Ellington Residential Mortgage REIT (EARN) — 10-Q Summary
Business Context and Reporting Period
The filing covers the quarter and six-month period ended June 30, 2015. The registrant identified in the filing is 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 a smaller non-Agency RMBS allocation, and uses repurchase agreements and derivatives to finance assets and manage interest-rate risk.
The request metadata identifies Ellington Credit Co, but the filing text identifies the registrant as Ellington Residential Mortgage REIT.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2015 | Three Months Ended June 30, 2014 | Six Months Ended June 30, 2015 | Six Months Ended June 30, 2014 |
|---|---|---|---|---|
| Interest income | $9.8 million | $11.6 million | $20.1 million | $23.5 million |
| Net interest income | $8.3 million | $10.5 million | $17.3 million | $21.3 million |
| Total expenses | $1.3 million | $1.3 million | $2.7 million | $2.7 million |
| Net income | $0.2 million | $11.1 million | $3.9 million | $13.8 million |
| GAAP EPS | $0.02 | $1.21 | $0.42 | $1.51 |
| Core earnings per share | $0.57 | $0.75 | $1.23 | $1.52 |
- Second-quarter Core Earnings were $5.2 million, or $0.57 per share, compared with $6.8 million, or $0.75 per share, in the prior-year quarter.
- Dividends declared were $0.55 per share in each quarter, or $1.10 per share for the first six months.
- Book value per share was $17.18 at June 30, 2015, compared with $17.71 at March 31, 2015 and $17.86 at December 31, 2014.
- Total assets were $1.52 billion and shareholders’ equity was $157.2 million at June 30, 2015, compared with $163.4 million at December 31, 2014.
- Cash and cash equivalents were $44.0 million, compared with $45.2 million at year-end 2014.
- Net cash provided by operating activities for the first six months was $13.6 million; investing activities provided $53.8 million; financing activities used $68.7 million. Cash decreased by $1.3 million.
Portfolio, Debt, Liquidity and Margins
| Balance-Sheet Item | June 30, 2015 | December 31, 2014 |
|---|---|---|
| Mortgage-backed securities at fair value | $1.335 billion | $1.393 billion |
| Agency RMBS | $1.305 billion | $1.361 billion |
| Non-Agency RMBS | $30.3 million | $32.5 million |
| Repurchase agreements | $1.264 billion | $1.323 billion |
| Debt-to-equity ratio | 8.04x | 8.10x |
- Repurchase borrowings had a weighted-average interest rate of 0.41% and weighted-average remaining maturity of 90 days, versus 0.35% and 60 days at December 31, 2014.
- Average repo borrowings during the second quarter were $1.25 billion, with an annualized average repo cost of funds of 0.39%, compared with 0.34% in the prior-year quarter.
- Including periodic interest-rate swap costs and interest on short U.S. Treasury positions, annualized average cost of funds was 1.09% for the quarter and 1.01% for the first six months.
- Collateral pledged under repurchase agreements had a fair value of approximately $1.3 billion. The weighted-average contractual haircut was 4.7%.
- Operating activities and investment sales supported liquidity, but the company remains highly dependent on continued repo availability and compliance with margin requirements.
Material Changes Versus Prior Comparable Period
- Second-quarter net income declined to $0.2 million from $11.1 million, primarily because RMBS valuation losses outweighed gains on hedging derivatives.
- Second-quarter net interest income declined 21% to $8.3 million, reflecting lower asset yields and premium-amortization adjustments, while interest expense increased because of higher repo rates and greater use of short U.S. Treasury securities.
- RMBS produced net realized and unrealized losses of $16.3 million in the second quarter, compared with gains of $25.8 million in the prior-year quarter. Derivatives produced gains of $9.4 million, compared with losses of $23.9 million.
- For the first six months, net income decreased to $3.9 million from $13.8 million and Core Earnings decreased to $11.2 million from $13.9 million.
- The RMBS portfolio declined by approximately $58.5 million from year-end, primarily reflecting portfolio sales, principal repayments and market-value changes.
- Shareholders’ equity declined by $6.1 million, as $10.1 million of dividends exceeded $3.9 million of net income.
- Short U.S. Treasury positions increased to $51.2 million fair value from $14.0 million at year-end. Net derivative fair value improved to a $0.5 million asset from a $5.6 million liability.
- The company entered into a Third Amended and Restated Management Agreement effective January 1, 2015, primarily redefining shareholders’ equity for management-fee purposes. The management fee remained 1.50% annually of defined shareholders’ equity.
Guidance, Outlook, Risks and Unusual Items
- Management provided no formal earnings or dividend guidance. Dividend declarations remain at the discretion of the Board of Trustees.
- Management expects to continue targeting specified Agency pools, particularly higher-coupon securities with favorable prepayment characteristics, yields or potential trading gains.
- The second quarter featured sharply rising interest rates, wider Agency RMBS spreads and significant market volatility. Management stated that derivative hedges substantially offset portfolio losses.
- The 10-year Treasury yield increased from 1.92% to 2.35% during the quarter, while the 30-year mortgage rate increased to 4.08%. Management expects continued interest-rate and prepayment volatility.
- The company’s long Agency portfolio was $1.305 billion, down from $1.357 billion at March 31, 2015. Its non-Agency portfolio was $30.3 million, down 4.5% from March 31.
- Net Agency premium as a percentage of long Agency RMBS fair value decreased to approximately 3.8% from 4.7% at March 31, reflecting greater use of short TBAs and lower specified-pool pay-ups.
- Primary risks include rising interest rates, refinancing and prepayment volatility, repo refinancing and margin-call risk, leverage, valuation uncertainty, non-Agency credit losses, counterparty exposure, regulatory changes affecting the GSEs, REIT qualification and Investment Company Act status.
- At June 30, three counterparties represented more than 5% of shareholders’ equity in repo exposure: J.P. Morgan Securities, RBC Capital Markets and Deutsche Bank Securities.
- Management reported no significant legal contingencies and no material changes to previously disclosed risk factors. No material off-balance-sheet arrangements were reported.
- Level 3 assets totaled $12.6 million. The company transferred $4.8 million of non-Agency RMBS from Level 3 to Level 2 and $3.3 million from Level 2 to Level 3, reflecting changes in price transparency.
- The filing reproduced an affiliate disclosure concerning Travelport’s Iran-related activities; the related gross revenue and net profit were still being determined and were not provided to EARN.
Important Facts for Investors to Verify
- Confirm the correct issuer identity, because the filing names Ellington Residential Mortgage REIT rather than Ellington Credit Co.
- Assess whether the $0.55 quarterly dividend was supported by Core Earnings of $0.57 per share and whether future dividends can be maintained under changing financing costs and asset values.
- Monitor book value, Agency RMBS spreads, interest-rate hedging results and the effect of further rate increases on the highly leveraged balance sheet.
- Review repo counterparties, haircuts, maturity concentration, margin-call requirements and the availability of replacement financing.
- Evaluate fair-value sensitivity, particularly the approximately $8.9 million estimated portfolio decline from an immediate 100-basis-point rate increase, noting that management’s model relies on assumptions about prepayments, yield-curve changes and volatility.
- Verify the company’s continued REIT qualification, dividend requirements, external-management economics and potential termination-fee obligations.