Ellington Financial Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. The company is an externally managed mortgage and credit investor operating as a REIT. Its portfolio includes mortgage-backed securities, residential and commercial mortgage loans, consumer loans, CLOs, derivatives, and strategic investments.
Financial performance and position
- Q2 earnings: Interest income was $39.3 million and interest expense was $14.7 million, producing net interest income of $24.6 million, versus $18.8 million in Q2 2019. Net income was $40.4 million; net income attributable to common stockholders was $37.3 million, or $0.85 per share, compared with $12.6 million, or $0.43 per share, a year earlier.
- First-half results: Interest income was $91.4 million, interest expense $36.8 million, and net interest income $54.6 million. The company reported a net loss of $87.9 million and a common-stockholder loss of $92.1 million, or $2.13 per share, versus common-stockholder income of $28.1 million, or $0.94 per share, in the first half of 2019.
- Other income and margins: Q2 other income was $23.7 million, following a first-half other loss of $118.5 million, primarily reflecting fair-value movements on securities, loans, and derivatives. Reported net interest margin excluding the catch-up premium amortization adjustment was 3.39% in Q2, versus 2.52% in Q2 2019. Management’s non-GAAP Core Earnings attributable to common stockholders were $17.1 million, or $0.39 per share, versus $13.6 million, or $0.46 per share.
- Balance sheet and liquidity: At June 30, total assets were $3.24 billion, total liabilities $2.40 billion, and total equity $837.7 million. Cash and cash equivalents were $146.5 million, with approximately $311.8 million of unencumbered assets. Book value per common share was $15.67.
- Debt and leverage: Repurchase agreements were $1.29 billion, down from $2.45 billion at December 31, 2019. Total debt-to-equity was 2.7:1, down from 3.8:1 at year-end; recourse debt-to-equity was 1.5:1. Senior notes totaled $86.0 million and mature in September 2022. The company reported compliance with its borrowing covenants.
- Cash flow and capital: First-half operating cash flow was $66.5 million and investing cash flow was $848.2 million; financing cash flow was negative $840.4 million. Cash, cash equivalents, and restricted cash increased by $74.2 million to $146.7 million. A January common-stock offering raised $95.3 million net; the company paid $36.7 million in dividends and repurchased $3.0 million of common stock.
Material changes and management commentary
- The first quarter’s COVID-19 market disruption caused substantial fair-value losses, elevated margin calls, and a reduction in Agency RMBS holdings and leverage. In Q2, credit prices and market liquidity improved, producing a partial recovery in portfolio values; the company said it met all margin calls in both quarters.
- During Q2, the company resumed credit and Agency investment activity, completed a non-QM loan securitization, obtained term financing for previously unfinanced loans, and extended some credit facilities. At quarter-end, portfolios remained smaller and leverage lower than before the pandemic, while cash was higher.
- Management cited Q2 gains in non-QM loans, non-Agency RMBS, CMBS, Agency specified pools, consumer loans, residential transition loans, and loan-originator investments. CLOs and euro-denominated RMBS generated losses, and credit hedges lost value as markets rebounded.
- Management continued to expect eventual principal losses on some credit investments from COVID-19’s economic effects. At June 30, 8.8% of the non-QM portfolio was in forbearance; 20.5% of the small-balance commercial mortgage portfolio had deferment or modification agreements; and 15.4% of consumer loans had entered deferment plans during March–June.
- Common dividends were reduced from $0.15 per share monthly early in 2020 to $0.08–$0.09 monthly from April onward. The board approved a $0.09-per-share dividend for September 2020 after quarter-end. The filing provides no earnings or portfolio guidance.
Risks, contingencies, and unusual items
- Liquidity remains exposed to repo renewals, collateral haircuts, margin calls, counterparty risk, and asset-price declines. Repo haircuts were higher than at year-end 2019; weighted average contractual haircuts were 36.2% for credit assets and 6.5% for Agency RMBS.
- Fair values for significant Level 3 assets rely on unobservable inputs and management models; COVID-related market dislocations reduced observable pricing inputs, with $130.1 million transferred into Level 3 during the first half.
- The company recorded $13.8 million of realized losses on securities where cost basis was deemed uncollectible. It also tracked expected future credit losses of $27.1 million on securities and $6.9 million across residential, commercial, and consumer loans.
- Other risks include borrower defaults and loss severity, elevated mortgage prepayments, interest-rate and spread changes, use of leverage, REIT qualification, and the company’s external-management and related-party arrangements. No material legal proceedings were reported; previously disclosed risk factors were said to have no material changes.
Key facts for investors to verify
- Whether Q2’s fair-value recovery is durable and how much of the first-half loss remains in portfolio valuations.
- Current delinquency, forbearance, deferment, and realized-loss trends across non-QM, commercial mortgage, and consumer loan exposures.
- Repo availability, collateral haircuts, margin requirements, and liquidity after quarter-end.
- Credit quality and valuation sensitivity of Level 3 holdings, including CLOs and securitized loans.
- Dividend coverage against recurring earnings and cash generation, considering the reduced common dividend and preferred obligations.
- Potential dilution and capital allocation following the January 2020 share issuance and ongoing repurchase authorization.