Ellington Financial Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; quarterly figures below include the three months ended December 31, 2018. The filing was issued March 14, 2019. Results are reported for Ellington Financial LLC, before its March 1, 2019 conversion to Ellington Financial Inc.
Business context
The externally managed company invests in mortgage-related and other financial assets, including Agency and non-Agency RMBS, mortgage loans, CMBS, consumer loans and ABS, CLOs, and derivatives. Management seeks risk-adjusted total returns through an opportunistic strategy; the credit portfolio was the primary driver of risk and return. The company reported under investment-company accounting for 2018 and stated that it would discontinue that accounting prospectively from January 1, 2019.
Financial performance and position
| Metric | 2018 | 2017 |
|---|---|---|
| Interest income | $131.0 million | $89.6 million |
| Total investment income | $135.0 million | $94.0 million |
| Total expenses | $91.9 million | $58.8 million |
| Net investment income | $43.1 million | $35.2 million |
| Net realized and unrealized gains on investments, secured borrowings, derivatives and currency | $6.8 million | $0.8 million |
| Increase in equity from operations | $49.9 million | $36.0 million |
| Increase in shareholders’ equity from operations | $46.7 million; $1.52 per share | $34.0 million; $1.04 per share |
| Net interest margin, including specified interest-rate swap effects | 3.12% | 3.63% |
| Net-asset-value-based total return, diluted | 9.21% | Not stated on the same diluted basis |
Fourth-quarter 2018 investment income was $36.9 million and net investment income was $10.2 million. A net loss of $11.3 million on realized and unrealized items reduced the quarter’s increase in equity from operations to $6.4 million, including non-controlling interests; shareholders’ equity from operations decreased $2.2 million, or $0.07 per share.
At year-end, total assets were $4.0 billion, total liabilities $3.4 billion, and equity $595.2 million. Common shareholders’ equity per share was $18.92, compared with $19.15 a year earlier; diluted book value per share was $18.92 versus $18.85. The filing says the year-end LTIP-unit redemption affected reported book value per common share but not fully diluted book value per share.
- Portfolio: Long credit investments were $1.480 billion, up from $1.025 billion; excluding non-retained tranches of consolidated non-QM securitizations, they were $1.185 billion, up approximately 31.7%. Long Agency RMBS were $975.4 million, up 11.9%.
- Debt and leverage: Total borrowings were approximately $2.0 billion, versus $1.5 billion; debt-to-equity was 3.36:1, versus 2.38:1. This ratio includes recourse and non-recourse borrowings and should be distinguished from management’s other leverage measures.
- Funding cost: Average cost of reverse repos and other secured borrowings rose to 2.81% from 1.83%, reflecting higher LIBOR and a greater share of credit-asset financing.
- Liquidity and cash flow: Cash and cash equivalents were $44.7 million, with $0.4 million restricted cash. Operating activities used $494.2 million; financing activities provided $491.6 million. Cash, cash equivalents and restricted cash declined $2.6 million to $45.1 million.
- Distributions and repurchases: Dividends declared were $1.64 per share for 2018, compared with $1.76 in 2017. The company repurchased 1.55 million shares in 2018 for $23.1 million at an average $14.95 per share.
Changes, outlook, risks and unusual items
- Results improved year over year, chiefly from higher net investment income and a reversal in derivative results: derivatives excluding currency hedges recorded $4.5 million in net realized and unrealized gains in 2018, versus $11.7 million in losses in 2017. Investment gains weakened to a $0.5 million loss from an $11.3 million gain.
- Credit-portfolio growth came mainly from residential and commercial mortgage loans and REO, consumer loans and ABS, and European RMBS. Management reported strong performance in several loan strategies and profitable credit hedges, while Agency RMBS price declines caused losses partly offset by interest-rate hedge gains.
- Management provided no numerical earnings or return guidance. It described continued opportunistic investing, portfolio reallocation as market conditions change, and plans to qualify as a REIT for 2019. It expects to maintain some Agency RMBS, in part to support its Investment Company Act exclusion.
- The Federal Reserve raised rates four times in 2018; short-term LIBOR increased and the yield curve flattened. Fourth-quarter market volatility and wider credit spreads were notable market conditions. The filing identifies interest-rate, spread, credit, prepayment, leverage, refinancing, liquidity, counterparty, valuation, regulatory and REIT-qualification risks.
- Reverse repos were mostly short-term: $1.23 billion, approximately 82%, had 90 days or less remaining at year-end. Management expects maturities to be funded mainly by rolling or renewing repos; inability to do so, margin calls, or asset-value declines could require asset sales. Contractual principal repayments shown for 2019 total approximately $1.55 billion.
- Subsequent events: the company elected corporate tax treatment effective January 1, 2019, intends to qualify as a REIT beginning in 2019, converted to a corporation effective March 1, 2019, and exchanged $86 million of 5.25% notes for 5.50% notes due 2022. The board later approved a $0.14-per-share dividend for April 2019, following a $0.41-per-share dividend approved for March.
- The company disclosed a January 2017 SEC subpoena concerning a loan originator and related loans, analyses, purchases, securitizations and servicing. It said it responded and intended to cooperate; no material legal proceeding was then considered pending, but the filing gave no assurance the inquiry would not lead to further investigation or proceedings.
- PwC issued unqualified opinions on the financial statements and internal control over financial reporting; management and the auditor reported effective controls as of December 31, 2018.
Most important facts for investors to verify
- Whether the planned 2019 REIT election and qualification requirements are met, including asset, income and distribution tests and the treatment of taxable REIT subsidiaries.
- Repo renewal capacity, collateral haircuts, margin-call exposure and the concentration and timing of 2019 debt maturities.
- The quality and performance of the expanded mortgage and consumer-loan portfolios, including non-performing loans, and the sensitivity of Level 3 valuations to assumptions.
- The sustainability of net interest margin and dividends as borrowing costs, portfolio mix and market rates change.
- Developments in the SEC inquiry, related-party arrangements and the company’s guarantees of a mortgage originator’s borrowings, capped at $25.0 million; $2.9 million was outstanding under the guaranteed arrangements at year-end.