valuation assumptions for Level 3 securities, particularly projected prepayments, losses, recoveries and option-adjusted spreads.
- Follow developments related to the SEC subpoena involving an Ellington affiliate and any implications for the company or its external manager.