Ellington Residential Mortgage REIT Reports Third Quarter 2022 Results

OLD GREENWICH, Conn.–()–Ellington Residential Mortgage REIT (NYSE: EARN) (the “Company”) today reported financial results for the quarter ended September 30, 2022.

Highlights

  • Net loss of $(13.7) million, or $(1.04) per share.
  • Adjusted Distributable Earnings1 of $3.0 million, or $0.23 per share.
  • Book value of $7.78 per share as of September 30, 2022, which includes the effects of dividends of $0.24 per share for the quarter.
  • Net interest margin2 of 1.28%.
  • Weighted average constant prepayment rate (“CPR”) for the fixed-rate Agency specified pool portfolio of 9.8%3.
  • Dividend yield of 13.9% based on the November 8, 2022 closing stock price of $6.89, and monthly dividend of $0.08 per common share declared on November 7, 2022.
  • Debt-to-equity ratio of 9.1:1 as of September 30, 2022.
  • Net mortgage assets-to-equity ratio of 7.5:14 as of September 30, 2022.
  • Cash and cash equivalents of $25.4 million as of September 30, 2022, in addition to other unencumbered assets of $2.6 million.
  • Issued 148,349 shares under the ATM Program at an average price of $8.43 per share. Repurchased 9,489 shares at an average price of $6.53 per share.

Third Quarter 2022 Results

In the fixed income markets, July started the third quarter on a constructive note, with volatility, interest rates, and most yield spreads reversing much of their second quarter increases. In August and September, however, markets took on a decidedly negative tone. Hawkish messaging from Fed officials, elevated inflation and recessionary concerns, and sharply rising interest rates pushed volatility higher and drove an inversion of the yield curve, all of which stressed equity and fixed income markets alike,” said Laurence Penn, Chief Executive Officer and President.

We saw widespread selling across asset classes, including forced selling by some asset managers to meet margin calls and redemptions, particularly in September. Liquidity deteriorated and yield spreads widened in virtually every fixed income sector, including Agency RMBS, with many sectors reaching their widest levels of the year. Meanwhile, the increased pace of Fed balance sheet runoff and weak bank demand represented further headwinds to Agency RMBS. Against this backdrop, Ellington Residential experienced a significant net loss for the quarter as net declines on our specified pools exceeded net gains on our interest rate hedges and carry from the portfolio, while delta hedging costs stemming from the volatility weighed further on results.

That said, we continued to hold a strong liquidity position, with cash and unencumbered assets representing 27% of our total equity at quarter end. Furthermore, a significant portion of our losses for the quarter—and indeed, for the year—resulted from yield spread widening, and we believe that the prospects of recouping many of these losses are strong.”

Looking ahead, with mortgage rates considerably higher and housing affordability at its lowest level in decades, prepayment rates have plummeted and we are seeing the first clear evidence of declining home prices. Meanwhile, the Fed continues to signal additional rate hikes. In this environment, pool selection, hedging, and risk management will be critical to performance, and we believe that Ellington’s modeling expertise and data analytics are distinct advantages. At the same time, EARN’s smaller size and strong liquidity management should enable us to be nimble as market conditions continue to evolve.”

________________________________

1 Adjusted Distributable Earnings is a non-GAAP financial measure. See “Reconciliation of Adjusted Distributable Earnings to Net Income (Loss)” below for an explanation regarding the calculation of Adjusted Distributable Earnings.

2 Net interest margin excludes the effect of the Catch-up Premium Amortization Adjustment.

3 Excludes recent purchases of fixed rate Agency specified pools with no prepayment history.

4 The Company defines its net mortgage assets-to-equity ratio as the net aggregate market value of its mortgage-backed securities (including the underlying market values of its long and short TBA positions) divided by total shareholders’ equity. As of September 30, 2022 the market value of the Company’s mortgage-backed securities and its net short TBA position was $934.7 million and $(161.3) million, respectively, and total shareholders’ equity was $103.0 million.

