Ellington Financial Inc. — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Amounts are in U.S. dollars; financial amounts below are in millions unless stated otherwise. Ellington is an externally managed REIT with an Investment Portfolio segment and, following its October 2022 acquisition, a Longbridge reverse-mortgage origination and servicing segment.
Key financial results
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Interest income | $88.1 | $62.7 | $175.3 | $113.8 |
| Interest expense | $63.4 | $26.0 | $123.1 | $40.0 |
| Net interest income | $24.7 | $36.7 | $52.2 | $73.8 |
| Total other income (loss) | $34.7 | $(69.6) | $86.3 | $(95.0) |
| Total expenses | $42.6 | $13.1 | $80.5 | $32.7 |
| Net income (loss) | $10.7 | $(61.5) | $55.5 | $(67.9) |
| Net income (loss) attributable to common stockholders | $2.9 | $(64.9) | $41.8 | $(74.8) |
| EPS, basic and diluted | $0.04 | $(1.08) | $0.62 | $(1.27) |
- Quarterly change: Results turned profitable versus Q2 2022, primarily because derivative gains and fair-value gains on certain borrowings outweighed losses on securities and loans. Higher preferred dividends, expenses, and interest costs tempered the improvement.
- Six-month change: The return to profit reflected gains in other income, including reverse-mortgage fair-value changes, versus substantial investment losses in the prior-year period. Net interest income declined as financing costs rose.
- Margins: Management reported credit-portfolio net interest margin of 2.91%, up from 2.49% sequentially, and Agency RMBS margin of 1.31%, up from 1.14%. Its broader investment-portfolio net interest margin, excluding the catch-up premium amortization adjustment and including specified swap settlements, was 2.62% for Q2 versus 2.66% a year earlier. These are management-defined measures.
- Adjusted Distributable Earnings (non-GAAP): Common-stockholder ADE was $0.38 per share in Q2 and $0.84 per share for the first half, compared with common dividends of $0.45 and $0.90 per share, respectively. The company cautions that ADE is not GAAP income, REIT taxable income, or cash available for distribution.
Financial position, debt and liquidity
- At June 30, total assets were $14.30 billion, total liabilities $12.96 billion, and total equity $1.345 billion. Common book value per share, after deducting preferred liquidation preference, was $14.70.
- Cash and restricted cash totaled $196.2 million, down from $221.9 million at year-end 2022. Six-month operating cash flow was negative $92.0 million; investing cash flow was negative $135.3 million; financing cash flow was positive $201.6 million. Cash declined $25.7 million overall.
- Total borrowings were $12.54 billion, including $3.01 billion of recourse borrowings and $9.53 billion of non-recourse borrowings, principally HMBS obligations and non-QM securitization debt. Management’s total debt-to-equity ratio was 9.3x, versus 9.0x at March 31; recourse debt-to-equity was 2.2x. The company’s ratios exclude certain items and should be read with its stated methodology.
- Repurchase agreements were $2.56 billion, with a 6.53% weighted-average rate and maturities ranging from 3 to 697 days. The $210 million of 5.875% senior notes mature in April 2027. Total HMBS-related obligations were $8.06 billion, secured by approximately $8.2 billion of related assets.
- Management said it expects capital resources to cover short- and long-term liquidity needs. It also warned that loss of financing access, falling collateral values, higher haircuts, margin calls, or faster mortgage prepayments could pressure liquidity and force asset sales or additional debt or equity issuance. Unfunded HECM borrower advances were $1.8 billion.
Business developments, outlook and risks
- Portfolio: Loans at fair value totaled $11.82 billion, including $8.47 billion of reverse-mortgage loans. Longbridge’s Q2 net income was driven by buyout-loan resolutions, proprietary reverse-mortgage loan gains, and hedges; management cited offsetting losses on the HMBS MSR equivalent and reduced gain-on-sale margins. Management said mortgage credit performance remained generally strong, but delinquencies had increased year to date.
- Interest-rate environment: The Federal Reserve held its target rate at 5.00%–5.25% in June after ten consecutive increases. Management noted that further increases were viewed as likely by most committee participants. Higher short-term rates raised borrowing costs; management said higher asset yields and positive carry on interest-rate swaps partly offset this effect.
- Pending acquisitions: The Arlington Asset Investment Corp. merger agreement provides for 0.3619 EFC common shares per Arlington common share, subject to adjustment, plus $0.09 cash funded by the Manager; Arlington preferred shares would convert into new EFC preferred series. The Great Ajax agreement provides for 0.5308 EFC common shares per Great Ajax common share, subject to adjustment, and potentially contingent cash consideration. Both deals remained subject to shareholder approval and customary conditions at filing. EFC would assume the targets’ assets and liabilities, including their debt.
- The filing identifies merger completion, integration, financing, potential dilution, transaction costs, dividend levels, and inherited liabilities as risks. Management’s expectation of operating efficiencies and benefits is not assured. It also disclosed potential differing interests: the larger equity base after acquisitions could increase management fees payable to the Manager.
- There was no formal earnings or dividend guidance. The board declared common dividends of $0.15 per share for August and September 2023. The filing notes that future dividends are discretionary and may be affected by liquidity, earnings, REIT requirements, debt covenants, and preferred-stock claims.
- Fair-value estimates rely substantially on models and unobservable inputs: Level 3 assets were $12.26 billion at quarter-end. Management cautions that actual values may differ materially from estimates. Other exposures include interest-rate, credit, prepayment, counterparty, and refinancing risks; residential mortgage exposures are geographically concentrated, including California and Florida.
Important facts for investors to verify
- Track whether Arlington and Great Ajax receive shareholder approval, close on the stated terms and timetable, and deliver the expected benefits without excessive integration costs or added leverage.
- Reconcile GAAP earnings, management-defined ADE, common dividends, and cash generation; assess whether distributions are sustainable through changing market conditions.
- Monitor repo maturities, borrowing rates, collateral haircuts, margin requirements, counterparty exposures, and the company’s ability to refinance or roll short-term funding.
- Review fair-value assumptions and credit performance, especially reverse-mortgage/HMBS valuations, Level 3 holdings, mortgage delinquencies, and buyout-loan resolutions.
- Assess the impact of rising interest rates on funding costs, hedges, asset values, prepayments, and Longbridge origination margins, as well as the company’s substantial unfunded HECM advance commitments.