Business Context and Reporting Period
Ellington Residential Mortgage REIT (the filing entity identified in the source; request metadata refers to Ellington Credit Co.) filed this unaudited Form 10-Q for the three months ended March 31, 2017. The externally managed REIT invests primarily in Agency residential mortgage-backed securities (RMBS), with smaller investments in non-Agency RMBS, and uses repurchase agreements and derivatives to finance and hedge its portfolio. The company had 9,130,897 common shares outstanding at March 31, 2017 and elected REIT tax treatment.
Financial Metrics
| Metric | Q1 2017 | Q1 2016 / Prior Period |
|---|---|---|
| Interest income | $12.3 million | $9.7 million |
| Interest expense | $3.2 million | $2.1 million |
| Net interest income | $9.2 million | $7.6 million |
| Total expenses | $1.3 million | $1.4 million |
| Net realized and unrealized securities gains/(losses) | $(5.3) million | $11.6 million gain |
| Net realized and unrealized derivative gains/(losses) | $(0.5) million | $(18.1) million |
| Net income/(loss) | $2.1 million | $(0.2) million |
| Basic and diluted EPS | $0.22 | $(0.03) |
| Dividend declared per share | $0.40 | $0.45 |
| Cash and cash equivalents at period end | $37.5 million | $33.5 million at December 31, 2016 |
| Shareholders’ equity | $140.1 million | $141.7 million at December 31, 2016 |
| Book value per share | $15.35 | $15.52 at December 31, 2016 |
| Repurchase agreement borrowings | $1.178 billion | $1.198 billion at December 31, 2016 |
The portfolio’s weighted-average yield before interest expense was 3.79% in Q1 2017, compared with 3.13% in Q1 2016. The reported yield benefited from a $2.6 million catch-up premium amortization adjustment; adjusted core earnings were $4.8 million, or $0.53 per share, compared with $4.6 million, or $0.50 per share, in Q1 2016.
At March 31, 2017, mortgage-backed securities totaled $1.230 billion at fair value, including $1.214 billion of Agency RMBS and $16.0 million of non-Agency RMBS. The company’s debt-to-equity ratio was 8.4:1, or 8.2:1 adjusted for unsettled security transactions. Average repo borrowings were $1.194 billion at an average cost of funds of 0.94%.
Operating activities provided $30.6 million of cash, investing activities used $3.3 million, and financing activities used $23.3 million. Cash increased by $4.0 million during the quarter. Dividends paid were $3.7 million.
Material Changes Versus Comparable Periods
- Net income improved to $2.1 million from a $0.2 million loss, primarily because net interest income increased and derivative losses were substantially lower than in Q1 2016.
- Net interest income increased 20% to $9.2 million, reflecting larger average Agency RMBS holdings and higher portfolio yields.
- Interest expense rose 55% to $3.2 million as average repo borrowings increased and financing costs rose with LIBOR. Average repo cost increased to 0.94% from 0.62% in Q1 2016.
- Unlike Q1 2016, when securities produced substantial gains, Q1 2017 included $5.3 million of net realized and unrealized securities losses, primarily from Agency RMBS valuation declines and realized trading losses.
- Derivative losses narrowed to $0.5 million from $18.1 million. Gains on interest rate swaps were offset by losses on short TBAs, U.S. Treasury securities, and futures.
- Non-Agency RMBS declined to $16.0 million from $19.4 million at year-end as the company sold securities it considered fully valued.
- Shareholders’ equity and book value per share declined despite quarterly profitability because the $3.7 million dividend exceeded net income.
- The dividend declined to $0.40 per share from $0.45 per share in the prior-year quarter.
Guidance, Outlook, Commentary, Risks, and Unusual Items
Management provided no formal quantitative earnings guidance. It expects to continue emphasizing Agency RMBS specified pools, particularly higher-coupon securities, while opportunistically allocating capital to non-Agency RMBS and other mortgage-related assets.
Management reported that the Federal Reserve raised the federal funds target range by 25 basis points in March 2017 and that potential changes to its reinvestment policy later in the year created valuation uncertainty for Agency RMBS. Agency RMBS spreads widened during the quarter, while mortgage prepayment rates remained relatively low. Management expects interest-rate hedging to remain important and uses swaps, TBAs, U.S. Treasury positions, futures, and other derivatives.
Principal risks include high leverage, short-term repo refinancing and margin-call exposure, rising borrowing costs, interest-rate and spread volatility, mortgage prepayment changes, valuation uncertainty for Level 3 securities, non-Agency credit losses, counterparty risk, and potential changes involving Fannie Mae, Freddie Mac, Federal Reserve policy, and applicable regulation. A parallel 100-basis-point rate increase was estimated to reduce portfolio market value by $8.8 million, or 6.26% of shareholders’ equity, although management cautioned that actual results could differ materially.
The company had no material legal proceedings reported against it. An Ellington affiliate received an SEC subpoena in January 2017 concerning a loan originator and related loan analysis, purchases, securitizations, and servicing; the affiliate responded and intended to cooperate. The filing states that the potential effect of this inquiry cannot be assured.
The company reported no material contingencies, no off-balance-sheet financing relationships, and no material changes to previously disclosed risk factors. It is externally managed under an agreement providing for a management fee equal to 1.50% annually of defined shareholders’ equity, plus certain expense reimbursements and a potential termination fee.
Investor Verification Checklist
- Verify the legal registrant and ticker because the supplied filing identifies Ellington Residential Mortgage REIT, while the request metadata identifies Ellington Credit Co.
- Reconcile GAAP net income of $0.22 per share with core earnings of $0.81 and adjusted core earnings of $0.53, including the $2.6 million catch-up premium amortization adjustment.
- Assess whether 8.4:1 leverage and $1.178 billion of repo borrowings remain appropriate under changing rates and potential margin calls.
- Review the sustainability of the $0.40 per-share dividend relative to adjusted core earnings, taxable income, liquidity, and REIT distribution requirements.
- Evaluate the sensitivity of Agency RMBS valuations and book value to Federal Reserve balance-sheet policy, spread widening, interest-rate movements, and prepayment speeds.
- Review the SEC inquiry involving an Ellington affiliate and monitor whether it develops into a material investigation, proceeding, liability, or reputational risk.
- Examine Level 3 valuation assumptions, including prepayment, loss, recovery, yield, and option-adjusted spread inputs.