Financial Results

The following table summarizes the Company’s portfolio of RMBS as of September 30, 2022 and June 30, 2022:

 

September 30, 2022

 

June 30, 2022

(In thousands)

Current Principal

 

Fair Value

 

Average

Price(1)

 

Cost

 

Average

Cost(1)

 

Current

Principal

 

Fair Value

 

Average

Price(1)

 

Cost

 

Average

Cost(1)

Agency RMBS(2)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

15-year fixed-rate mortgages

$

78,506

 

$

72,465

 

$

92.31

 

$

78,802

 

$

100.38

 

$

104,064

 

$

100,513

 

$

96.59

 

$

106,445

 

$

102.29

20-year fixed-rate mortgages

 

10,979

 

 

9,612

 

 

87.55

 

 

11,700

 

 

106.57

 

 

33,430

 

 

30,409

 

 

90.96

 

 

34,840

 

 

104.22

30-year fixed-rate mortgages

 

879,451

 

 

800,161

 

 

90.98

 

 

891,933

 

 

101.42

 

 

795,468

 

 

762,304

 

 

95.83

 

 

824,015

 

 

103.59

ARMs

 

8,808

 

 

8,748

 

 

99.32

 

 

9,579

 

 

108.75

 

 

9,266

 

 

9,416

 

 

101.62

 

 

9,964

 

 

107.53

Reverse mortgages

 

18,044

 

 

18,385

 

 

101.89

 

 

20,058

 

 

111.16

 

 

18,781

 

 

19,381

 

 

103.19

 

 

20,665

 

 

110.03

Total Agency RMBS

 

995,788

 

 

909,371

 

 

91.32

 

 

1,012,072

 

 

101.64

 

 

961,009

 

 

922,023

 

 

95.94

 

 

995,929

 

 

103.63

Non-Agency RMBS(2)

 

10,595

 

 

7,720

 

 

72.86

 

 

7,402

 

 

69.86

 

 

10,622

 

 

7,969

 

 

75.02

 

 

7,369

 

 

69.37

Total RMBS(2)

 

1,006,383

 

 

917,091

 

 

91.13

 

 

1,019,474

 

 

101.30

 

 

971,631

 

 

929,992

 

 

95.71

 

 

1,003,298

 

 

103.26

Agency IOs

 

n/a

 

 

9,396

 

 

n/a

 

 

9,928

 

 

n/a

 

 

n/a

 

 

9,450

 

 

n/a

 

 

11,096

 

 

n/a

Non-Agency IOs

 

n/a

 

 

8,181

 

 

n/a

 

 

6,428

 

 

n/a

 

 

n/a

 

 

8,205

 

 

n/a

 

 

6,570

 

 

n/a

Total mortgage-backed securities

 

 

$

934,668

 

 

 

$

1,035,830

 

 

 

 

 

$

947,647

 

 

 

$

1,020,964

 

 

(1) Represents the dollar amount (not shown in thousands) per $100 of current principal of the price or cost for the security.

(2) Excludes IOs.

The Company’s Agency RMBS holdings decreased slightly to $909.4 million as of September 30, 2022, as compared to $922.0 million as of June 30, 2022. Over the same period, the Company’s holdings of interest-only securities and non-Agency RMBS also decreased modestly. The Company’s Agency RMBS portfolio turnover was 19% for the quarter.

The Company’s debt-to-equity ratio, adjusted for unsettled purchases and sales, increased to 9.1:1 as of September 30, 2022, as compared to 7.9:1 as of June 30, 2022. The increase was primarily due to lower shareholders’ equity quarter over quarter as the Company’s portfolio size remained relatively constant. Similarly, the Company’s net mortgage assets-to-equity ratio increased to 7.5:1 from 6.8:1 over the same period.

After positive performance in July, Agency RMBS significantly underperformed U.S. Treasury securities and interest rate swaps in August and September, and for the third quarter overall, as persistently high inflation weakened market sentiment, drove volatility higher, and led the Federal Reserve to continue the rapid tightening of its monetary policy. The Federal Reserve increased its target range for the federal funds rate by 0.75% in both July and September, which left the benchmark rate at its highest level since 2008, and also accelerated the runoff of its balance sheet in September. Interest rates rose significantly during the quarter, particularly short-term interest rates, and actual and implied interest rate volatility surged, with the MOVE index in September reaching its highest level since the COVID-related market volatility of March 2020.

