Ellington Credit Company: Q1 2024 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three months ended March 31, 2024. The company approved a strategic transformation on March 29, 2024, transitioning from a primarily residential mortgage-backed securities strategy to corporate collateralized loan obligations. It revoked its REIT election effective January 1, 2024 and began operating as a taxable C corporation. The company changed its name from Ellington Residential Mortgage REIT to Ellington Credit Company on April 19, 2024.
Management intends to gradually liquidate mortgage-related assets, expand CLO investments, and seek shareholder approval later in 2024 to convert to a registered closed-end fund taxed as a regulated investment company. The company remains externally managed and has no employees.
Financial performance and key metrics
| Metric | Q1 2024 | Q1 2023 |
|---|---|---|
| Interest income | $10.4 million | $9.3 million |
| Interest expense | $10.1 million | $9.7 million |
| Net interest income (expense) | $0.3 million | $(0.4) million |
| Total expenses | $1.6 million | $1.3 million |
| Other income | $5.6 million | $4.0 million |
| Net income | $4.0 million | $2.3 million |
| Basic and diluted EPS | $0.20 | $0.17 |
| Adjusted Distributable Earnings | $5.3 million, or $0.27 per share | $2.8 million, or $0.21 per share |
- Adjusted net interest margin, excluding catch-up amortization adjustments, was 3.03%, versus 1.16% in Q1 2023. Portfolio yield was 5.20%, while adjusted cost of funds was 2.17%.
- Net realized and unrealized gains on derivatives were $13.7 million, principally reflecting gains on interest rate swaps as rates increased. Securities produced net realized and unrealized losses of $8.1 million, including $10.8 million of Agency RMBS losses, partially offset by CLO and non-Agency RMBS gains.
- Total assets were $964.0 million and shareholders’ equity was $142.9 million at March 31, 2024, compared with $945.7 million and $136.2 million, respectively, at December 31, 2023.
- Book value per share was $7.21, down from $7.32 at year-end after a $0.24 per-share dividend; economic return was 1.8%.
- Securities at fair value totaled $812.0 million. CLO holdings increased to $45.1 million from $17.4 million at December 31, 2023, consisting of $33.8 million of CLO notes and $11.3 million of CLO equity.
- Cash and cash equivalents were $22.4 million, down from $38.5 million. Management also reported $57.1 million of other unencumbered assets.
Debt, liquidity and cash flow
- Repurchase agreement borrowings were $683.2 million at March 31, 2024, down from $729.5 million at year-end, with a weighted-average rate of 5.47% and 19 counterparties. Approximately 96% was collateralized by Agency RMBS.
- Total debt-to-equity was 4.8:1, or 4.9:1 adjusted for unsettled transactions, versus 5.4:1 and 5.3:1, respectively, at December 31, 2023.
- Operating activities used $1.2 million of cash; investing activities provided $40.6 million; and financing activities used $55.5 million. Cash decreased by $16.1 million during the quarter.
- The company issued 1.2 million common shares through its ATM programs for $7.4 million of net proceeds. Remaining authorization under the 2023 ATM program was $78.4 million at March 31, 2024.
- Dividends declared totaled $0.24 per share for the quarter. The board subsequently approved monthly dividends of $0.08 per share payable in May and June 2024.
Material changes versus prior comparable periods
- Net income increased 69% to $4.0 million from $2.3 million, driven by positive net interest income and stronger derivative results.
- Interest income increased 11%, while interest expense increased 4%; expenses increased 25%, primarily due to higher management, professional and compensation costs.
- Derivative results improved from an $8.8 million net loss in Q1 2023 to a $13.7 million net gain in Q1 2024. Securities results declined from a $12.8 million net gain to an $8.1 million net loss, reflecting higher rates and weaker Agency RMBS pricing.
- Average credit-portfolio holdings increased to $44.1 million from $20.7 million, while average Agency holdings declined to $732.6 million from $970.9 million.
- Common shares outstanding increased to 19.8 million from 13.8 million at March 31, 2023, primarily due to ATM issuance.
- The company incurred $0.3 million of income tax expense in Q1 2024; no income tax expense was recorded in Q1 2023 while the company operated as a REIT.
Guidance, outlook, risks and unusual items
Management plans to substantially increase CLO investments and reduce mortgage-backed securities holdings. Immediately before a planned RIC conversion, it expects to liquidate most remaining mortgage and real-estate-related assets and reduce leverage to levels permitted under the Investment Company Act. No assurance is provided that shareholder approval or the conversion will occur.
- The company had approximately $36.2 million of federal NOL carryforwards at March 31, 2024. A valuation allowance of $11.1 million was recorded against remaining deferred tax assets after expected utilization of approximately $0.6 million.
- A Rights Agreement entered into on April 23, 2024 is intended to preserve NOLs by discouraging ownership of 4.9% or more of the common shares without board approval. It may limit share accumulation, deter potential acquirers and reduce market liquidity.
- CLO investments generally involve below-investment-grade corporate loans, leverage, first-loss exposure, credit deterioration and liquidity risk. CLO warehouse or loan accumulation facilities could expose the company to losses if collateral cannot be placed into a CLO.
- Short-term repo financing creates refinancing, margin-call and collateral risk. Changes in asset values, haircuts or counterparty terms could require additional collateral or forced asset sales.
- Reported fair values include $35.3 million of Level 3 securities. Valuations depend on models, third-party pricing and assumptions regarding yields, prepayments, defaults and recoveries.
- Management identified no material legal proceedings or significant contingencies, and reported effective disclosure controls as of March 31, 2024.
Important facts for investors to verify
- Whether the planned closed-end fund and RIC conversion receives the required shareholder approvals and is completed on the expected timetable.
- The pace and economics of the shift from Agency RMBS to CLO notes, CLO equity and any loan accumulation facilities.
- Actual dividend coverage, particularly because Adjusted Distributable Earnings excludes significant realized and unrealized valuation changes and may not equal cash available for distribution.
- Repo renewal terms, collateral haircuts, margin requirements, counterparty concentrations and the effect of leverage on liquidity.
- The recoverability and Section 382 limitations of the company’s NOL carryforwards.
- Level 3 valuation assumptions and sensitivity to interest rates, credit spreads, defaults, recoveries and prepayment speeds.
- Future dilution from the ATM program and the potential effects of the Rights Agreement on share ownership and market liquidity.