Ellington Residential Mortgage REIT (EARN) — Form 10-Q Summary
Reporting period: Three months ended March 31, 2020; filed May 11, 2020. The filing identifies the registrant as Ellington Residential Mortgage REIT, although the request metadata refers to Ellington Credit Co.
Business Context
EARN is an externally managed Maryland REIT that invests primarily in Agency residential mortgage-backed securities (RMBS), with smaller investments in non-Agency RMBS and related mortgage assets. It finances Agency RMBS principally through short-term repurchase agreements and uses derivatives to manage interest-rate risk. The Company had 12,319,616 common shares outstanding as of May 5, 2020 and no preferred shares outstanding.
Key Financial Metrics
| Metric | Q1 2020 / March 31, 2020 | Comparable period / December 31, 2019 |
|---|---|---|
| Interest income | $9.9 million | $12.6 million in Q1 2019 |
| Interest expense | $6.1 million | $9.6 million in Q1 2019 |
| Net interest income | $3.8 million | $3.1 million in Q1 2019 |
| Total expenses | $1.3 million | $1.4 million in Q1 2019 |
| Net realized and unrealized securities gains | $7.9 million | $20.3 million in Q1 2019 |
| Net realized and unrealized derivative losses | $(27.1) million | $(13.1) million in Q1 2019 |
| Net income (loss) | $(16.7) million | $8.9 million in Q1 2019 |
| Basic and diluted EPS | $(1.35) | $0.72 in Q1 2019 |
| Core earnings | $3.4 million, or $0.27 per share | $3.3 million, or $0.27 per share |
| Net interest margin | 1.20%, excluding catch-up premium amortization | 0.91% in Q1 2019 |
| Cash and cash equivalents | $59.7 million | $35.4 million at December 31, 2019 |
| Total assets | $1.281 billion | $1.489 billion at December 31, 2019 |
| Shareholders’ equity | $139.7 million | $160.8 million at December 31, 2019 |
| Book value per share | $11.34 | $12.91 at December 31, 2019 |
| RMBS at fair value | $1.051 billion | $1.402 billion at December 31, 2019 |
| Repurchase agreement borrowings | $1.109 billion at 1.61% weighted average rate | $1.296 billion at 2.00% |
| Adjusted debt-to-equity ratio | 7.2:1 | 8.1:1 |
| Dividend declared per share | $0.28 | $0.34 in Q1 2019 |
Cash Flow, Portfolio, and Liquidity
- Operating activities provided $5.6 million of cash, while investing activities provided $205.7 million.
- Financing activities used $187.0 million, primarily reflecting net repayments of repurchase agreements.
- Cash increased by $24.3 million to $59.7 million during the quarter.
- The RMBS portfolio was 97% Agency RMBS by fair value, including $1.043 billion of Agency RMBS and $7.5 million of non-Agency RMBS. Agency interest-only securities were $15.6 million.
- The Company held approximately $12.1 million of other unencumbered assets in addition to cash.
- Average repo borrowing cost declined to 1.86% from 2.15% in the preceding quarter; total average cost of funds, including swaps and short Treasuries, was 1.85%.
Material Changes Versus Prior Periods
- Net income declined from $8.9 million to a $16.7 million loss, primarily because derivative losses increased substantially and securities gains declined.
- Derivative losses were driven by sharp declines in interest rates and high volatility: net realized and unrealized losses were $17.5 million on interest-rate swaps, $6.2 million on futures, and $3.4 million on TBAs.
- Agency RMBS generated $11.8 million of net realized and unrealized gains, but these gains were more than offset by hedge losses, short Treasury losses, and non-Agency RMBS losses.
- The Company reduced the RMBS portfolio by approximately 25% and lowered leverage in response to COVID-19-related market dislocation and liquidity risk. Management reported that it avoided forced asset sales.
- Book value per share fell 12.2%, from $12.91 to $11.34, and the quarterly economic return was negative 10.0% after the $0.28 dividend.
- Net interest income increased despite lower interest income because repo costs and average borrowings declined more rapidly than portfolio yields.
- The Company repurchased 136,142 common shares for $1.0 million, or $7.24 per share, during the quarter.
Outlook, Risks, and Unusual Items
COVID-19 caused significant market volatility, illiquidity, widening Agency RMBS spreads, and margin calls during March. The Company satisfied all reported margin calls, but warned that continued market disruption could increase haircuts, collateral requirements, financing costs, and the risk of forced asset sales. Management stated that repo financing was rolled in an orderly manner through the filing date, although haircuts were sometimes higher.
Management was considering increasing capital allocation to non-Agency RMBS following spread widening, but the filing provides no formal earnings, leverage, or dividend guidance. Future dividends remain discretionary and depend on earnings, liquidity, financial condition, REIT requirements, financing conditions, and Board approval.
- Primary risks include interest-rate volatility, prepayment risk, non-Agency credit losses, short-term repo refinancing risk, counterparty exposure, collateral and margin requirements, and fair-value uncertainty.
- COVID-19 could increase mortgage delinquencies, forbearances, defaults, and losses, particularly in non-Agency assets.
- The Company’s fair values rely partly on third-party valuations and models using assumptions about prepayments, defaults, recoveries, and loss severities; these estimates may be less reliable during market dislocations.
- The Management Agreement provides for a 1.50% annual management fee based on shareholders’ equity and, in specified termination circumstances, a termination fee equal to 5% of defined shareholders’ equity.
- No material legal proceedings or significant contingencies were reported. The Company had no off-balance-sheet relationships with unconsolidated entities.
- Disclosure controls and procedures were assessed as effective as of March 31, 2020.
Investor Verification Items
- Verify the registrant identity and ticker: the filing is for Ellington Residential Mortgage REIT, ticker EARN, not an entity expressly named Ellington Credit Co.
- Reconcile GAAP net loss of $16.7 million with core earnings of $3.4 million and assess the treatment of mark-to-market derivative losses.
- Review the sustainability of the $0.28 quarterly dividend given the decline in book value, COVID-19 risks, and the Board’s discretionary dividend policy.
- Monitor repo renewals, haircuts, collateral requirements, margin calls, and the concentration of $1.1 billion of borrowings across 16 counterparties.
- Assess the sensitivity of book value and liquidity to interest rates, prepayments, Agency RMBS spreads, derivative valuations, and non-Agency credit performance.
- Confirm post-quarter-end developments, since the filing states that the ultimate COVID-19 impact on financial condition, liquidity, and results cannot be reasonably predicted.