Ellington Residential Mortgage REIT (EARN) — Q3 2022 Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2022. The filing identifies the registrant as Ellington Residential Mortgage REIT; the request metadata refers to Ellington Credit Co.
Business Context
EARN is an externally managed Maryland REIT investing primarily in Agency residential mortgage-backed securities (RMBS), with smaller positions in non-Agency RMBS, interest-only securities, U.S. Treasury securities and interest-rate derivatives. The company finances its portfolio primarily through repurchase agreements and uses derivatives to hedge interest-rate exposure.
Financial Performance and Key Metrics
| Metric | Q3 2022 | Q3 2021 | 9M 2022 | 9M 2021 |
|---|---|---|---|---|
| Interest income | $9.5 million | $5.5 million | $25.1 million | $21.9 million |
| Net interest income | $5.2 million | $4.9 million | $17.7 million | $19.9 million |
| Total expenses | $1.2 million | $1.4 million | $3.9 million | $4.4 million |
| Net realized and unrealized securities gains/(losses) | $(55.8) million | $(2.9) million | $(164.1) million | $(20.3) million |
| Net realized and unrealized derivative gains/(losses) | $38.2 million | $0.2 million | $108.3 million | $1.3 million |
| Net income/(loss) | $(13.7) million | $0.9 million | $(41.9) million | $(3.6) million |
| EPS | $(1.04) | $0.07 | $(3.19) | $(0.28) |
| Adjusted Distributable Earnings | $3.0 million | $4.0 million | $10.6 million | $12.4 million |
| Adjusted Distributable Earnings per share | $0.23 | $0.31 | $0.80 | $0.99 |
Q3 net interest margin was 1.28%, compared with 1.88% in the prior-year quarter. For the nine-month period, net interest margin was 1.59%, compared with 1.95% in the prior-year period. The company reported a 2.95% portfolio yield and a 1.67% adjusted average cost of funds in Q3 2022.
Balance Sheet, Liquidity and Capital
- Total assets were $1.19 billion at September 30, 2022, down from $1.60 billion at December 31, 2021.
- Mortgage-backed securities were $934.7 million, compared with $1.31 billion at year-end 2021. Agency RMBS represented $918.8 million of fair value; non-Agency RMBS totaled $15.9 million.
- Cash and cash equivalents were $25.4 million, down from $69.0 million at December 31, 2021. Management also reported $2.6 million of other unencumbered assets.
- Repurchase-agreement borrowings were $938.0 million, compared with $1.06 billion at year-end 2021. The weighted-average borrowing rate was 2.51%, versus 0.18% at year-end 2021.
- Debt-to-equity was 9.1:1 at September 30, 2022, compared with 6.9:1 at December 31, 2021. Adjusted debt-to-equity was also 9.1:1.
- Shareholders’ equity was $103.0 million, down from $154.2 million. Book value per share was $7.78, versus $11.76 at December 31, 2021 and $9.07 at June 30, 2022.
- Operating activities provided $18.2 million of cash during the first nine months; investing activities provided $40.2 million; financing activities used $102.1 million. Cash decreased by $43.6 million.
- The company had repurchase agreements with 15 counterparties and stated that available capital resources were sufficient for anticipated short- and long-term liquidity needs.
Material Changes and Unusual Items
- Rapid increases in interest rates and wider RMBS spreads produced $55.8 million of Q3 securities losses and $164.1 million of nine-month securities losses, principally in Agency RMBS.
- Hedges generated $38.2 million of Q3 gains and $108.3 million of nine-month gains, substantially offsetting—but not eliminating—securities losses.
- Gross unrealized RMBS losses increased to $104.3 million at September 30, 2022, from $12.4 million at December 31, 2021.
- Interest expense rose sharply as repo funding costs increased. Q3 average repo borrowing cost was 1.79%, compared with 0.17% in Q3 2021.
- Despite higher interest rates, fixed-rate specified-pool prepayment rates declined to 9.8% in Q3 from 13.9% in Q2 and 21.9% in Q3 2021.
- The company issued 148,349 common shares through its at-the-market program for $1.2 million of net proceeds during the nine months and repurchased 40,021 shares for $0.3 million.
- Dividends declared totaled $0.24 per share for Q3 and $0.80 per share for the first nine months, compared with $0.30 and $0.88, respectively, in the comparable 2021 periods.
Guidance, Outlook and Risks
No formal earnings or dividend guidance was provided. Management expected to increase the company’s allocation to non-Agency RMBS beginning in the fourth quarter because of perceived market opportunities. The Board subsequently approved monthly dividends of $0.08 per share payable in November and December 2022.
Management characterized the market as exposed to significant interest-rate, prepayment, extension, financing, liquidity, credit, valuation and policy risks. The Federal Reserve’s rapid tightening and balance-sheet reduction increased funding costs, market volatility and pressure on Agency RMBS valuations. Management also highlighted maturity mismatches between longer-lived RMBS assets and shorter-term repo financing, margin-call risk, counterparty exposure, non-Agency credit risk, and uncertainty surrounding LIBOR-to-SOFR transition.
The company reported no material legal proceedings, no material changes to previously disclosed risk factors, no off-balance-sheet arrangements involving unconsolidated entities, and no significant contingencies known to management. Disclosure controls were deemed effective as of September 30, 2022.
Investor Verification Checklist
- Verify the sustainability of dividends relative to Adjusted Distributable Earnings, taxable income and available liquidity.
- Assess whether the $7.78 book value per share and $103.0 million equity base can withstand additional RMBS spread widening or interest-rate increases.
- Review repo maturities, haircuts, margin requirements and counterparty concentration, particularly with debt-to-equity at 9.1:1.
- Evaluate the assumptions supporting fair values, including prepayment, default, recovery, yield and option-adjusted-spread inputs for Level 3 assets.
- Compare future funding costs with portfolio yields and monitor the decline in net interest margin.
- Confirm the effect of additional non-Agency RMBS investments on credit risk and leverage.
- Review subsequent-quarter results for continued securities losses, derivative hedge effectiveness, cash utilization and any changes to dividend policy.