Ellington Financial Inc. — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Unless otherwise noted, amounts are in U.S. dollars; financial statement amounts are in millions.
Business context
Ellington Financial is an externally managed REIT investing in residential and commercial mortgage loans and securities, consumer credit, CLOs, derivatives, and equity or debt investments in loan originators. Its portfolio is financed substantially with repurchase agreements and securitizations. The filing describes a sharply deteriorating market environment in Q2, with rapid interest-rate increases, widening spreads, and elevated volatility.
Financial performance and position
| Metric | Q2 2022 | Comparable period / change |
|---|---|---|
| Net interest income | $36.7 | $34.7 in Q2 2021 |
| Net income (loss) attributable to common stockholders | $(64.9) | $32.7 in Q2 2021 |
| GAAP diluted loss per common share | $(1.08) | $0.75 income per share in Q2 2021 |
| Adjusted Distributable Earnings attributable to common stockholders, a non-GAAP measure | $24.9; $0.41 per share | $22.3; $0.51 per share in Q2 2021 |
For the six months ended June 30, net interest income was $73.8 versus $63.5 in 2021; net loss attributable to common stockholders was $74.8 versus net income of $70.5; and Adjusted Distributable Earnings attributable to common stockholders was $48.1, or $0.82 per share, versus $41.1, or $0.94 per share. Adjusted Distributable Earnings is not GAAP income, taxable income, or cash available for dividends.
- Revenue and costs: Q2 interest income rose to $62.7 from $45.9 year over year, but interest expense increased to $26.0 from $11.2. Six-month interest income was $113.8 and expense was $40.0.
- Other income and margins: Q2 other loss was $69.6, including $194.2 of realized and unrealized losses on securities and loans, partly offset by $49.3 of derivative gains and $67.3 of fair-value gains on securitized-loan borrowings. Credit-portfolio net interest margin fell sequentially to 2.75% from 3.62%; Agency RMBS margin, excluding the catch-up premium amortization adjustment, fell to 1.76% from 1.98%.
- Cash flow: Six-month operating cash flow was $81.3; investing activities used $1,309.1 and financing activities provided $1,359.4. Cash and cash equivalents rose to $224.5 from $92.7 at year-end 2021. Dividends paid during the six months were $60.2.
- Balance sheet and liquidity: Total assets were $6,178.9 and total liabilities $4,944.4 at June 30. Total equity was $1,234.5, down from $1,323.6 at year-end. Management reported book value of $16.22 per common share and debt-to-equity of 3.8:1, or recourse debt-to-equity of 2.6:1.
- Debt: Repurchase agreements were $2,865.2; other secured borrowings were $1,493.6, including $1,448.2 of fair-value-option securitization debt; and senior notes totaled $296.0 at par. The $86.0 of 5.50% notes matured in September 2022; $210.0 of 5.875% notes mature in April 2027. Repo weighted-average borrowing rate was 2.26% at quarter-end, up from 0.82% at December 31, 2021.
- Dividends and capital: Common dividends declared for the first half totaled $0.90 per share. The company issued 2.57 million common shares through its ATM program for $45.2 net proceeds and repurchased 88,184 shares for $1.2. The board subsequently approved common dividends of $0.15 per share payable in August and September 2022.
Material changes versus prior periods
- Results shifted from profit to loss: Q2 common-stockholder results swung by $97.5 year over year, primarily because of fair-value and realized losses on securities and loans and losses on unconsolidated investments.
- The credit portfolio, excluding non-retained tranches of consolidated securitizations, grew about 16% sequentially to $2.66 billion, led by non-QM, residential transition, and small-balance commercial mortgage loans. Long Agency RMBS declined 11% to $1.34 billion.
- Residential mortgage loans at fair value rose to $3.49 billion from $2.42 billion at year-end; consumer loans fell to $7.4 million from $62.4 million, largely after the sale of performing consumer loans into a securitization.
- Borrowings and leverage increased, while financing costs rose materially. Management reported secured-funding average cost of 2.03% in Q2 versus 1.31% in Q1.
- Fair-value gains on securitized-loan debt partly offset losses on the related non-QM loans. These are accounting valuation changes and should not be interpreted as equivalent cash gains.
Outlook, commentary, and risks
- Management provided no specific earnings or return guidance. It said it would continue to adjust asset allocation opportunistically and use hedges as market conditions change, while maintaining Agency RMBS holdings for investment, REIT, and regulatory purposes.
- The Federal Reserve raised its target rate by 0.75 percentage point in June and began reducing its balance sheet. Management cited rising Treasury and mortgage rates, spread widening, high volatility, inflation, and weaker economic growth as drivers of losses and funding-cost pressure.
- Management said it expected current capital resources and credit availability to meet short- and long-term liquidity needs. It warned that failed repo refinancing, asset-value declines, or derivative changes could trigger margin calls, constrain cash, or force asset sales or additional financing.
- Fair-value estimation is a significant risk: $3.95 billion of fair-value assets and $1.65 billion of fair-value liabilities were classified as Level 3 at June 30, relying on significant unobservable inputs. Management cautioned that actual realizable values could differ materially.
- Other notable exposures include credit and collateral losses, borrower defaults, prepayment and extension risk, interest-rate and spread volatility, counterparty concentration, leverage and refinancing risk, and REIT qualification requirements. The company reported no material change to previously disclosed risk factors and no material legal proceedings.
- The planned purchase of Home Point Capital’s 49.6% Longbridge ownership interest remained subject to regulatory approval and closing conditions. If completed, Ellington expected to own substantially all of Longbridge and consolidate its results.
- The company recorded a $9.6 million valuation allowance against deferred tax assets at its taxable REIT subsidiary. It reported compliance with borrowing covenants at June 30.
Important facts for investors to verify
- Whether the September 2022 maturity of the $86 million 5.50% senior notes was refinanced or repaid, and the effect on cash and leverage.
- Subsequent repo renewal terms, borrowing costs, collateral haircuts, counterparty exposures, and any margin calls.
- Whether portfolio marks and Level 3 assumptions remain supportable, especially for residential loans, unconsolidated loan originators, and securitized positions.
- Progress and final terms of the proposed Longbridge acquisition, including its financing, accounting, and impact on consolidated leverage and earnings.
- Whether Adjusted Distributable Earnings and cash generation support ongoing common and preferred dividends; reconcile this non-GAAP measure to GAAP results and REIT taxable income.
- Trends in loan delinquencies, credit losses, mortgage prepayments, and the performance of loan-originator investments as rates and spreads change.