Ellington Financial Inc. annual report, FY2021

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Ellington Financial Inc. — 2021 Form 10-K

Reporting period: Fiscal year ended December 31, 2021; the filing also reports fourth-quarter results. Amounts are in U.S. dollars.

Business context

Ellington Financial is an externally managed REIT investing across mortgage loans and securities, consumer credit, commercial real estate debt, CLOs, corporate assets, derivatives, and equity interests in loan originators. Its credit portfolio is the principal driver of risk and return; it also maintains a highly leveraged Agency RMBS portfolio. The company reported under GAAP and stated that it qualified as a REIT.

Financial performance and position

  • Full-year earnings: Net income was $140.6 million, compared with $28.4 million in 2020. Net income attributable to common stockholders was $125.3 million, or $2.58 per share, versus $17.2 million, or $0.39 per share.
  • Core Earnings: A company-defined non-GAAP measure, Core Earnings attributable to common stockholders was $88.9 million, or $1.83 per share, versus $70.9 million, or $1.63 per share. It excludes specified realized and unrealized items and other adjustments; it is not a substitute for GAAP results.
  • Fourth quarter: Net income attributable to common stockholders was $34.3 million, or $0.61 per share. Net interest income was $38.5 million; total other loss was $12.5 million.
  • Interest income and margins: Full-year interest income was $175.5 million, up from $173.5 million; interest expense fell to $44.0 million from $61.7 million, lifting net interest income to $131.5 million from $111.9 million. Average cost of funds declined to 1.29% from 2.25%. Net interest margin, including specified interest-rate-swap costs and excluding the catch-up premium amortization adjustment, was 3.15%, down from 3.43%.
  • Other income and investment results: Net other income was $19.6 million, compared with a $65.2 million loss in 2020. Realized and unrealized losses on securities and loans were $25.8 million, partly offset by $21.9 million of gains on derivatives and $23.0 million of other net income. Earnings from unconsolidated entities rose to $58.1 million from $37.9 million, driven chiefly by loan-originator investments.
  • Portfolio: Long credit investments, excluding non-retained securitization tranches, were $2.065 billion, up 44% from $1.434 billion. Agency RMBS fair value was $1.697 billion, up 77%. Residential mortgage loans and REO were $2.017 billion; non-QM loans represented the bulk of residential loan value.
  • Balance sheet and liquidity: Total assets were $5.177 billion and liabilities $3.854 billion, versus $3.414 billion and $2.492 billion, respectively, at year-end 2020. Cash and cash equivalents were $92.7 million; unencumbered assets were $808.1 million, compared with $111.6 million and $442.5 million a year earlier. Management said available capital resources were expected to meet short- and long-term liquidity needs.
  • Debt and leverage: Total debt-to-equity was 2.7:1, versus 2.6:1; recourse debt-to-equity increased to 2.0:1 from 1.6:1. Repurchase agreements totaled $2.470 billion. The company had $86 million of 5.50% Senior Notes due September 2022 and said it expected to refinance them on or before maturity.
  • Cash flow: Operating activities provided $51.3 million, investing activities used $2.025 billion, and financing activities provided $1.955 billion. Cash, cash equivalents, and restricted cash declined by $19.0 million to $92.8 million.
  • Dividends and capital: Common dividends declared for 2021 totaled $1.64 per share, up from $1.26 in 2020; the board declared $0.15 monthly dividends for January and February 2022. 2021 common and preferred offerings generated net proceeds of approximately $360.7 million. Common shares outstanding rose to 57.5 million from 43.8 million.

Changes versus 2020

  • GAAP common-stockholder earnings improved substantially from 2020, when first-quarter COVID-related market disruption contributed to large losses. 2021 results benefited from higher net interest income, derivative gains, and stronger earnings from unconsolidated investments.
  • Lower borrowing costs helped, though average yields declined: total portfolio yield was 4.62% versus 5.63%, and credit portfolio yield was 6.15% versus 7.44%.
  • The credit portfolio expanded, especially residential loans, while CLO and CMBS holdings declined in part through securitizations and opportunistic sales. Agency RMBS holdings were rebuilt after their substantial reduction in 2020.
  • Equity increased to $1.324 billion from $921.6 million, reflecting earnings and substantial common and preferred stock issuance, partly offset by dividends and distributions.

Outlook, commentary, risks, and unusual items

  • Outlook: No quantified earnings or return guidance is provided. Management described its strategy as opportunistic and flexible, and expected to continue investing across targeted asset classes while managing hedges, leverage, and liquidity. The filing noted the Federal Reserve’s late-2021 tapering and signals of prospective rate increases; management’s expectations are not a guarantee of results.
  • Longbridge transaction: After year-end, Ellington agreed to buy Home Point Capital’s 49.6% interest in Longbridge for an estimated $75 million. Closing was expected in the second quarter of 2022, subject to approvals and other conditions. Ellington already owned 49.6%; if completed, it expected to consolidate Longbridge, which reported $6.7 billion of assets and $6.6 billion of liabilities at December 31, 2021. This could materially change reported scale, segments, assets, and risks.
  • Funding and market risks: Short-term repo financing exposes the company to refinancing, haircut, margin-call, and forced-sale risk. Rising interest rates may pressure asset values, borrower performance, and funding costs; hedges may not fully offset exposures. The filing also highlights credit and prepayment risk, illiquid and model-valued assets, counterparty exposure, and LIBOR transition risk.
  • Concentration and valuation: Residential loans were a large and growing share of the credit portfolio; residential mortgage collateral was concentrated in California (40.2% of residential loan unpaid principal balance). A significant portion of loans and other investments used Level 3 valuations. The auditor identified valuation of certain investments based on management’s internal techniques as a critical audit matter.
  • Management and REIT risks: The company relies on its external manager and has related-party and allocation conflicts. Its broad investment discretion and REIT and Investment Company Act compliance requirements can constrain or change investment choices. Common dividends are discretionary and depend on earnings, liquidity, covenants, and REIT requirements.
  • Other disclosures: No material legal proceedings were reported. The auditor expressed unqualified opinions on the financial statements and internal control over financial reporting; management and the auditor reported effective controls as of year-end.

Most important facts for investors to verify

  • Whether Longbridge closed as planned, the final purchase price and financing, and the effects of consolidation on earnings, leverage, liquidity, segments, and goodwill.
  • The refinancing or repayment of the $86 million Senior Notes due September 2022 and the maturity, renewal, and collateral terms of repo and other borrowings.
  • Whether cash, unencumbered assets, and access to financing remain adequate under adverse market conditions and margin calls.
  • The performance, credit quality, and valuation assumptions for non-QM and other residential loans, Level 3 assets, and loan-originator investments.
  • The sustainability of common and preferred dividends after capital issuance, higher leverage, and the company’s REIT distribution obligations.
  • How rising rates, Fed balance-sheet changes, credit spreads, prepayments, and the LIBOR transition affect net interest income and hedging effectiveness.