Ellington Residential Mortgage REIT: Horrible behavior but payments continue (NYSE:EARN)

Andrei Popov

Ellington Residential Mortgage REIT (NYSE:New York Stock Exchange:obtain) is a mortgage real estate investment trust (mREIT) that we traded in years ago. This company, like many others in this space, has gone through a lot of pain during the COVID outbreak, 2021 years. Here in 2022, interest rates have skyrocketed and these stocks have been crushed. The Fed’s extremely aggressive response to high inflation continues to move markets, but it also results in extreme volatility in interest rates, weighing heavily on real estate companies like Ellington that buy and sell mortgages and mortgage bundles. I’m leaning against it.

This has been a very painful year for mREITs, ending in September when mREITs and the market flashed. Ellington is in a tough field. Rising interest rates are causing problems for mortgage-backed securities and related products. We have seen interest rate spreads widen, but the constant movement of interest rates has led to a reversal. Actions taken by the Federal Reserve in the past few months have weighed heavily on operations. Overall, the sector as a whole fell. Companies that buy and sell mortgages and bundles of mortgages are having a hard time. It’s the toughest environment for these companies in decades.

Given the higher interest rates on new mortgages, the risk of prepayments has decreased, but spreads are all over the place and book values ​​have decreased. More rate hikes are slated and if the Fed raises the federal funds rate target rate by 75 basis points for his 4th consecutive time, we’re still stuck because the sector is tough to navigate. We are not out of danger. The pressure was reflected in just-reported earnings, but the company continues to pay generous dividends. let’s discuss.

I felt the pain in my earning potential

In an earlier report Earnings in the third quarter, found that interest rates continued to spike and interest rate volatility surged to levels never seen before. The third quarter saw liquidity problems and widening yield spreads, but prices fell across most fixed income sectors, including agency RMBS. It hurts. Lower values ​​and spreads led to book value devastation. The key metrics we’re seeing have been crushed, but that dividend continues to pay out.

key indicators

Latest data*

Q3 2022 book value and % change from Q1 2022

$7.78 (-14.2%)

Q3 2022 Net Interest Spread


Quarterly Current Dividend (Yield)

$0.24 (15.7%)

Q3 2022 Net Income (Loss) Per Share


Third Quarter 2022 Distributable Earnings Per Share


Dividend target?


52-Week Stock Range


sauce: Ellington Residential Mortgage REIT Q3 2022 Results


*As of September 30, 2022

** by distributable income

Dividend coverage is important

Remember, going back in time, this company has cut its dividend multiple times over the years. In Q3 2022, $0.08 monthly payments, or he $0.24 per quarter, weren’t covered, so no surprises here at all. But I’m surprised it was just a one-cent misrepresentation.

Well, last quarter’s dividend was well covered. So we haven’t seen any cuts yet, but after another quarter or two like this we’ll see the pain. The good news is that a rate hike looks set for his early 2023, easing the yield curve inversion. In short, better days are on the way, but we’re not out of the woods just yet. Net income was a big loss on top of last quarter’s losses, but we don’t really care about this measure of mREIT dividends.

What do you mean? Now, in our estimates, the most important metric to watch here is distributable income (previously called core income). As we pointed out, this figure is lacking. This is because net interest margins have shrunk significantly and the earning power of his mREIT has subsequently declined. Margins fell because yields fell because interest rates were much higher on the short end of the curve, causing a sharp rise in the cost of funds that outpaced the movement in asset yields. It was hard. After all, this is still the name of the income, so compensation is important. Distributable earnings are a solid indicator of dividend coverage, and while EARN failed this quarter, it’s been a terrible quarter for almost all mREITs.

There weren’t many positives in this quarter. Given that interest rates are so high, I would argue that prepayments would be reduced, reducing portfolio volatility somewhat. Interest rates are so high that refinancing many mortgages doesn’t make much sense. In terms of earnings, as I mentioned earlier, there was a net loss. No surprises here. The company saw a net loss of $13.7 million, or a loss of $1.04 per share, compared to a loss of $0.82 per common share in the second quarter.

But again, a better measure of a company’s ability to pay dividends is distributable earnings, and we saw only a small decline here. Distributable earnings are $3 million, or 1 share. It was $0.23 per person. We targeted a $0.24 print to cover the dividend, but given how the sector as a whole has been quarterly, we wouldn’t be surprised if Ellington fell short.

The driving force for the quarter was CEO Lawrence Penn said:

However, the market was clearly negative in August and September. Hawkish messages from Fed officials, heightened inflation and recession fears, and a sharp rise in interest rates have pushed up volatility and caused an inversion of the yield curve..margin calls… meanwhile, the Fed’s The increasing pace of balance sheet outflows and weak bank demand created further headwinds for agency RMBS.Against this backdrop, Ellington Residential suffered a significant net loss

So you have it. The macro situation was abysmal and mREITs suffered heavy losses. Ellington was no exception.Significant reduction in book value due to agency RMBS devaluation

Book value hit hard as spreads fluctuated and RMBS fell in value

What happened here is common to many people in space. Book value declined significantly by 14.2% to $7.78 from $9.07 in the second quarter. It is further down from $11.76 in Q1. Just an ugly road and Ellington stock followed suit. If the stock is $6.70, there is a reservation discount of $1.08. This equates to a 14% discount. The volatility is so high here that we tend to favor discounts of this size, but the book value will be difficult to stabilize.

Still, you should ask yourself at what point is the income worth further devaluation of the book value.because it’s a dividend Maintained. Ellington pays $0.08 monthly and $0.24 quarterly. If there is another severe pressure, as in September, and revenues fall further, there is a possibility of a cut. But for now, Ellington’s 15.7% yield on her is tempting. But be aware that performance may need to be recovered or cut.

take home

Ellington Residential Mortgage REIT’s yield is currently over 15% and could go higher if EARN stock falls, providing downside protection. Any extreme moves in interest rates should subside in the next month or so. In order for this business model to be sufficiently profitable, the yield inversion must be mitigated. But for now, Ellington Residential Mortgage REIT should be able to continue paying. For coverage, we should continue to monitor distributable earnings.

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