Ellington Financial LLC — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; unaudited. The filing identifies the registrant as Ellington Financial LLC. The company is an externally managed specialty finance firm investing primarily in mortgage-related and consumer-related assets, as well as CLOs, corporate credit, real estate and derivatives.
Financial performance and position
| Metric | Q1 2017 / Mar. 31, 2017 | Comparable period / Dec. 31, 2016 |
|---|---|---|
| Investment income | $23.8 million | $22.1 million, Q1 2016 |
| Net investment income | $11.8 million | $11.8 million, Q1 2016 |
| Net increase in shareholders’ equity from operations | $15.3 million; $0.47 per share | $(23.2) million; $(0.69) per share, Q1 2016 |
| Total assets | $2.93 billion | $2.41 billion |
| Total liabilities | $2.28 billion | $1.77 billion |
| Total equity | $654.5 million | $644.8 million |
| Cash and cash equivalents | $104.2 million | $123.3 million |
| Borrowings | $1.148 billion | $1.058 billion |
- Q1 net realized and unrealized gains were $4.0 million, versus losses of $35.0 million in Q1 2016. Management attributed most of the year-over-year improvement to substantially smaller losses on credit hedges.
- Interest expense rose to $6.0 million from $3.5 million, while total expenses increased to $12.1 million from $10.3 million. Average cost of funds was 1.48%, compared with 1.06% in Q1 2016; management cited higher short-term rates and a greater share of higher-cost loan financing.
- Reported net investment income was $11.8 million in both periods. The annualized net investment income ratio to average equity was 7.36%; the total expense ratio was 7.53%.
- Net interest margin, including periodic payments on interest-rate swaps, was 4.39%, versus 4.01% in Q1 2016.
- Operating activities used $107.6 million of cash, compared with $19.0 million used in Q1 2016. Financing activities provided $88.5 million; cash declined $19.1 million during the quarter.
- Debt-to-equity was 1.75:1; leverage excluding U.S. Treasury securities was 1.70:1. The filing says borrowings are primarily short-term reverse repurchase agreements, with a weighted-average remaining term of 59 days.
- Book value per common share was $19.78; diluted book value per share was $19.50. The company paid $0.45 per share in dividends during the quarter for the prior period and approved a further $0.45 per-share dividend for Q1, payable June 15, 2017.
Material changes and portfolio developments
- Assets and liabilities expanded substantially from year-end, while equity increased modestly. Long investments at fair value rose to $1.86 billion from $1.51 billion.
- Management reported long Credit holdings of $640.3 million, excluding corporate relative-value positions, hedges and other derivatives. It increased mortgage loans, REO, CLOs and corporate debt, while reducing U.S. non-Agency RMBS holdings to $80.9 million from $102.7 million.
- Non-QM mortgage loans increased to $96.2 million from $71.6 million; performing and distressed leveraged loans rose to $58.3 million from $19.9 million; U.S. CLOs increased to $42.9 million from $22.5 million.
- Long Agency RMBS reported in management’s portfolio discussion increased to $841.3 million from $827.4 million. Agency holdings experienced $3.3 million of net realized and unrealized losses, while the related interest-rate hedging portfolio lost $1.4 million.
- Dividends were $0.45 per share in Q1 2017, down from $0.50 in Q1 2016. The company repurchased 130,488 shares in the quarter at an average $15.73 per share, for $2.1 million.
Outlook, commentary and risks
- No numerical earnings or return guidance is provided. Management expects to adjust asset allocations as credit and liquidity conditions change, and anticipates maintaining a core Agency RMBS portfolio. It expects reverse repos to remain its principal financing source.
- Management described opportunities in non-performing and bridge loans, non-QM mortgages, consumer loans, CLOs and corporate credit. It noted that Agency RMBS spreads widened in Q1 amid uncertainty about when the Federal Reserve may stop reinvesting principal payments; the Fed raised its policy rate by 0.25% in March.
- Key exposures include credit and borrower defaults, mortgage and consumer-loan prepayments, interest rates, foreign currency, leverage, short-term financing availability, collateral margin calls and counterparty risk. Management cautions that its interest-rate sensitivity analysis is model-based and illustrative, not a prediction of results.
- Fair value depends in part on management models and unobservable inputs. Level 3 investments totaled $623.5 million at quarter-end; the filing notes that actual realizable values may differ materially from estimates.
- The company disclosed a maximum $125.0 million guarantee of a mortgage originator’s obligations under a third-party master repurchase agreement. Remaining estimated contingent consumer-loan purchase obligations were approximately $241.9 million in principal balance.
- The company reported no material legal proceedings that it or its Manager currently considers material, but disclosed an SEC subpoena received in January 2017 concerning a loan originator and related loans, analysis, purchases, securitizations and servicing. The company says it responded and intends to cooperate; it cannot assure that the inquiry will not lead to further investigation or proceedings.
- Management concluded disclosure controls were effective as of March 31, 2017. It reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether short-term repo financing remains available on acceptable terms, and the potential liquidity and margin-call impact of falling collateral values or higher prepayments.
- How portfolio growth, higher borrowing costs and leverage affect recurring net investment income and dividend coverage.
- The assumptions and valuation sensitivity for Level 3 holdings, including loans, CLOs and non-Agency securities.
- The status and potential implications of the SEC subpoena, the $125.0 million guarantee and the consumer-loan purchase commitments.
- Whether the $0.45 per-share dividend remains supportable as market conditions, financing costs and portfolio results change.