Business Context and Reporting Period
The filing is an annual Form 10-K for the fiscal year ended December 31, 2019, filed March 12, 2020. The registrant identified in the filing is Ellington Residential Mortgage REIT (NYSE: EARN), although the request metadata refers to Ellington Credit Co.
The company is an externally managed Maryland REIT that invests primarily in Agency residential mortgage-backed securities, with smaller allocations to non-Agency RMBS and other mortgage-related assets. It uses repurchase agreements and derivatives to finance assets and manage interest-rate and prepayment risks. Blackstone Funds owned approximately 25% of outstanding common shares at year-end.
Key Financial Metrics
| Metric | 2019 / December 31, 2019 | 2018 / December 31, 2018 |
|---|---|---|
| Interest income | $43.8 million | $54.6 million |
| Net interest income | $8.6 million | $22.0 million |
| Net income (loss) | $22.3 million | $(11.3) million |
| Net income (loss) per share | $1.79 | $(0.88) |
| Core Earnings | $11.3 million, or $0.91 per share | $17.2 million, or $1.34 per share |
| Net interest margin | 0.88% | 1.20% |
| Mortgage-backed securities at fair value | $1.402 billion | $1.540 billion |
| Shareholders’ equity | $160.8 million | $153.8 million |
| Book value per share | $12.91 | $12.30 |
| Repurchase agreement borrowings | $1.296 billion | $1.482 billion |
| Debt-to-equity ratio | 8.1:1 | 9.6:1 |
| Cash and cash equivalents | $35.4 million | $18.6 million |
The portfolio was approximately 98% Agency RMBS by fair value, including $1.241 billion of fixed-rate Agency specified pools, $33.3 million of Agency ARMs, $99.9 million of Agency reverse mortgage pools, $18.2 million of Agency interest-only securities, and $8.9 million of non-Agency RMBS.
Operating activities provided $17.5 million of cash, investing activities provided $221.9 million, and financing activities used $222.6 million. Cash increased by $16.8 million during the year. Dividends declared totaled $1.18 per share, compared with $1.45 per share in 2018.
Material Changes Versus the Prior Comparable Period
- Net income improved to $22.3 million from a $11.3 million loss, primarily because securities generated $51.5 million of net realized and unrealized gains versus a $35.8 million loss in 2018.
- Derivative performance reversed: financial derivatives produced a $32.5 million loss in 2019 versus a $7.9 million gain in 2018, reflecting losses on interest-rate swaps, futures, and TBAs as rates declined.
- Net interest income declined 61% to $8.6 million. Interest income fell because of lower average Agency RMBS holdings and a $5.9 million negative catch-up premium amortization adjustment, while interest expense increased to $35.3 million from $32.5 million.
- The portfolio declined 9% to $1.402 billion, while repo borrowings declined 12.5% to $1.296 billion. Leverage decreased from 9.6:1 to 8.1:1.
- Book value per share increased 5.0% to $12.91 after $1.18 per share of dividends; management reported a 14.6% 2019 economic return.
- Prepayment pressure increased materially. The three-month constant prepayment rate on fixed-rate specified pools rose to 14.9% in the fourth quarter from 6.6% in the fourth quarter of 2018.
- The average pay-up on specified pools increased to 2.05% at year-end from 0.58% at year-end 2018, reflecting higher perceived prepayment protection value.
Fourth-Quarter Results, Outlook, Risks, and Unusual Items
For the three months ended December 31, 2019, the company reported net income of $9.7 million, or $0.78 per share, compared with a $10.1 million loss, or $(0.80) per share, in the fourth quarter of 2018. Fourth-quarter net interest income was $1.4 million, other income was $9.6 million, and the declared dividend was $0.28 per share.
No formal earnings or portfolio guidance was provided. Management stated that it expected to continue emphasizing Agency specified pools and active portfolio management, while retaining flexibility to increase non-Agency RMBS exposure if more attractive entry points develop. The Board approved a $0.28 per-share dividend for the first quarter of 2020, payable April 27, 2020.
Key risks include high leverage and short-term repo refinancing, margin calls, counterparty exposure, interest-rate and yield-curve changes, faster-than-expected mortgage prepayments, declining net interest margins, valuation uncertainty, non-Agency credit losses, changes to Fannie Mae and Freddie Mac, LIBOR transition, REIT qualification requirements, and maintaining exclusion from Investment Company Act registration. The filing also identifies pandemics, including COVID-19, as a potential risk but does not quantify any impact on 2019 results.
Unusual items included the $5.9 million negative catch-up premium amortization adjustment, a $4.3 million impairment charge on Agency interest-only securities due to increased prepayments, and $32.5 million of net losses on financial derivatives. The company had no material legal proceedings, no off-balance-sheet financing arrangements, and reported effective disclosure controls and internal control over financial reporting. PricewaterhouseCoopers LLP issued an unqualified audit opinion.
The external management agreement provides for a fee equal to 1.50% annually of defined shareholders’ equity, plus reimbursement of certain expenses. The agreement may require a termination fee equal to 5% of defined shareholders’ equity if the company terminates or does not renew it in specified circumstances.
Important Facts for Investors to Verify
- Confirm the registrant identity and ticker because the filing names Ellington Residential Mortgage REIT, while the request metadata names Ellington Credit Co.
- Reconcile recurring earnings and dividend coverage: 2019 Core Earnings declined to $0.91 per share while declared dividends totaled $1.18 per share.
- Assess the sustainability of the 2019 book-value gain and economic return given that a substantial portion of reported income came from mark-to-market securities gains.
- Review repo maturity, haircut, margin-call, and counterparty disclosures supporting the 8.1:1 debt-to-equity ratio and $1.296 billion of borrowings.
- Evaluate sensitivity to prepayments, particularly the Agency interest-only portfolio and the higher net Agency premium of 5.3% at year-end.
- Review assumptions used for Level 3 valuations, including prepayment, loss, recovery, yield, and option-adjusted-spread assumptions.
- Monitor REIT qualification, Investment Company Act exclusion, GSE reform, LIBOR-to-SOFR transition, and COVID-19-related market effects.