Ellington Financial Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Ellington Financial is an externally managed REIT investing across mortgage-related securities and loans, consumer credit, CLOs, derivatives, and related businesses. Amounts below are U.S. dollars; financial statement figures are generally in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Interest income | $43.1 | $40.0 | $134.5 | $114.5 |
| Interest expense | $12.9 | $20.0 | $49.7 | $57.3 |
| Net interest income | $30.1 | $20.0 | $84.8 | $57.3 |
| Total other income (loss) | $21.1 | $3.7 | $(97.4) | $12.0 |
| Net income (loss) | $49.7 | $18.7 | $(38.2) | $48.9 |
| Net income (loss) attributable to common stockholders | $46.2 | $17.3 | $(45.9) | $45.3 |
| Basic and diluted earnings (loss) per common share | $1.06 | $0.53 | $(1.06) | $1.47 |
| Core earnings attributable to common stockholders per share | $0.41 | $0.47 | $1.26 | $1.38 |
Core earnings are a company-defined non-GAAP measure and exclude specified fair-value changes and other items; they should not be treated as a substitute for GAAP results. Q3 net interest margin, including specified interest-rate-swap effects and excluding the catch-up premium amortization adjustment, was 3.84%, versus 2.74% a year earlier. The filing does not provide a directly comparable consolidated revenue line; interest income is shown above.
- Balance sheet at September 30: Total assets were $3.35 billion, total liabilities $2.48 billion, and total equity $872.3 million. Cash and cash equivalents were $126.8 million, versus $72.3 million at year-end 2019. Management reported approximately $305.8 million of unencumbered assets.
- Leverage and debt: Total debt-to-equity was 2.7:1, compared with 3.8:1 at December 31, 2019; recourse debt-to-equity was 1.7:1. Secured borrowings totaled approximately $2.3 billion, and $86.0 million of senior notes mature in September 2022 and bear 5.50% interest. Average cost of funds in Q3 was 2.06%, down from 3.12% in Q3 2019.
- Cash flow, nine months: Operating activities provided $82.5 million; investing activities provided $713.5 million; financing activities used $741.5 million. Cash, cash equivalents, and restricted cash increased $54.5 million to $127.0 million.
- Book value and capital: Book value per common share was $16.45. A January follow-on offering issued 5.29 million shares and raised net proceeds of $95.3 million. Common shares outstanding were 43.78 million at September 30, up from 38.65 million at year-end 2019.
- Dividends: Common dividends declared totaled $0.27 per share in Q3 and $0.97 for the first nine months, versus $0.42 and $1.39 in the comparable 2019 periods. The board subsequently approved common dividends of $0.09 per share for November and $0.10 for December 2020. Series A preferred dividends were $0.421875 per share for the quarter.
Material changes versus comparable periods
- Q3 common-stockholder earnings rose to $46.2 million from $17.3 million. Higher net interest income, positive investment fair-value performance, and $11.4 million of earnings from unconsolidated entities contributed; derivative losses and higher expenses partly offset gains.
- For the first nine months, the company moved from $45.3 million of common-stockholder income to a $45.9 million loss. The main driver was $97.4 million of total other losses, including $67.8 million of realized and unrealized losses on securities and loans and $27.8 million of losses on derivatives.
- Net interest income increased in both comparison periods as interest expense declined with lower financing rates. The credit portfolio was larger year over year, while the Agency RMBS portfolio was reduced substantially during the market disruption.
- Assets fell to $3.35 billion from $4.34 billion at year-end 2019, and total secured borrowings declined to about $2.3 billion from $3.2 billion. Management said it deliberately reduced Agency exposure and leverage and held more cash during the COVID-19 market shock.
- Q3 Core Earnings per share declined to $0.41 from $0.47, despite stronger GAAP Q3 income. Nine-month Core Earnings per share also declined, to $1.26 from $1.38.
Year-over-year results require care: the company prospectively discontinued investment-company accounting effective January 1, 2019 and changed presentation and accounting for certain assets and liabilities. The filing states that post-2018 statements are not comparable with earlier periods prepared under the prior accounting basis.
Outlook, commentary, risks, and unusual items
- Management said investment activity resumed in May and June after being substantially suspended during the acute market disruption. The long credit portfolio increased approximately 5% in Q3 to $2.095 billion; long Agency RMBS was $919.9 million. Management nevertheless kept portfolios smaller, leverage relatively low, and cash higher than before COVID-19 because of continued economic uncertainty.
- Management described improved liquidity and more typical margin calls in Q2 and Q3 after unusually high calls in Q1, and said all margin calls during the nine months were met. It reported no specific earnings or dividend guidance; future asset allocation is intended to respond to changing credit and liquidity conditions.
- COVID-19 remained a material risk to asset values and borrower performance. At September 30, non-QM loans with $9.8 million unpaid principal were in forbearance; $28.6 million of small-balance commercial mortgage loans had entered deferment or modification; and consumer loans with $20.8 million unpaid principal had entered a deferment plan at some point from March through September. The company reported increased residential mortgage delinquencies, with $64.4 million fair value of residential mortgage loans 90 days or more past due and on non-accrual, versus $19.4 million at year-end 2019.
- Management tracked expected future credit losses of $28.4 million on securities, $2.6 million on residential mortgage loans, $0.4 million on commercial mortgage loans, and $4.7 million on consumer loans. These estimates and fair values depend in part on assumptions and less observable inputs; $1.90 billion of recurring fair-value assets were classified as Level 3.
- Liquidity and financing risks include repo maturity and rollover requirements, collateral haircuts, counterparty exposure, and possible margin calls. Repo haircuts were higher than at year-end 2019, though management said market levels had eased from early April. The filing warns that inability to finance Agency RMBS or sharp declines in credit-asset or derivative values could strain liquidity and require asset sales or additional financing.
- Other risks include interest-rate, prepayment, credit, and foreign-exchange exposure; REIT qualification and Investment Company Act requirements; and reliance on third-party servicers. The filing reports no material change to previously disclosed risk factors and no material legal proceeding currently identified by the company.
- Unusual items include Q3 unrealized gains on an investment in a mortgage originator and $11.4 million of total earnings from unconsolidated entities; the originator-related unrealized gains were $8.9 million in Q3. Related-party arrangements include asset purchases, financing, guarantees, and management-fee rebates. No incentive fee was accrued for the periods presented.
Important facts for investors to verify
- Whether the Q3 recovery in credit-asset prices and originator-related gains is sustainable, and how much of reported earnings reflects unrealized fair-value changes.
- Current portfolio credit quality, forbearance and modification trends, subsequent defaults, and the realization of the company’s expected credit-loss estimates.
- Liquidity under stress: repo maturities, collateral haircuts, unencumbered assets, margin-call capacity, and refinancing of secured debt.
- The calculation and composition of leverage and book value, including securitization liabilities and any differences between recourse and non-recourse debt.
- The economics, valuation inputs, conflicts, and performance of related-party investments and transactions, including the mortgage originator investment.
- Common and preferred dividend coverage, future board decisions, and the effect of the 2020 share issuance on per-share results and book value.
- Potential effects of the transition from LIBOR and the company’s ability to maintain REIT status and its Investment Company Act exemption.