Ellington Financial LLC (EFC) — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011; financial statements are unaudited. The filing identifies the registrant as Ellington Financial LLC. The company is an externally managed specialty finance business focused on mortgage-related assets and derivatives.
Key financial metrics
| Metric | Q2 2011 / June 30, 2011 | Comparable period / prior year-end |
|---|---|---|
| Interest income | $16.7 million for Q2; $32.5 million for first half | $10.8 million and $22.7 million, respectively, in 2010 |
| Net investment income | $12.1 million for Q2; $22.7 million for first half | $6.7 million and $14.1 million, respectively, in 2010 |
| Net result from operations | Q2 loss of $1.3 million, or $(0.08) per share; first-half income of $9.8 million, or $0.58 per share | Q2 2010 income of $3.7 million, or $0.30 per share; first-half 2010 income of $11.3 million, or $0.92 per share |
| Net asset value per share | $23.31 | $24.47 at December 31, 2010 |
| Total assets / shareholders’ equity | $1.98 billion / $384.9 million | $2.33 billion / $403.7 million at December 31, 2010 |
| Cash and cash equivalents | $45.4 million | $35.8 million at December 31, 2010 |
| Reverse-repurchase borrowings | $801.9 million; debt-to-equity ratio 2.08:1 | $777.8 million and 1.93:1 at December 31, 2010 |
| Cash flow | First-half operating cash flow $14.8 million; financing cash use $5.2 million; cash increased $9.6 million | First-half 2010 operating cash flow $157.4 million; cash increased $6.5 million |
Q2 net asset-based total return after incentive fee was -0.37%; first-half return was 2.26%. Market-based total return, including reinvested dividends, was -7.01% for Q2 and 1.86% for the first half. The reported annualized net investment income ratio was 12.43% for Q2 and 11.73% for the first half; total expense ratios were 4.71% and 4.86%, respectively.
Material changes versus comparable periods
- Q2 results swung from $3.7 million of income in 2010 to a $1.3 million loss in 2011. Higher net investment income was more than offset by investment valuation losses, especially in non-Agency mortgage securities and short TBA and Treasury positions.
- First-half income declined to $9.8 million from $11.3 million. Net investment income increased substantially, but investment gains turned to losses; derivative results improved compared with 2010.
- Interest income rose with a larger portfolio following the October 2010 public offering and increased leverage. Average first-half borrowings grew to $875.9 million from $481.0 million.
- Portfolio mix shifted: non-Agency MBS and commercial mortgage holdings rose to $372.5 million from $334.9 million, while Agency RMBS excluding TBAs fell to $780.2 million from $851.0 million. Net short TBA exposure declined to $475.0 million from $695.3 million.
- Dividends paid in the first half totaled $28.9 million, versus $18.5 million in first-half 2010. The declared quarterly dividend was $0.40 per share, compared with $0.25 for Q2 2010.
Outlook, risks and unusual items
- Management said non-Agency RMBS strategies were the primary drivers of risk and return and expected to remain so near term; it expected CMBS and commercial mortgage loans to grow as components of the strategy. No numerical earnings or return guidance is provided.
- Management believed available capital resources would meet anticipated liquidity needs. It cautioned that inability to finance Agency RMBS could cause serious short-term liquidity strain; falling collateral values could trigger margin calls, forced asset sales, and financing constraints. Reverse repos had remaining terms of 7 to 237 days; about 79% were with four counterparties.
- Key exposures include mortgage credit and loss severity, prepayments, interest-rate movements, illiquid private-label securities, valuation uncertainty, counterparty concentration and reliance on repo financing. Approximately $378.7 million of investments and $69.8 million of derivative assets were Level 3 at quarter-end, valued using significant unobservable inputs and judgment.
- Q2 non-Agency MBS valuations were pressured by Federal Reserve sales from Maiden Lane II and broader risk-asset weakness; Agency securities strengthened as interest rates fell, hurting short TBA and Treasury positions. Management noted that prices in some non-Agency sectors had declined 10% to 30% from March 31, before partial recovery after quarter-end developments.
- Subsequent events: the board approved a $0.40 per-share dividend payable September 15, 2011 and a $10 million share-repurchase program. S&P downgraded the U.S. long-term rating on August 5 and Fannie Mae and Freddie Mac on August 8; management said the ultimate market impact was unclear.
- The filing reports no material legal proceedings against the company or Manager and no material changes to previously disclosed risk factors. Management concluded disclosure controls were effective as of June 30, 2011.
Important facts for investors to verify
- Whether reported fair values for Level 3 private-label securities and credit derivatives remain supportable given limited liquidity and significant valuation assumptions.
- Repo renewal capacity, margin requirements, collateral availability and counterparty concentration, particularly under adverse market moves.
- How credit losses, foreclosure delays, prepayment speeds and interest-rate changes affect portfolio income and book value.
- Whether the $0.40 quarterly dividend is sustainable relative to recurring investment income, realized and unrealized results, and liquidity needs.
- The effects of the post-quarter U.S. and GSE rating downgrades, the proposed Bank of America mortgage settlement, and the announced share-repurchase program.