Agency RMBS durations extended in response to the higher interest rates, while the elevated volatility contributed to substantial yield spread widening during the quarter. As a result, the Company had significant losses on its Agency RMBS, which exceeded net gains on its interest rate hedges and net interest income.

In the current higher interest rate environment, the specified pool market has become less focused on prepayment protection, and more focused on extension protection. Many of the Company’s specified pools are considered to offer significant extension protection relative to their TBA counterparts. Thus, despite surging mortgage rates, average pay-ups on the Company’s existing specified pool portfolio actually increased quarter over quarter, as the increase in the value of the extension protection provided by these specified pools more than offset the reduction in the value of its prepayment protection. On the other hand, the Company’s new purchases during the quarter consisted of pools with much lower pay-ups, and as a result, overall pay-ups on the Company’s specified pools decreased modestly to 1.02% as of September 30, 2022, as compared to 1.09% as of June 30, 2022.

During the quarter, the Company continued to hedge interest rate risk through the use of interest rate swaps and short positions in TBAs, U.S. Treasury securities, and futures. The Company again ended the quarter with a net short TBA position, both on a notional basis and as measured by 10-year equivalents. Ten-year equivalents for a group of positions represent the amount of 10-year U.S. Treasury securities that would be expected to experience a similar change in market value under a standard parallel move in interest rates.

The Company’s non-Agency RMBS portfolio generated positive results during the quarter, as net interest income exceeded net mark-to-market losses. The Company expects to increase its allocation to non-Agency RMBS beginning in the fourth quarter, given current market opportunities.

During the quarter, higher interest rates drove a significant increase in the Company’s cost of funds, which exceeded the increase in its asset yields, and as a result, the Company’s net interest margin declined quarter over quarter. Driven by the lower net interest margin, as well as lower average holdings quarter over quarter, Adjusted Distributable Earnings also declined sequentially.

Reconciliation of Adjusted Distributable Earnings to Net Income (Loss)

The Company calculates Adjusted Distributable Earnings as net income (loss), excluding realized and change in net unrealized gains and (losses) on securities and financial derivatives, and excluding other income or loss items that are of a non-recurring nature. Adjusted Distributable Earnings also excludes the effect of the Catch-up Premium Amortization Adjustment on interest income. The Catch-up Premium Amortization Adjustment is a quarterly adjustment to premium amortization triggered by changes in actual and projected prepayments on the Company’s Agency RMBS (accompanied by a corresponding offsetting adjustment to realized and unrealized gains and losses). The adjustment is calculated as of the beginning of each quarter based on the Company’s then-current assumptions about cashflows and prepayments, and can vary significantly from quarter to quarter. Adjusted Distributable Earnings includes net realized and change in net unrealized gains (losses) associated with periodic settlements on interest rate swaps.

Adjusted Distributable Earnings is a supplemental non-GAAP financial measure. The Company believes that the presentation of Adjusted Distributable Earnings provides information useful to investors, because: (i) the Company believes that it is a useful indicator of both current and projected long-term financial performance, in that it excludes the impact of certain current-period earnings components that the Company believes are less useful in forecasting long-term performance and dividend-paying ability; (ii) the Company uses it to evaluate the effective net yield provided by its portfolio, after the effects of financial leverage; and (iii), the Company believes that presenting Adjusted Distributable Earnings assists investors in measuring and evaluating its operating performance, and comparing its operating performance to that of its residential mortgage REIT peers. Please note, however, that: (I) the Company’s calculation of Adjusted Distributable Earnings may differ from the calculation of similarly titled non-GAAP financial measures by its peers, with the result that these non-GAAP financial measures might not be directly comparable; and (II) Adjusted Distributable Earnings excludes certain items, such as most realized and unrealized gains and losses, that may impact the amount of cash that is actually available for distribution.

