Ellington Financial Inc. — Q2 2021 Form 10-Q
Reporting period: Three and six months ended June 30, 2021. Amounts are U.S. dollars; financial statement figures are in millions unless stated otherwise. Ellington Financial is an externally managed REIT investing in mortgage loans and securities, consumer credit, CLOs, derivatives, and related businesses.
Financial performance and position
- Net interest income: Q2 was $34.7 million, up from $24.6 million a year earlier; first-half net interest income was $63.5 million versus $54.6 million. Lower borrowing costs supported the increase, while credit-portfolio yields were lower.
- Net income: Q2 net income was $36.5 million, compared with $40.4 million in Q2 2020. Net income attributable to common stockholders was $32.7 million, or $0.75 per share, versus $37.3 million, or $0.85 per share. First-half net income attributable to common stockholders was $70.5 million, or $1.61 per share, compared with a $92.1 million loss, or $2.13 per share, in 2020.
- Core Earnings, a company-defined non-GAAP measure: Attributable to common stockholders, Q2 was $22.3 million, or $0.51 per share, versus $17.1 million, or $0.39 per share. First-half Core Earnings were $41.1 million, or $0.94 per share, versus $36.9 million, or $0.85 per share.
- Other income and investments: Q2 other income was $5.7 million, down from $23.7 million. The 2021 quarter included $18.6 million of earnings from unconsolidated entities, principally gains on loan-originator investments, and $5.3 million of net derivative losses. First-half other income was $25.9 million, versus a $118.5 million loss in 2020.
- Margins and costs: Q2 average cost of funds was 1.33%, versus 1.52% in Q1 2021. Management reported a Q2 net interest margin of 3.49%, excluding the catch-up premium amortization adjustment and including specified interest-swap costs. A $7.2 million incentive fee was incurred in Q2; none was incurred in the comparable 2020 period.
- Balance sheet and leverage: At June 30, total assets were $4.28 billion, liabilities $3.33 billion, and total equity $955.1 million. Cash and cash equivalents were $134.7 million. Book value per common share was $18.47. Total borrowings were approximately $3.09 billion; the reported debt-to-equity ratio was 3.2:1, including non-recourse borrowings, and recourse debt-to-equity was 1.9:1.
- Liquidity and cash flow: First-half operating cash flow was $44.2 million, investing cash flow was negative $879.1 million, and financing cash flow was $858.0 million. Cash, cash equivalents, and restricted cash increased $23.0 million to $134.9 million. The company also reported approximately $511 million of unencumbered assets.
- Dividends and capital: Common dividends declared for the first half totaled $0.74 per share, versus $0.70 in 2020. Subsequent to quarter-end, the company issued 6.303 million common shares for net proceeds of $113.1 million; 50,122,057 common shares were outstanding on August 6, 2021.
Material changes versus comparable periods
- First-half results rebounded from the severe market-related losses recorded in the first half of 2020. Management attributed the change primarily to gains on securities, loans, and derivatives, and gains from unconsolidated investments.
- Q2 common-stockholder earnings declined year over year despite higher net interest income, reflecting lower securities-and-loan gains and the new incentive fee. Q2 2020 gains had benefited from a sharp recovery in credit prices and market liquidity after the early-pandemic disruption.
- From December 31, 2020 to June 30, 2021, assets rose from $3.41 billion to $4.28 billion and total borrowings increased. The portfolio grew in residential mortgage loans, Agency RMBS, and loan-originator investments; CLO and CMBS holdings declined.
- Q2 credit holdings performed well, while the Agency RMBS strategy recorded a small net loss as spreads widened, especially for higher-coupon securities. Credit hedges detracted as credit spreads tightened.
Outlook, risks, and unusual items
- Outlook: No quantified earnings or return guidance is provided. Management expects to adjust asset allocation as credit and liquidity conditions change, continue using leverage and opportunistic hedges, and says current capital resources should meet anticipated liquidity needs.
- Market backdrop: The Federal Reserve maintained its 0.00%–0.25% federal funds target and continued monthly Treasury and Agency MBS purchases during Q2. Long-term Treasury yields and mortgage rates declined during the quarter; management noted that the rise in COVID cases near quarter-end challenged the economic outlook.
- Funding and liquidity risk: Repo borrowings increased to $1.92 billion, with $575.1 million, or 30%, due within 181–360 days and $272.1 million due within 30 days. Repo financing is subject to collateral haircuts, margin calls, and renewal risk. Management warns that inability to finance Agency RMBS, asset-value declines, or higher prepayments could strain liquidity and force asset sales or additional borrowing/equity issuance.
- Credit, rates, and valuation: The portfolio remains exposed to borrower defaults and loss severity, mortgage prepayments, interest-rate movements, and counterparty risk. Significant holdings are Level 3 and valued using models and unobservable assumptions; actual realizable values may differ materially. Residential mortgage exposure is concentrated in California (41.9% of unpaid principal balance) and Florida (15.5%).
- Commitments and contingencies: The company had $649.7 million of unfunded commitments to purchase eligible residential mortgage loans, plus $15.8 million of other residential-loan commitments. It guaranteed up to $25 million of a related mortgage originator’s repo obligations; $8.1 million was outstanding under the guaranteed facilities at quarter-end. Securitized non-QM loans may also be subject to repurchase obligations for breaches of representations and warranties.
- Other notable items: A June non-QM securitization expanded fair-value-measured securitization debt. The company reported no material legal proceedings and no material change in previously disclosed risk factors. Management concluded disclosure controls were effective at June 30, 2021.
Important facts for investors to verify
- Reconcile GAAP earnings with Core Earnings and assess how much reported performance depends on fair-value changes and gains on unconsolidated investments.
- Review repo maturities, collateral requirements, counterparty exposure, and the ability to refinance or replace short-term funding.
- Assess the $649.7 million residential-loan purchase commitment, related-party origination arrangements, and potential securitization repurchase obligations.
- Examine Level 3 valuation assumptions, credit performance and geographic concentration in mortgage holdings, and sensitivity to rates and prepayments.
- Evaluate the post-quarter share issuance, resulting dilution, use of proceeds, and the sustainability of common dividends relative to earnings and liquidity.