Ellington Financial Inc. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Ellington Financial is an externally managed REIT investing in mortgage and other credit assets, Agency and non-Agency securities, loans, derivatives, and loan-originator interests. Amounts below are in U.S. dollars; financial statement figures are generally in millions.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Interest income | $40.1 | $43.1 | $126.1 | $134.5 |
| Interest expense | $10.6 | $12.9 | $33.1 | $49.7 |
| Net interest income | $29.5 | $30.1 | $93.0 | $84.8 |
| Other income (loss) | $6.1 | $21.1 | $32.1 | $(97.4) |
| Total expenses | $16.2 | $10.5 | $48.0 | $32.6 |
| Net income (loss) attributable to common stockholders | $20.6 | $46.2 | $91.1 | $(45.9) |
| GAAP diluted EPS | $0.41 | $1.06 | $1.99 | $(1.06) |
| Core earnings attributable to common stockholders (non-GAAP) | $23.0 | $18.0 | $64.0 | $54.9 |
| Core earnings per share (non-GAAP) | $0.46 | $0.41 | $1.40 | $1.26 |
Q3 net interest margin, including the cost of interest-rate swaps and excluding the catch-up premium amortization adjustment, was 3.40%, versus 3.84% a year earlier; the comparable nine-month margins were 3.39% and 3.41%. Q3 average cost of funds was 1.15%, down from 2.06% in Q3 2020. The company recorded a negative $2.9 million catch-up premium amortization adjustment in Q3 2021, reducing interest income.
Balance sheet, cash flow, debt, and liquidity
- At September 30, 2021, total assets were $4.42 billion, total liabilities $3.32 billion, and total equity $1.10 billion. Common-stockholders’ equity, less preferred liquidation preference, implied book value of $18.35 per common share.
- Cash and cash equivalents were $103.6 million; management also reported approximately $648.9 million of unencumbered assets.
- Secured borrowings were approximately $3.1 billion; $86.0 million of senior notes were outstanding, bearing 5.50% interest and maturing September 2022. Total debt-to-equity was 2.9:1 and recourse debt-to-equity was 1.8:1 at quarter-end.
- Repurchase agreements totaled $2.11 billion, up from $1.50 billion at December 2020. Their weighted-average rate was 0.80% and weighted-average remaining term was 147 days. The company relies on continued repo rollovers and collateral availability.
- For the first nine months, operating activities provided $58.8 million; investing activities used $1.22 billion; financing activities provided $1.16 billion. Cash, cash equivalents, and restricted cash declined $8.0 million to $103.8 million.
- Common dividends declared totaled $1.19 per share for the first nine months of 2021. After quarter-end, the board approved $0.15-per-share common dividends for November and December 2021, and the quarterly preferred dividend of $0.421875 per share.
Material changes versus comparable periods
- Q3 2021 common-stockholder net income fell to $20.6 million from $46.2 million, mainly because realized and unrealized investment gains and earnings from unconsolidated entities were lower, while incentive fees increased. Core earnings per share nevertheless increased to $0.46 from $0.41.
- Nine-month results swung to $91.1 million of common-stockholder net income from a $45.9 million loss in 2020, when COVID-19-related market dislocations drove substantial investment and derivative losses. Net interest income improved despite lower interest income, as borrowing costs fell.
- The long credit portfolio excluding non-retained securitization tranches increased 24% during Q3 to $1.69 billion, principally as July offering proceeds funded growth in non-QM and residential transition loans; commercial mortgage loans and non-Agency RMBS also expanded. Long Agency RMBS grew 4% to $1.54 billion.
- Common shares outstanding rose to 51.68 million from 43.78 million at year-end 2020, reflecting the July follow-on offering and ATM issuance. The July offering generated $113.1 million net proceeds; the ATM program generated $28.2 million through September 30. A further October offering raised $103.5 million net.
- Consolidated assets and liabilities increased with portfolio expansion. The Level 3 recurring fair-value assets were $2.38 billion at quarter-end, making valuation assumptions an important sensitivity.
Management commentary, outlook, and risks
Management described Q3 performance as strong across most primary credit strategies, supported by net interest income and realized and unrealized gains. Loan strategies generated high returns on equity; CMBS, CLO, and non-Agency RMBS performance was also described as strong. Longbridge Financial, an investee, reported a quarterly net loss as mark-to-market losses on its mortgage-servicing-rights portfolio outweighed record originations, detracting from Ellington’s results. Agency RMBS results were modestly positive amid mixed market performance.
No numerical earnings or portfolio guidance was provided. Management said it expected capital resources to be sufficient for short- and long-term liquidity needs and intended to adjust asset allocation with market conditions. It noted that loss of Agency RMBS financing, declines in collateral values, margin calls, increased prepayments, or inability to roll repos could create liquidity pressure and force asset sales or new debt or equity issuance.
- Market and valuation risk: Results are exposed to interest rates, spread movements, prepayments, credit defaults and recoveries, and foreign exchange. Many loans and other holdings use Level 3 models and unobservable inputs; actual proceeds may differ materially from estimated fair values.
- Funding and leverage: Repo financing entails collateral haircuts, margin calls, counterparty exposure, and refinancing risk. The company had $395.8 million of repos maturing within 30 days and $1.33 billion within 90 days at quarter-end.
- Commitments and contingencies: Unfunded commitments included $639.9 million to purchase eligible residential mortgage loans, $29.4 million relating to residential mortgage investments, and $0.9 million under a corporate-loan line of credit. Guarantees of a mortgage-originator’s repo obligations were capped at $25.0 million; $10.4 million was outstanding under the guaranteed arrangements.
- Other risks: Residential mortgage exposure was concentrated in California (41.2% of unpaid principal), Florida (15.0%), and Texas (11.7%). REIT qualification requires compliance with tax rules, including distribution requirements. The filing reported no material legal proceedings and no material changes to previously disclosed risk factors.
Most important facts for investors to verify
- Whether non-GAAP Core Earnings of $0.46 per share better indicate recurring results than Q3 GAAP EPS of $0.41, and how much future results depend on fair-value marks and investment gains.
- The sustainability of portfolio yields and margins as asset yields declined, incentive fees rose, and market interest rates and prepayment assumptions change.
- Repo renewal terms, collateral haircuts, margin-call capacity, and the September 2022 senior-note maturity, alongside the company’s stated liquidity resources.
- Funding and deployment plans for the $639.9 million residential-loan purchase commitment and the impact of additional share issuance on per-share book value and earnings.
- Credit performance, geographic concentration, and the sensitivity of Level 3 assets and securitization financing to changes in defaults, recoveries, prepayments, and valuation inputs.