Ellington Residential Mortgage REIT (EARN) — Form 10-Q Summary
Reporting period: Quarter and six months ended June 30, 2014. The supplied metadata identifies “Ellington Credit Co,” but the filing registrant is Ellington Residential Mortgage REIT.
Business Context
EARN is an externally managed Maryland REIT investing primarily in Agency residential mortgage-backed securities, with a smaller non-Agency RMBS portfolio. It finances Agency RMBS principally through short-term repurchase agreements and uses interest-rate swaps, swaptions and TBA contracts to hedge borrowing-cost and interest-rate exposure. The company had 9,139,842 common shares outstanding at June 30, 2014 and no preferred shares outstanding.
Financial Metrics
| Metric | Three months ended June 30, 2014 | Six months ended June 30, 2014 |
|---|---|---|
| Interest income | $11.6 million | $23.5 million |
| Interest expense | $1.1 million | $2.2 million |
| Net interest income | $10.5 million | $21.3 million |
| Total expenses | $1.3 million | $2.7 million |
| Net income | $11.1 million | $13.8 million |
| Basic earnings per share | $1.21 | $1.51 |
| Core earnings, non-GAAP | $6.8 million, or $0.75 per share | $13.9 million, or $1.52 per share |
| Dividends declared per share | $0.55 | $1.10 |
- Assets: $1.524 billion at June 30, 2014, compared with $1.511 billion at December 31, 2013.
- RMBS portfolio: $1.344 billion at fair value, including $1.309 billion of Agency RMBS and $35.7 million of non-Agency RMBS.
- Cash and liquidity: $49.9 million of cash and cash equivalents, broadly unchanged from $50.1 million at year-end.
- Debt: $1.286 billion of repurchase agreements, with a weighted-average interest rate of 0.33% and approximately 50 days of remaining maturity.
- Leverage: Debt-to-equity ratio of 7.52 to 1, versus 7.84 to 1 at December 31, 2013.
- Equity and book value: Shareholders’ equity of $171.0 million and book value per share of $18.71, versus $167.2 million and $18.29, respectively, at year-end.
- Portfolio yield and funding cost: Weighted-average RMBS yield was 3.43% for the quarter and 3.45% for the six-month period. Average repo cost was 0.34% for the quarter and 0.36% for the six-month period; including interest-rate swaps, management reported average funding costs of 1.10% and 1.12%, respectively.
- Cash flow: Operating activities provided $9.9 million and investing activities provided $24.3 million during the first six months. Financing activities used $34.4 million, including $9.6 million of dividends paid. Cash decreased by $0.2 million.
Material Changes Versus Prior Comparable Period
- Second-quarter net income improved from a $9.7 million loss in 2013 to $11.1 million of income in 2014; six-month results improved from an $8.6 million loss to $13.8 million of income.
- Net interest income increased from $3.8 million to $10.5 million for the quarter and from $4.1 million to $21.3 million for the six-month period, primarily reflecting the larger investment portfolio.
- RMBS-related gains were $25.8 million in the quarter and $40.4 million for the six-month period, compared with losses of $48.8 million and $47.7 million, respectively, in the prior-year periods.
- Derivative results reversed: the company recorded derivative losses of $23.9 million for the quarter and $45.1 million for the six-month period, compared with gains of $36.7 million in the respective 2013 periods. Falling long-term interest rates increased RMBS values but reduced the value of interest-rate hedges.
- Core earnings rose from $1.3 million to $6.8 million for the quarter and from $1.4 million to $13.9 million for the six-month period.
- The RMBS portfolio increased modestly from $1.326 billion at year-end to $1.344 billion, while derivative net carrying value declined from $33.9 million to $3.3 million.
- The company shifted modestly away from 30-year pools toward 15-year and adjustable-rate Agency RMBS and increased non-Agency RMBS fair value from $30.7 million to $35.7 million.
Outlook, Commentary and Risks
- Management reported that Agency and non-Agency RMBS rallied during the quarter as interest rates declined and volatility remained relatively low. Repo financing remained readily available, with increased lender competition and lower borrowing costs.
- The Federal Reserve continued tapering asset purchases, reducing monthly purchases to $25 billion overall by quarter-end, while maintaining a federal funds target range of 0% to 0.25%. Management expects continued tapering and potential increases in mortgage originations to pressure Agency RMBS valuations.
- Management expects prepayments may increase, which could adversely affect specified pools and interest-only securities. Prepayment behavior remains a major driver of asset performance.
- Key risks include rising interest rates, market volatility, repo refinancing and margin-call risk, changes in Agency RMBS and GSE policies, prepayment risk, credit losses and valuation uncertainty in non-Agency RMBS, and reduced dealer or bank liquidity due to regulatory capital changes.
- Fair-value measurements included $49.9 million of Level 3 RMBS assets, valued using market quotes and discounted-cash-flow models with significant assumptions regarding yields, prepayments, losses and recoveries.
- The company expects available cash, investment cash flows and financing capacity to satisfy anticipated liquidity needs, but substantially all borrowings are short-term and collateralized by Agency RMBS.
- No material legal proceedings or significant contingencies were reported. Management concluded disclosure controls were effective as of June 30, 2014.
- The external management agreement provides for a 1.50% annual management fee based on defined shareholders’ equity, reimbursement of certain expenses without a dollar limit, and a potential termination fee equal to 5% of defined shareholders’ equity.
Important Facts for Investors to Verify
- Confirm the issuer identity because the filing is for Ellington Residential Mortgage REIT, not an entity named Ellington Credit Co.
- Assess sustainability of core earnings and the $0.55 quarterly dividend against taxable income, cash generation and hedging costs.
- Review sensitivity to interest-rate movements: modeled total portfolio value changed by approximately negative $11.4 million for either an immediate 100-basis-point increase or decrease in rates.
- Monitor the 7.52-to-1 debt-to-equity leverage ratio, short repo maturities, collateral haircuts and counterparty concentrations.
- Evaluate the effect of higher prepayments on Agency specified pools and interest-only securities.
- Review Level 3 valuation assumptions and the credit, loss-severity and liquidity risks of the non-Agency RMBS portfolio.
- Track Federal Reserve tapering, GSE reform proposals, bank capital regulations and their effects on MBS pricing and repo availability.