In addition, because Adjusted Distributable Earnings is an incomplete measure of the Company’s financial results and differs from net income (loss) computed in accordance with U.S. GAAP, it should be considered supplementary to, and not as a substitute for, net income (loss) computed in accordance with U.S. GAAP.

Furthermore, Adjusted Distributable Earnings is different than REIT taxable income. As a result, the determination of whether the Company has met the requirement to distribute at least 90% of its annual REIT taxable income (subject to certain adjustments) to its shareholders, in order to maintain qualification as a REIT, is not based on whether it distributed 90% of its Adjusted Distributable Earnings.

In setting the Company’s dividends, the Company’s Board of Trustees considers the Company’s earnings, liquidity, financial condition, REIT distribution requirements, and financial covenants, along with other factors that the Board of Trustees may deem relevant from time to time.

The following table reconciles, for the three-month periods ended September 30, 2022 and June 30, 2022, the Company’s Adjusted Distributable Earnings to the line on the Company’s Consolidated Statement of Operations entitled Net Income (Loss), which the Company believes is the most directly comparable U.S. GAAP measure:

 

 

Three-Month Period Ended

(In thousands except share amounts and per share amounts)

 

September 30, 2022

 

June 30, 2022

Net Income (Loss)

 

$

(13,671

)

 

$

(10,740

)

Adjustments:

 

 

 

 

Net realized (gains) losses on securities

 

 

28,236

 

 

 

15,464

 

Change in net unrealized (gains) losses on securities

 

 

27,574

 

 

 

28,134

 

Net realized (gains) losses on financial derivatives

 

 

(2,355

)

 

 

(30,477

)

Change in net unrealized (gains) losses on financial derivatives

 

 

(35,825

)

 

 

3,428

 

Net realized gains (losses) on periodic settlements of interest rate swaps

 

 

364

 

 

 

(232

)

Change in net unrealized gains (losses) on accrued periodic settlements of interest rate swaps

 

 

19

 

 

 

(328

)

Negative (positive) component of interest income represented by Catch-up Premium Amortization Adjustment

 

 

(1,381

)

 

 

(1,595

)

Subtotal

 

 

16,632

 

 

 

14,394

 

Adjusted Distributable Earnings

 

$

2,961

 

 

$

3,654

 

Weighted Average Shares Outstanding

 

 

13,146,727

 

 

 

13,106,585

 

Adjusted Distributable Earnings Per Share

 

$

0.23

 

 

$

0.28

 

About Ellington Residential Mortgage REIT

Ellington Residential Mortgage REIT is a mortgage real estate investment trust that specializes in acquiring, investing in and managing residential mortgage- and real estate-related assets, with a primary focus on residential mortgage-backed securities for which the principal and interest payments are guaranteed by a U.S. government Agency or a U.S. government-sponsored enterprise. Ellington Residential Mortgage REIT is externally managed and advised by Ellington Residential Mortgage Management LLC, an affiliate of Ellington Management Group, L.L.C.

Conference Call

The Company will host a conference call at 11:00 a.m. Eastern Time on Thursday, November 10, 2022, to discuss its financial results for the quarter ended September 30, 2022. To participate in the event by telephone, please dial (800) 445-7795 at least 10 minutes prior to the start time and reference the conference ID: EARNQ322. International callers should dial (785) 424-1789 and reference the same conference ID. The conference call will also be webcast live over the Internet and can be accessed via the “For Our Shareholders” section of the Company’s web site at www.earnreit.com. To listen to the live webcast, please visit www.earnreit.com at least 15 minutes prior to the start of the call to register, download, and install necessary audio software. In connection with the release of these financial results, the Company also posted an investor presentation, that will accompany the conference call, on the Company’s website at www.earnreit.com under “For Our Shareholders—Presentations.”

A dial-in replay of the conference call will be available on Thursday, November 10, 2022, at approximately 2:00 p.m. Eastern Time through Thursday, November 17, 2022 at approximately 11:59 p.m. Eastern Time. To access this replay, please dial (800) 925-9539. International callers should dial (402) 220-5389. A replay of the conference call will also be archived on the Company’s web site at www.earnreit.com.

