Ellington Financial Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Ellington invests in mortgage-related securities and loans, consumer credit, CLOs, derivatives, real estate, and strategic equity investments; it is externally managed by an Ellington affiliate. The company converted from an LLC to a corporation effective March 1, 2019 and intends to qualify as a REIT beginning with 2019.
Financial results and position
| Metric | Q3 2019 | Nine months 2019 |
|---|---|---|
| Interest income | $40.0 million | $114.5 million |
| Interest expense | $20.0 million | $57.3 million |
| Net interest income | $20.0 million | $57.3 million |
| Total other income | $3.7 million | $12.0 million |
| Total expenses | $7.8 million | $27.0 million |
| Net income attributable to common stockholders | $17.3 million; $0.53 per share | $45.3 million; $1.47 per share |
| Core Earnings attributable to common stockholders (non-GAAP) | $15.4 million; $0.47 per share | $42.4 million; $1.38 per share |
| Net interest margin (management measure) | 2.52% | 2.56% |
At September 30, total assets were $3.63 billion, total liabilities $2.96 billion, and total equity $669.0 million. Cash and restricted cash were $33.4 million. Book value was $18.81 per share. Total debt-to-equity was 4.0:1; recourse debt-to-equity was 2.9:1. Secured borrowings were approximately $2.59 billion and senior notes were $86.0 million, bearing 5.50% interest and maturing in September 2022. The company reported compliance with the senior-note covenants.
For the first nine months, operating activities provided $56.1 million, investing activities used $713.3 million, and financing activities provided $645.5 million. Cash, cash equivalents, and restricted cash declined $11.7 million to $33.4 million. Common dividends declared were $0.42 per share for Q3 and $1.39 year to date.
Changes and comparisons
- The portfolio expanded during Q3, funded in part by a July common-stock offering of 4.025 million shares that generated $69.8 million in net proceeds. Long Agency RMBS rose 16.9% from June 30 to $1.565 billion; total long credit investments rose 7.3% to $1.652 billion.
- Interest income increased from $35.3 million in Q3 2018 to $40.0 million in Q3 2019, while interest expense rose from $15.7 million to $20.0 million. Management attributed the increases mainly to a larger portfolio and higher borrowings. Weighted average total portfolio yield fell to 5.57% from 6.12%, and net interest margin declined to 2.52% from 3.26%.
- Q3 2019 net income attributable to common stockholders was $17.3 million. The corresponding 2018 presentation reported a $6.7 million increase in shareholders’ equity from operations; accounting and presentation changes mean these measures are not directly comparable. Effective January 1, 2019, the company discontinued investment-company accounting prospectively and retained fair-value accounting for eligible instruments.
- Interest-rate declines supported Agency RMBS and several credit strategies, but derivatives recorded net losses of $7.9 million in Q3 and $41.0 million year to date. Q3 gains on securities and loans were $9.9 million.
Outlook, risks, and unusual items
- No numerical earnings or return guidance was provided. Management described an opportunistic, flexible allocation strategy and expects to continue using Agency RMBS, leverage, and hedges, subject to REIT and regulatory requirements.
- Management said it expects available cash, investment cash flows, financing, and capital-market access to meet liquidity needs. However, repos are short-term and collateralized: 78.5% of the $2.06 billion outstanding matured within 90 days. Margin calls, inability to roll financing, asset sales, or reduced access to funding could pressure liquidity.
- Market risks include interest-rate and yield-curve movements, mortgage prepayments, credit defaults and loss severity, collateral values, foreign exchange, derivative exposure, and counterparty concentration. September’s repo-market rate spike and elevated market volatility were noted; the Federal Reserve’s repo operations helped normalize repo rates.
- Fair-value estimation is a significant judgment area: $1.49 billion of assets and $438.8 million of liabilities were Level 3 at quarter-end. Residential mortgage exposure was geographically concentrated, with 48.9% of residential mortgage unpaid principal balance in California. Five non-performing commercial mortgage loans had $62.3 million unpaid principal and $38.4 million fair value.
- The filing reports an SEC subpoena received in January 2017 concerning a loan originator, related loans, analyses, purchases, securitizations, and servicing. The company said it was cooperating; it could not assure that inquiries would not lead to further investigation or proceedings. No material legal proceedings were reported.
- Subsequent to quarter-end, the company issued 4.6 million Series A preferred shares for approximately $111 million net proceeds. The preferred stock pays a 6.750% fixed dividend through October 2024, then a floating rate of three-month LIBOR plus 5.196%. The board also approved common dividends of $0.14 per share for November and December 2019.
Important facts for investors to verify
- Progress toward the 2019 REIT election and the company’s ability to satisfy ongoing REIT qualification and distribution requirements.
- Repo rollover capacity, collateral haircuts, margin-call sensitivity, and the concentration of financing counterparties.
- Credit performance, impairment assumptions, non-performing loans, and the sensitivity of Level 3 valuations to prepayment, default, recovery, and yield assumptions.
- Whether portfolio yields and net interest margins can support common and preferred dividends as funding costs and asset prepayments change.
- Developments in the SEC inquiry and any related legal or regulatory exposure.