Ellington Financial Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Unaudited results. Ellington Financial is an externally managed mortgage and credit-focused REIT; results include its Longbridge reverse-mortgage origination and servicing business, acquired in October 2022.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Interest income | $96.2 million | $78.6 million | $271.5 million | $192.4 million |
| Interest expense | $68.7 million | $42.1 million | $191.8 million | $82.1 million |
| Net interest income | $27.5 million | $36.5 million | $79.7 million | $110.3 million |
| Net income (loss) | $13.1 million | $(29.7) million | $68.6 million | $(97.7) million |
| Net income (loss) attributable to common stockholders | $6.6 million | $(33.3) million | $48.4 million | $(108.1) million |
| GAAP diluted EPS | $0.10 | $(0.55) | $0.72 | $(1.82) |
| Adjusted Distributable Earnings attributable to common stockholders per share (non-GAAP) | $0.33 | $0.44 | $1.17 | $1.26 |
Q3 non-GAAP Adjusted Distributable Earnings (ADE) per share was below the $0.45 common dividend per share; nine-month ADE per share was below the $1.35 declared per share. Management cautions that ADE is not GAAP net income, REIT taxable income, or a direct measure of cash available for distribution.
- Balance sheet at September 30: Assets $14.45 billion; liabilities $13.11 billion; total equity $1.34 billion. Common book value per share, after preferred liquidation preference, was $14.33.
- Liquidity and cash flow: Cash and cash equivalents were $174.7 million, plus $1.6 million restricted cash, versus $217.1 million and $4.8 million, respectively, at year-end 2022. Nine-month operating cash flow was $(162.9) million and investing cash flow $(121.5) million; cash, cash equivalents and restricted cash fell $45.6 million to $176.3 million.
- Debt and leverage: Total borrowings were $12.67 billion, including $2.57 billion repos, $1.71 billion other secured borrowings (including fair-value debt), $8.18 billion HMBS obligations and $210 million senior notes at par. Total debt-to-equity was 9.5:1; recourse debt-to-equity was 2.3:1. Average secured financing cost was 5.55% in Q3, up from 5.31% in Q2; repo rates at quarter-end ranged from 4.73% to 9.32%.
- Margins: Investment Portfolio credit net interest margin rose slightly quarter over quarter to 2.95% from 2.91%. Agency RMBS margin, excluding catch-up amortization, declined to 1.05% from 1.31%. The overall nine-month GAAP net interest income declined despite higher interest income, as funding expense increased materially.
Material changes and operating results
- Common-stockholder results turned positive versus Q3 2022, principally because total other income was $26.2 million versus a $26.3 million loss. Nine-month net income also improved sharply from the prior-year loss. Results remain sensitive to fair-value marks and hedging performance.
- Q3 other income included $82.1 million net realized and unrealized derivative gains, offset by $81.2 million net losses on securities and loans. Longbridge reported $31.8 million other income, including gains on reverse loans and servicing assets, partly offset by HMBS-related losses.
- Higher rates lifted asset yields but increased financing costs. Nine-month interest expense more than doubled year over year, while total expenses rose to $120.0 million from $47.1 million. Longbridge’s consolidation and related personnel, servicing, and operating costs contribute to the comparison; 2022 did not include Longbridge’s full-period results.
- Longbridge portfolio assets, as defined by management, increased 14% sequentially to $488.2 million, driven mainly by proprietary reverse mortgage originations and an MSR portfolio acquired from a bankrupt servicer in July. Origination volume was $306.8 million in Q3, slightly above Q2.
- Common equity issuance produced $75.0 million net proceeds during the first nine months; a February Series C preferred issuance generated $96.5 million net proceeds. The company repurchased 1.08 million common shares for $12.4 million in the nine-month period.
Outlook, commentary and risks
- Management said it expects available capital resources to meet short- and long-term liquidity needs, but identified dependence on refinancing or rolling repos, asset-sale capacity and access to equity and debt capital markets. About 35% of repo borrowings matured within 30 days at quarter-end.
- Management reported rising long-term rates, elevated rate volatility, historically low mortgage refinancing and prepayment activity, and continued pressure on housing affordability. It noted recent increases in mortgage-loan delinquencies and said it was monitoring them.
- Key exposures include interest-rate and spread movements, credit defaults and loss severity, mortgage prepayments, collateral valuations, counterparty risk, margin calls, repo renewal and haircut changes, and Level 3 fair-value estimation. The filing’s rate sensitivity model estimates a $23.6 million portfolio-value decline for an immediate parallel 100-basis-point rate decrease and a $4.4 million increase for a 100-basis-point increase; management stresses that actual outcomes may differ materially.
- The company had $1.9 billion of unfunded commitments for further HECM borrower advances, in addition to other loan and investment commitments. HMBS-related mandatory repurchases and the timing and recovery of FHA claims can create liquidity and valuation uncertainty.
- The proposed Arlington Asset Investment Corp. merger remained pending, subject to shareholder approval and customary conditions; management expected a closing before year-end. The Great Ajax merger was terminated October 20, 2023; Ellington paid a $5 million termination fee and bought 1,666,666 newly issued Great Ajax shares for $11 million.
- The board declared common dividends of $0.15 per share payable in November and December 2023. No quantitative earnings or margin guidance was provided. The company reported no material legal proceedings then pending, while noting potential regulatory inquiries and proceedings as a general risk.
Most important facts for investors to verify
- Whether recurring earnings and cash generation support common and preferred dividends, given Q3 and year-to-date ADE per share below declared common dividends.
- How repo renewal, borrowing costs, collateral haircuts and margin calls affect liquidity and leverage, particularly with substantial short-dated repo maturities.
- Performance and valuation assumptions for Longbridge’s reverse mortgage loans, HMBS obligations and MSRs, including the July servicing portfolio acquisition and FHA claim recoveries.
- Credit quality trends in residential and commercial loans, including the rise in 90-day-past-due residential mortgage fair value to $105.4 million from $47.0 million at year-end, and commercial mortgage fair value to $32.2 million from $17.6 million.
- Completion terms and financial effects of the Arlington merger, and the subsequent Great Ajax termination fee and equity investment.
- The composition and sensitivity of Level 3 assets and liabilities, and the extent to which fair-value marks—not realized cash returns—drive reported earnings.