Cautionary Statement Regarding Forward-Looking Statements

This press release contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve numerous risks and uncertainties. Actual results may differ from the Company’s beliefs, expectations, estimates, and projections and, consequently, you should not rely on these forward-looking statements as predictions of future events. Forward-looking statements are not historical in nature and can be identified by words such as “believe,” “expect,” “anticipate,” “estimate,” “project,” “plan,” “continue,” “intend,” “should,” “would,” “could,” “goal,” “objective,” “will,” “may,” “seek,” or similar expressions or their negative forms, or by references to strategy, plans, or intentions. Examples of forward-looking statements in this press release include, without limitation, the Company’s beliefs regarding the current economic and investment environment, the Company’s ability to implement its investment and hedging strategies, the Company’s future prospects and the protection of the Company’s net interest margin from prepayments, volatility and its impact on the Company, the performance of the Company’s investment and hedging strategies, the Company’s exposure to prepayment risk in the Company’s Agency portfolio, and statements regarding the drivers of the Company’s returns. The Company’s results can fluctuate from month to month and from quarter to quarter depending on a variety of factors, some of which are beyond the Company’s control and/or are difficult to predict, including, without limitation, changes in interest rates and the market value of the Company’s securities, changes in mortgage default rates and prepayment rates, the Company’s ability to borrow to finance its assets, changes in government regulations affecting the Company’s business, the Company’s ability to maintain its exclusion from registration under the Investment Company Act of 1940 and other changes in market conditions and economic trends, including changes resulting from the economic effects related to the COVID-19 pandemic, and associated responses to the pandemic. Furthermore, forward-looking statements are subject to risks and uncertainties, including, among other things, those described in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021 which can be accessed through the link to the Company’s SEC filings under “For Our Shareholders” on the Company’s website (www.earnreit.com) or at the SEC’s website (www.sec.gov). Other risks, uncertainties, and factors that could cause actual results to differ materially from those projected or implied may be described from time to time in reports we file with the SEC, including reports on Forms 10-Q, 10-K and 8-K. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

ELLINGTON RESIDENTIAL MORTGAGE REIT

CONSOLIDATED STATEMENT OF OPERATIONS

(UNAUDITED)

 

 

Three-Month Period Ended

 

Nine-Month Period Ended

 

 

September 30,

2022

 

June 30,

2022

 

September 30,

2022

(In thousands except share amounts and per share amounts)

 

 

 

 

 

 

INTEREST INCOME (EXPENSE)

 

 

 

 

 

 

Interest income

 

$

9,457

 

 

$

9,087

 

 

$

25,079

 

Interest expense

 

 

(4,268

)

 

 

(1,972

)

 

 

(7,343

)

Total net interest income

 

 

5,189

 

 

 

7,115

 

 

 

17,736

 

EXPENSES

 

 

 

 

 

 

Management fees to affiliate

 

 

388

 

 

 

447

 

 

 

1,335

 

Professional fees

 

 

205

 

 

 

211

 

 

 

621

 

Compensation expense

 

 

183

 

 

 

191

 

 

 

537

 

Insurance expense

 

 

101

 

 

 

101

 

 

 

301

 

Other operating expenses

 

 

353

 

 

 

356

 

 

 

1,063

 

Total expenses

 

 

1,230

 

 

 

1,306

 

 

 

3,857

 

OTHER INCOME (LOSS)

 

 

 

 

 

 

Net realized gains (losses) on securities

 

 

(28,236

)

 

 

(15,464

)

 

 

(57,870

)

Net realized gains (losses) on financial derivatives

 

 

2,355

 

 

 

30,477

 

 

 

48,186

 

Change in net unrealized gains (losses) on securities

 

 

(27,574

)

 

 

(28,134

)

 

 

(106,224

)

Change in net unrealized gains (losses) on financial derivatives

 

 

35,825

 

 

 

(3,428

)

 

 

60,151

 

Total other income (loss)

 

 

(17,630

)

 

 

(16,549

)

 

 

(55,757

)

NET INCOME (LOSS)

 

$

(13,671

)

 

