Business Context and Reporting Period
The filing is Ellington Residential Mortgage REIT’s unaudited Form 10-Q for the quarter and six-month period ended June 30, 2020. The company is an externally managed Maryland REIT investing primarily in Agency residential mortgage-backed securities (RMBS), with a smaller non-Agency RMBS portfolio, and using repurchase agreements and derivatives for financing and hedging.
The source metadata identifies Ellington Credit Co., while the filing’s registrant is Ellington Residential Mortgage REIT (NYSE: EARN); this entity identification should be verified.
Financial Highlights
| Metric | Three months ended June 30, 2020 | Six months ended June 30, 2020 |
|---|---|---|
| Interest income | $3.5 million | $13.4 million |
| Net interest income | $1.2 million | $4.9 million |
| Total other income | $21.9 million | $2.7 million |
| Net income | $21.3 million | $4.6 million |
| GAAP earnings per share | $1.73 | $0.37 |
| Core earnings | $3.2 million, or $0.26 per share | $6.6 million, or $0.53 per share |
| Net interest margin, excluding catch-up amortization adjustment | 1.86% | 1.49% |
| Dividends declared per share | $0.28 | $0.56 |
- June 30, 2020 assets were $1.292 billion, including $1.154 billion of mortgage-backed securities and $50.9 million of cash and cash equivalents.
- Shareholders’ equity was $157.7 million, compared with $160.8 million at December 31, 2019. Book value was $12.80 per share, versus $12.91 at year-end and $11.34 at March 31, 2020.
- Repurchase-agreement borrowings were $909.8 million, compared with $1.296 billion at December 31, 2019. The weighted-average borrowing rate was 0.38%, versus 2.00% at year-end.
- Adjusted debt-to-equity was 6.8:1 at June 30, 2020, compared with 7.2:1 at March 31 and 8.1:1 at December 31, 2019.
- The RMBS portfolio consisted primarily of Agency RMBS, including $970.4 million of fixed-rate specified pools, $100.4 million of Agency reverse mortgage pools, $26.8 million of Agency ARMs, $14.5 million of Agency interest-only securities, and $42.0 million of non-Agency RMBS.
- Cash flow from operating activities was $9.1 million for the six months. Investing activities provided $391.4 million, financing activities used $385.0 million, and cash increased by $15.6 million to $50.9 million.
Material Changes Versus Prior Comparable Period
- Second-quarter net income improved from a $0.1 million loss in 2019 to $21.3 million of income in 2020, primarily due to stronger securities and derivative valuation results.
- Six-month net income declined from $8.8 million in 2019 to $4.6 million in 2020. Securities gains decreased to $28.7 million from $36.2 million, while derivative losses improved to $26.0 million from $30.3 million.
- Net interest income declined to $1.2 million from $2.5 million for the quarter and to $4.9 million from $5.5 million for the six-month period. Interest income fell substantially because of lower average Agency RMBS holdings, lower asset yields, and a larger negative catch-up premium amortization adjustment.
- Lower short-term interest rates and reduced borrowings lowered second-quarter interest expense to $2.3 million from $9.7 million, and reduced the average total cost of funds to 1.13% from 2.56%.
- The company reduced leverage and increased liquidity during the first quarter in response to COVID-19 market dislocations, then increased RMBS holdings during the second quarter as markets stabilized. Total RMBS increased approximately 10% from March 31 to $1.154 billion.
- Non-Agency RMBS increased more than fivefold from $7.5 million at March 31, 2020 to $42.0 million at June 30, 2020.
- During the six months, the company repurchased 136,142 common shares for $1.0 million at an average price of $7.24 per share.
Outlook, Commentary, Risks, and Unusual Items
Management reported that Federal Reserve actions stabilized Agency RMBS markets and that margin calls and financing terms reverted to more typical levels. Management expects available cash, investment cash flows, repo financing, and potential equity resources to meet anticipated liquidity needs, but this expectation is subject to market conditions and financing availability.
- COVID-19 created significant volatility, illiquidity, margin calls, and valuation uncertainty. The company satisfied all margin calls received during the first-quarter disruption.
- Mortgage prepayments increased materially; the company’s specified-pool constant prepayment rate was 18.0% in the second quarter versus 15.4% in the first quarter and 9.6% in the year-earlier quarter. Higher prepayments can reduce asset yields and adversely affect interest-only securities.
- The company’s net Agency premium increased to approximately 6.6% of specified-pool fair value from 5.6% at March 31, reflecting greater exposure to prepayment risk, although specified pools are intended to provide some protection.
- Derivative liabilities increased to $12.1 million from $2.0 million at year-end, and net derivative fair value moved to a $9.0 million liability from a $2.1 million asset.
- At June 30, the company had $50.9 million of cash and approximately $45.1 million of other unencumbered assets. It posted $15.6 million of net cash collateral to repo counterparties.
- Key risks include interest-rate movements, prepayment speeds, repo refinancing and margin-call risk, non-Agency credit losses, valuation uncertainty, counterparty exposure, changing Federal Reserve and government-sponsored enterprise policies, COVID-19 effects, and REIT and Investment Company Act qualification requirements.
- The company had no material legal proceedings, no material recorded indemnification liabilities, and no off-balance-sheet relationships with unconsolidated entities. Management stated that disclosure controls were effective as of June 30, 2020.
Important Facts for Investors to Verify
- Confirm the issuer identity and ticker because the request metadata names Ellington Credit Co., while the filing names Ellington Residential Mortgage REIT, ticker EARN.
- Reconcile GAAP net income with core earnings and determine how much reported profitability depends on unrealized fair-value gains, particularly the $21.9 million of second-quarter other income.
- Monitor repo availability, collateral haircuts, margin calls, counterparty concentration, and the company’s 6.8:1 adjusted debt-to-equity ratio.
- Assess the impact of continued mortgage prepayments on specified pools, Agency interest-only securities, premium amortization, and future net interest income.
- Review the increased non-Agency RMBS allocation for credit quality, valuation assumptions, expected losses, and liquidity.
- Verify future dividend sustainability against core earnings, taxable income, liquidity needs, and REIT distribution requirements.