Ellington Residential Mortgage REIT (NYSE: EARN) — Q2 2023 Form 10-Q Summary
Filing identity: The supplied filing is for Ellington Residential Mortgage REIT, not Ellington Credit Co. The report covers the quarter and six-month period ended June 30, 2023; it was filed August 14, 2023.
Business Context and Reporting Period
EARN is an externally managed Maryland REIT focused primarily on Agency residential mortgage-backed securities (RMBS), with a smaller allocation to non-Agency RMBS and interest-only securities. It finances assets primarily through repurchase agreements and uses interest-rate swaps, TBAs, Treasury securities, futures and other derivatives to manage interest-rate exposure.
At June 30, 2023, EARN had 14,378,193 common shares outstanding and no preferred shares outstanding. Management stated that disclosure controls and procedures were effective as of June 30, 2023.
Financial Metrics
| Metric | Q2 2023 | Q2 2022 | Six Months 2023 | Six Months 2022 |
|---|---|---|---|---|
| Interest income | $10.1 million | $9.1 million | $19.4 million | $15.6 million |
| Interest expense | $(11.7) million | $(2.0) million | $(21.4) million | $(3.1) million |
| Net interest income | $(1.6) million | $7.1 million | $(2.0) million | $12.5 million |
| Total expenses | $1.5 million | $1.3 million | $2.8 million | $2.6 million |
| Net income (loss) | $1.2 million | $(10.7) million | $3.5 million | $(28.2) million |
| Basic and diluted EPS | $0.09 | $(0.82) | $0.26 | $(2.15) |
| Adjusted distributable earnings | $2.4 million | $3.7 million | $5.2 million | $7.6 million |
| Adjusted distributable earnings per share | $0.17 | $0.28 | $0.38 | $0.58 |
The Q2 weighted-average portfolio yield, excluding the catch-up premium amortization adjustment, was 3.95%, compared with an adjusted average cost of funds of 3.02%, producing a 0.93% net interest margin. For the six-month period, the comparable figures were 3.81%, 2.78% and 1.03%, respectively.
Balance Sheet, Debt and Liquidity
- Total assets were $1.084 billion at June 30, 2023, compared with $1.054 billion at December 31, 2022.
- Mortgage-backed securities at fair value were $920.7 million, including $896.3 million of Agency RMBS and $24.4 million of non-Agency RMBS.
- Shareholders’ equity was $116.7 million, compared with $112.4 million at year-end 2022.
- Book value per share was $8.12, compared with $8.40 at December 31, 2022 and $8.31 at March 31, 2023.
- Repurchase-agreement borrowings were $875.0 million, with a weighted-average interest rate of 5.29%, compared with $842.5 million at December 31, 2022 at 3.70%.
- The debt-to-equity ratio was 7.5:1; adjusted for unsettled purchases and sales, it was 7.6:1.
- Cash and cash equivalents were $43.7 million, compared with $34.8 million at year-end 2022. Management also reported $7.2 million of other unencumbered assets.
- Cash flow from operating activities was $(4.4) million and cash flow from investing activities was $(18.5) million for the six months ended June 30, 2023. Financing activities provided $31.8 million, resulting in an $8.9 million increase in cash.
Material Changes Versus Prior Comparable Period
- Net income improved to $1.2 million in Q2 2023 from a $10.7 million loss in Q2 2022, primarily because derivative gains and lower securities losses more than offset the deterioration in net interest income.
- Six-month net income improved to $3.5 million from a $28.2 million loss.
- Interest income increased, but higher repo financing costs caused net interest income to fall from $7.1 million to a negative $1.6 million in Q2.
- Q2 net realized and unrealized gains on financial derivatives were $17.7 million, while securities generated net realized and unrealized losses of $13.4 million. In Q2 2022, the corresponding amounts were a $27.0 million derivative gain and a $43.6 million securities loss.
- Average repo borrowing costs rose to 5.22% in Q2 2023 from 0.68% in Q2 2022, reflecting sharply higher short-term interest rates.
- The Q2 dividend was $0.24 per share, compared with $0.26 per share in Q2 2022. The company issued 1.0 million shares under its ATM program during the first six months, generating $7.3 million of net proceeds.
Guidance, Outlook, Risks and Unusual Items
Management did not provide formal earnings guidance. It expects capital resources to be sufficient for anticipated short- and long-term liquidity requirements and may increase its allocation to non-Agency RMBS when market opportunities arise.
Management reported that higher interest rates, rising SOFR and higher mortgage rates increased financing costs, while hedges generated gains. The company’s Q2 economic return was 0.6%, after including the $0.24 per-share dividend, despite book value per share declining during the quarter.
- Key risks include interest-rate volatility, repo refinancing and margin-call risk, leverage, collateral haircuts, liquidity constraints, prepayment and extension risk, non-Agency credit risk, valuation uncertainty and counterparty exposure.
- At June 30, 2023, gross unrealized losses on RMBS were $52.0 million. Certain securities also generated $0.4 million of realized credit-related losses during the first six months.
- Level 3 assets totaled $19.3 million, primarily non-Agency RMBS and Agency interest-only securities, which rely on significant unobservable inputs and model assumptions.
- The company had $46.1 million of aggregate repo counterparty amount at risk, $21.5 million of derivative counterparty amount at risk excluding TBAs, and $2.4 million of TBA counterparty amount at risk.
- The external 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.
- The Board approved monthly dividends of $0.08 per share payable in August and September 2023.
- No material legal proceedings or material changes to previously disclosed risk factors were reported.
Most Important Facts for Investors to Verify
- Confirm the issuer identity: the supplied filing is EARN, Ellington Residential Mortgage REIT, rather than Ellington Credit Co.
- Reconcile GAAP net income with adjusted distributable earnings and assess dividend coverage, particularly as adjusted distributable earnings per share declined year over year.
- Monitor the effect of repo rates, SOFR and hedge performance on net interest margin and distributable earnings.
- Evaluate leverage, short-term repo maturities, collateral haircuts and the company’s ability to meet margin calls or refinance borrowings.
- Review the sensitivity analysis showing that a 100-basis-point rate increase was estimated to reduce portfolio fair value by $6.9 million, subject to model limitations.
- Assess the valuation and credit assumptions supporting Level 3 assets and the portfolio’s $52.0 million of gross unrealized RMBS losses.
- Verify the sustainability of the $0.08 monthly dividend against taxable income, liquidity, distributable earnings and future capital needs.