$

(10,740

)

 

$

(41,878

)

NET INCOME (LOSS) PER COMMON SHARE:

 

 

 

 

 

 

Basic and Diluted

 

$

(1.04

)

 

$

(0.82

)

 

$

(3.19

)

WEIGHTED AVERAGE SHARES OUTSTANDING

 

 

13,146,727

 

 

 

13,106,585

 

 

 

13,121,214

 

CASH DIVIDENDS PER SHARE:

 

 

 

 

 

 

Dividends declared

 

$

0.24

 

 

$

0.26

 

 

$

0.80

 

ELLINGTON RESIDENTIAL MORTGAGE REIT

CONSOLIDATED BALANCE SHEET

(UNAUDITED)

 

 

 

As of

 

 

September 30,

2022

 

June 30,

2022

 

December 31,

2021(1)

(In thousands except share amounts and per share amounts)

 

 

 

 

 

 

ASSETS

 

 

 

 

 

 

Cash and cash equivalents

 

$

25,408

 

 

$

37,472

 

 

$

69,028

 

Mortgage-backed securities, at fair value

 

 

934,668

 

 

 

947,647

 

 

 

1,311,361

 

Other investments, at fair value

 

 

8,498

 

 

 

7,648

 

 

 

309

 

Due from brokers

 

 

48,595

 

 

 

45,643

 

 

 

88,662

 

Financial derivatives–assets, at fair value

 

 

71,853

 

 

 

34,527

 

 

 

6,638

 

Reverse repurchase agreements

 

 

21,774

 

 

 

11,005

 

 

 

117,505

 

Receivable for securities sold

 

 

73,945

 

 

 

34,217

 

 

 

 

Interest receivable

 

 

3,855

 

 

 

3,009

 

 

 

4,504

 

Other assets

 

 

638

 

 

 

650

 

 

 

459

 

Total Assets

 

$

1,189,234

 

 

$

1,121,818

 

 

$

1,598,466

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

 

Repurchase agreements

 

$

938,046

 

 

$

950,339

 

 

$

1,064,835

 

Payable for securities purchased

 

 

72,957

 

 

 

15,579

 

 

 

255,136

 

Due to brokers

 

 

44,115

 

 

 

19,320

 

 

 

1,959

 

Financial derivatives–liabilities, at fair value

 

 

4,440

 

 

 

2,938

 

 

 

1,103

 

U.S. Treasury securities sold short, at fair value

 

 

21,577

 

 

 

10,989

 

 

 

117,195

 

Dividend payable

 

 

1,060

 

 

 

1,046

 

 

 

1,311

 

Accrued expenses

 

 

1,306

 

 

 

1,216

 

 

 

1,236

 

Management fee payable to affiliate

 

 

388

 

 

 

447

 

 

 

581

 

Interest payable

 

 

2,340

 

 

 

1,314

 

 

 

885

 

Total Liabilities

 

 

1,086,229

 

 

 

1,003,188

 

 

 

1,444,241

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

Preferred shares, par value $0.01 per share, 100,000,000 shares authorized; (0 shares issued and outstanding, respectively)

 

 

 

 

 

 

 

 

 

Common shares, par value $0.01 per share, 500,000,000 shares authorized; (13,245,298, 13,079,394 and 13,109,926 shares issued and outstanding, respectively)

 

 

132

 

 

 

131

 

 

 

131

 

Additional paid-in-capital

 

 

240,026

 

 

 

238,816

 

 

 

238,865

 

Accumulated deficit

 

 

(137,153

)

 

 

(120,317

)

 

 

(84,771

)

Total Shareholders’ Equity

 

 

103,005

 

 

 

118,630

 

 

 

154,225

 

Total Liabilities and Shareholders’ Equity

 

$

1,189,234

 

 

$

1,121,818

 

 

$

1,598,466

 

SUPPLEMENTAL PER SHARE INFORMATION

 

 

 

 

 

 

Book Value Per Share

 

$

7.78

 

 

$

9.07

 

 

$

11.76

 

(1) Derived from audited financial statements as of December 31, 2021.

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