Ellington Financial Inc. (Ellington Financial LLC) — Q1 2013 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2013; unaudited results are compared with Q1 2012. Ellington is an externally managed specialty finance company investing primarily in mortgage-related assets and derivatives. From January 1, 2013, operations are conducted through its operating partnership, of which the Company owned 99% at quarter-end.
Key financial metrics
| Metric | Q1 2013 / March 31, 2013 | Comparable / prior date |
|---|---|---|
| Interest income | $18.4 million | $15.7 million in Q1 2012 |
| Net investment income | $10.6 million | $11.0 million in Q1 2012 |
| Net increase in equity from operations | $40.7 million; $40.3 million attributable to shareholders; $1.94 per share | $32.1 million; $1.90 per share in Q1 2012 |
| Assets / liabilities / total equity | $2.317 billion / $1.796 billion / $520.6 million | $2.152 billion / $1.646 billion / $506.4 million at December 31, 2012 |
| Cash and cash equivalents | $64.8 million | $59.1 million at December 31, 2012 |
| Reverse-repo borrowings | $965.3 million; debt-to-equity ratio 1.86:1 | $905.7 million at December 31, 2012 |
| Investment fair value | $1.536 billion | $1.375 billion at December 31, 2012 |
| Book value per common share | $25.28 | $24.86 at December 31, 2012 |
Net investment income was 9.41% of average equity versus 11.51% a year earlier. Total expenses were $7.8 million, including a $2.1 million incentive fee, versus $4.8 million and no incentive fee in Q1 2012. Average repo borrowing cost was 0.80%, compared with 0.78%.
Cash used in operating activities was $26.5 million; financing provided $32.2 million, including net repo borrowings and a $4.7 million non-controlling-interest contribution. Cash increased $5.7 million. Dividends paid were $31.9 million. Net asset-based total return was 7.87% versus 8.66% in Q1 2012; market-based total return was 16.90% versus 16.21%.
Material changes versus prior periods
- Operating results improved, principally because of realized and unrealized gains in non-Agency mortgage assets amid a continuing market rally. Net gains on investments were $36.8 million, partly offset by $6.7 million of derivative losses.
- Non-Agency RMBS fair value rose to $553.6 million from $524.9 million at year-end; Agency RMBS rose to $844.8 million from $767.6 million. The Company also acquired $11.6 million of CLOs and reduced CMBS holdings.
- Net short TBA exposure decreased to $517.3 million from $565.1 million. Net short interest-rate swap notional increased to $530.8 million from $236.4 million; the Company also increased short credit protection positions on corporate bond indices.
- Reverse-repo borrowings increased by $59.6 million. The Company reported 12 repo counterparties, up from 10 at year-end, and average remaining repo maturity of 81 days versus 57 days.
- The management agreement was revised effective January 1, 2013, moving fee calculations to the operating-partnership level. A 1% non-controlling interest was reflected in results and equity.
Outlook, commentary, risks, and unusual items
- Management expected near-term support for non-Agency MBS from improving housing indicators, continued demand for yield, and accommodative Federal Reserve policy, while emphasizing security selection and active portfolio rotation. No specific earnings or return guidance was provided.
- Management noted Agency RMBS prepayment and valuation risks, including uncertainty around Federal Reserve policy and elevated refinancing activity. It used short TBAs, swaps, and other instruments to manage interest-rate and prepayment exposure.
- Key risks include credit losses and foreclosure delays, prepayments, interest-rate volatility, repo rollover and margin-call risk, financing-market disruption, and counterparty concentration. Management warned that inability to finance Agency RMBS could create significant liquidity strain.
- Fair values include substantial Level 3 exposure: $601.2 million of investments and $26.4 million of derivative assets. Valuations rely on third-party indications and models using judgmental assumptions such as prepayments, losses, recoveries, and yields; actual sale values may differ materially.
- The Board approved a $0.77-per-share Q1 dividend payable June 17, 2013. The quarter’s reported dividends declared included $0.77 per share and a special $0.75 per share. No material legal proceedings were reported; management said disclosure controls were effective.
Important facts for investors to verify
- Whether the non-Agency MBS rally, gains, and reported book value are sustainable, given the portfolio’s credit exposure and Level 3 valuation uncertainty.
- Repo availability, collateral terms, counterparty concentrations, maturity schedule, and the effect of potential margin calls on liquidity.
- Whether interest income can support dividends after management fees, incentive fees, financing costs, and other expenses.
- The evolving balance between Agency RMBS, non-Agency assets, TBAs, and credit and interest-rate hedges, including the risks from prepayments and changing rates.
- That the $1.94 per-share operating result includes substantial realized and unrealized gains and should not be treated as a recurring earnings forecast.