Ellington Financial LLC — Q1 2016 Form 10-Q
Reporting period: Unaudited quarter ended March 31, 2016; results are compared with Q1 2015 and balance-sheet amounts with December 31, 2015. Ellington is an externally managed specialty finance company investing primarily in mortgage assets and related derivatives, alongside consumer loans, CLOs, corporate credit, and other financial assets. Amounts below are U.S. dollars; financial statement amounts are generally in millions unless noted.
Financial results and position
- Investment income and profit: Total investment income was $22.1 million versus $26.8 million. Net investment income fell to $11.8 million from $17.5 million. The company reported a $23.2 million decrease in shareholders’ equity from operations, or $(0.69) per share, versus a $19.3 million increase, or $0.57 per share, in Q1 2015.
- Drivers and margins: Net realized and unrealized losses on investments, derivatives, and foreign currency totaled $35.0 million, versus a $2.0 million gain a year earlier. Net interest margin, including interest-rate swap payments, was 4.01%, down from 4.41%; net investment income to average equity was 6.58%, down from 8.92%.
- Cash flow and liquidity: Operating activities used $19.0 million, compared with providing $338.2 million in Q1 2015. Cash and cash equivalents declined to $142.1 million from $183.9 million; restricted cash was $4.5 million. The company said it expected available cash, investment cash flows, and financing access to meet liquidity needs, while warning that financing disruption or margin calls could strain liquidity.
- Assets, equity, and per-share value: Total assets were $2.903 billion and total liabilities $2.208 billion, compared with $2.992 billion and $2.253 billion at year-end. Total equity was $694.9 million, down from $739.0 million. Reported common equity per share was $20.91 versus $22.10; diluted book value per share was $20.63 versus $21.80.
- Debt and leverage: Reverse repurchase borrowings were $1.149 billion and new securitized debt was $23.2 million. Management reported debt-to-equity of 1.69:1 (1.67:1 excluding U.S. Treasury securities). The quarter’s average cost of funds was 1.06%, up from 0.75% in Q1 2015; including interest-rate swap payments, average cost of funds was 1.34% versus 1.02%.
- Portfolio: Investments at fair value totaled $1.626 billion. Agency RMBS remained a major holding; long Credit assets were approximately $600.3 million. Consumer loans and related ABS grew to $143.9 million fair value from $115.4 million at year-end. The company also held $712.1 million of investments sold short and reported $190.8 million of derivative assets and $85.7 million of derivative liabilities.
Material changes versus comparable periods
- Results swung from Q1 2015 profit to a Q1 2016 loss, reflecting substantially larger investment and derivative losses and lower net investment income.
- Interest income declined to $20.4 million from $26.5 million, primarily due to lower average portfolio holdings and a lower average yield in the Credit portfolio. Average borrowings also fell, but financing costs rose.
- Management attributed losses to volatile markets: credit spreads widened early in the quarter and then rallied, hurting the company’s long structured-credit holdings and short credit hedges. Falling interest rates also hurt interest-rate hedges.
- Equity declined $44.0 million during the quarter, reflecting operating losses, $16.9 million of dividends, $1.9 million of distributions to non-controlling interests, and $2.8 million of share repurchases, partly offset by non-controlling-interest contributions.
- The company entered a commercial-loan and real-estate securitization financing in March, recording $23.2 million of debt against collateral with a reported fair value of $39.1 million. It repurchased 163,033 shares at an average $17.38 per share.
Outlook, commentary, and risks
- Outlook: No quantitative earnings guidance was provided. Management said it would continue to adjust asset allocations and hedges as market conditions change, and saw potential opportunities in credit-sensitive assets and consumer and mortgage loans.
- Markets: Management described Q1 volatility as extremely high. It cited a 50-basis-point decline in the 10-year Treasury yield to 1.77%, and noted that the Federal Reserve held its target rate at 0.25%–0.50%. Management saw continued risk of rising rates, spread volatility, and higher prepayments.
- Financing and liquidity risks: Reverse repos are short-term, collateralized borrowings subject to renewal and margin calls; 39.4% of outstanding reverse repos matured within 30 days at quarter-end. Management warned that loss of Agency RMBS financing, falling collateral values, derivative movements, or rapid prepayments could cause liquidity pressure and require asset sales or new financing.
- Credit, valuation, and concentration risks: The portfolio includes non-performing and distressed loans, unsecured consumer loans, subordinated CMBS B-pieces, and derivatives. Significant assets are Level 3 and depend on unobservable inputs and management estimates; the filing cautions that actual fair values may differ materially. Credit, interest-rate, prepayment, foreign-exchange, counterparty, and funding risks are material.
- Commitments and contingencies: Consumer-loan purchase commitments included $34.1 million remaining under one agreement and a separate $375 million commitment under which $2.7 million had been purchased. The company also disclosed a $12.5 million maximum guarantee of a mortgage-originator warehouse facility, a separate guarantee tied to a repo facility with approximately $123.6 million drawn, and $13.6 million of mortgage-loan purchase commitments contingent on closings.
- Distributions and legal matters: The board approved a $0.50-per-share Q1 dividend, payable June 15, 2016. The company reported no material legal proceedings and no material changes to previously disclosed risk factors.
Most important facts for investors to verify
- Whether operating and investment performance recover from the Q1 loss, and how income and distributions compare over subsequent quarters.
- Current reverse-repo availability, renewal terms, haircuts, counterparty exposures, and the company’s ability to meet collateral calls.
- Performance and fair-value assumptions for Level 3 holdings, especially loans, consumer assets, non-Agency securities, and distressed credit.
- Exposure and potential cash requirements under loan-purchase commitments, guarantees, and the jointly financed commercial-asset securitization.
- Whether dividend levels remain supportable alongside book value, liquidity requirements, leverage, and share repurchases.