Ellington Financial Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended September 30, 2022. Ellington Financial is an externally managed REIT investing in mortgage-related assets, loans, securities, derivatives, and related businesses. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Financial results and position
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Net interest income | $36.5 | $29.5 | $110.3 | $93.0 |
| Net income (loss) | $(29.7) | $24.0 | $(97.7) | $101.7 |
| Net income (loss) attributable to common stockholders | $(33.3) | $20.6 | $(108.1) | $91.1 |
| GAAP earnings (loss) per common share | $(0.55) | $0.41 | $(1.82) | $1.99 |
| Adjusted Distributable Earnings attributable to common stockholders (non-GAAP), per share | $26.5; $0.44/share | $23.0; $0.46/share | $74.6; $1.26/share | $64.0; $1.40/share |
Balance sheet at September 30: Total assets were $6.343 billion and total liabilities were $5.162 billion; total equity was $1.181 billion. Cash and cash equivalents were $175.2 million. Securities were $1.523 billion, loans $3.823 billion, and investments in unconsolidated entities $171.4 million. Book value per common share was $15.22, calculated after deducting preferred liquidation preference.
Funding and leverage: Repurchase agreements were $2.895 billion; other secured borrowings were $1.677 billion, including $1.636 billion of fair-valued securitization debt; and $210 million of 5.875% senior notes mature in April 2027. The $86 million 5.50% senior notes were repaid at maturity in September. Total debt-to-equity was 4.1:1 (3.8:1 at June 30); adjusted recourse debt-to-equity, excluding U.S. Treasuries and adjusted for unsettled trades, was 2.6:1. Q3 average secured funding cost increased to 3.14% from 2.03% in Q2. The filing reports $3.154 billion of contractual principal repayments due in the next 12 months, including repos.
Cash flow, nine months: Operating activities provided $70.2 million; investing activities used $1.586 billion; financing activities provided $1.598 billion. Cash increased by $82.4 million to $175.2 million. Dividends paid were $91.5 million.
Changes and operating performance
- Net losses replaced prior-year profits, driven chiefly by fair-value and realized losses on securities and loans (Q3 $(184.0) million; nine months $(528.5) million) and losses from unconsolidated investments (Q3 $(25.5) million; nine months $(54.3) million).
- Derivative gains and fair-value gains on securitization borrowings partly offset asset losses. Q3 derivative gains were $69.3 million and gains on fair-valued other secured borrowings were $79.4 million. These borrowing gains are accounting marks and correspond to securitized non-QM loan fair-value losses; they are not equivalent to operating cash gains.
- Interest income rose substantially, but so did funding expense: Q3 interest income was $78.6 million versus $40.1 million; interest expense was $42.1 million versus $10.6 million. The increase reflected a larger credit portfolio and higher financing rates and borrowings.
- Q3 net interest margin, excluding the Agency premium catch-up adjustment and incorporating interest-rate swap settlements in funding cost, was 2.42% versus 3.40% a year earlier. Credit-portfolio margin declined quarter over quarter to 2.34% from 2.75%; Agency RMBS margin fell to 1.00% from 1.76%.
- Long credit investments, excluding non-retained securitization tranches, grew 3% quarter over quarter to $2.742 billion, mainly from residential transition loans. Long Agency RMBS declined 15% to $1.135 billion. Residential mortgage loans increased to $3.823 billion from $2.415 billion at year-end; consumer loans declined sharply after the sale of most performing loans into a securitization.
- Fair-value declines include substantial unrealized amounts. The company reported $4.224 billion of Level 3 assets at quarter-end, making model inputs and unobservable valuations important to reported results.
Outlook, risks, and notable items
- Management provided no specific numerical earnings or return guidance. It described an opportunistic, flexible investment strategy and expects to continue holding some Agency RMBS, while shifting allocations as credit and liquidity conditions change. Management stated that capital resources were expected to meet anticipated short- and long-term liquidity needs.
- Management cited rapid Federal Reserve tightening, rising rates, widening spreads, elevated volatility, and weaker mortgage origination economics. It reported Q3 2022 10-year Treasury yields up 81 basis points and 30-year mortgage rates at 6.70%. Rising rates and spreads pressured asset marks and loan-originator valuations.
- Liquidity risks include repo renewals and margin calls, collateral haircuts, prepayment-related cash timing, and counterparty concentration. At September 30, repo rates ranged from 0.20% to 6.89%, average repo rate was 4.00%, and weighted-average repo maturity was 106 days. Nomura’s reported repo amount at risk was $209.5 million, or 17.7% of equity. Management warned that inability to finance Agency RMBS or severe asset-value declines could strain liquidity and force asset sales or new financing.
- Credit, default and recovery risks affect mortgage, consumer, corporate, and securitized assets. Residential loans were geographically concentrated, including 34.2% of unpaid principal in California; commercial loan exposure included 69.8% multifamily by property type. Two commercial mortgage loans totaling $31.8 million were non-performing, and $38.4 million of residential mortgage principal was 90 days or more past due.
- On October 3, 2022, after quarter-end, the company paid $38.9 million for an additional 49.6% interest in Longbridge, bringing its ownership to a controlling interest. It expected to consolidate Longbridge beginning in Q4, adding reverse mortgage and servicing activities and a separate segment. Purchase accounting was incomplete at filing. Longbridge-related risks include funding and covenant compliance, FHA/Ginnie Mae requirements, regulatory changes, and reliance on a single reverse-mortgage subservicer.
- The company recorded a $18.7 million valuation allowance fully reserving deferred tax assets at its taxable REIT subsidiary. It reported no material legal proceedings and said disclosure controls were effective, with no material quarter changes to internal control over financial reporting.
- The Board declared common dividends of $0.15 per share payable in November and December 2022. Q3 Adjusted Distributable Earnings were $0.44 per common share versus $0.45 declared; nine-month Adjusted Distributable Earnings were $1.26 per share versus $1.35 declared. This non-GAAP measure is not REIT taxable income or cash available for distribution.
Most important facts for investors to verify
- How much of the reported loss reflects realized losses versus fair-value marks, and how sensitive are Level 3 valuations to yields, defaults, prepayments, and recoveries?
- Whether portfolio income can keep pace with higher financing costs, and whether margins and dividend coverage stabilize.
- Repo rollovers, haircuts, collateral and counterparty exposures, near-term repayment needs, and available liquidity after the Longbridge cash purchase.
- Longbridge’s post-acquisition results, purchase accounting, funding and covenant position, and ability to maintain FHA/Ginnie Mae approvals and servicing arrangements.
- Credit performance and concentration in residential transition/non-QM loans, commercial mortgages, and consumer assets, including delinquency and foreclosure trends.
- Whether distributions remain sustainable given GAAP losses, leverage, REIT distribution requirements, and the distinction between Adjusted Distributable Earnings and taxable or distributable cash.