Ellington Financial LLC Reports First Quarter 2013 Results

OLD GREENWICH, Conn., May 6, 2013 /PRNewswire/ -- Ellington Financial LLC (NYSE: EFC) (the "Company") today reported financial results for the quarter ended March 31, 2013.

Highlights

  • Net increase in shareholders' equity resulting from operations ("net income") for the first quarter was $40.3 million or $1.94 per basic and diluted share and represented an average non-annualized return on shareholders' equity of 7.8%.
  • Book value per share as of March 31, 2013 was $24.78 on a diluted basis after payment of a quarterly dividend of $0.77 per share and a special dividend of $0.75 per share, as compared to book value per share of $24.38 on a diluted basis as of December 31, 2012.
  • The Company's non-Agency strategy generated gross income of $45.7 million for the quarter ended March 31, 2013.
  • The Company's Agency RMBS strategy generated gross income of $0.7 million for the quarter ended March 31, 2013. 
  • The Company's Board of Directors declared a dividend of $0.77 per share for the first quarter of 2013 payable on June 17, 2013 to shareholders of record on May 31, 2013.

First Quarter 2013 Results

For the quarter ended March 31, 2013, the Company recognized net income of $40.3 million, or $1.94 per diluted share. This compares to net income of $24.8 million, or $1.19 per diluted share, for the quarter ended December 31, 2012. The Company's results reflect positive contributions from both of its core strategies—non-Agency MBS as well as Agency RMBS.

The Company's non-Agency strategy generated gross income in the amount of $45.7 million for the quarter, or $2.17 per share. During the first quarter, the market for non-Agency MBS extended its 2012 rally, driven by both fundamental and technical factors. On the fundamental side, home prices resumed their upward trend (all the more so on a seasonally adjusted basis), unemployment declined, and the U.S. economy (as measured by GDP) grew by 2.5%. On the technical side, the continued absence of a robust new issue market, together with the lack of distressed selling, continued to buoy prices in non-Agency RMBS. The non-Agency securitization market has still not recovered nearly enough to make non-Agency securitization a large-scale viable option for mortgage originators. As a result, the vast majority of residential mortgage originations not retained in portfolios by banks are funneled into Agency RMBS. Thus the non-Agency RMBS market continues to shrink: as the mortgage loans underlying non-Agency RMBS prepay or default, they are more likely to be replaced with government-guaranteed mortgages. On the other hand, the securitization markets for commercial mortgage loans and syndicated corporate loans offer an interesting contrast; these securitization markets (i.e., the CMBS and CLO markets) have almost completely healed since the financial crisis, and faced with a heavy supply of new CMBS and CLO issuances in the first quarter as compared to recent quarters, valuations in those sectors weakened somewhat towards the end of the quarter. While yields have steadily declined over the past year on most non-Agency RMBS, yields offered in this asset class still compare very favorably to other fixed income sectors.

The Company's income during the quarter from its non-Agency MBS strategy consisted of interest income and net realized and unrealized gains on long non-Agency MBS. During the quarter, the Company continued to sell securities that, in its view, were nearing their full price potential, while reinvesting the sales proceeds into securities with greater upside potential, for example from a reduction in future default rates. While most non-Agency RMBS assets have rallied substantially over the past year, it is the Company's view that the MBS market has not sufficiently differentiated between sectors. As a result, security selection remains a significant factor in portfolio management, and the Company believes that its analytical approach to security selection will continue to help it generate superior returns in this environment.

In the commercial mortgage strategy, the Company reduced its holdings of CMBS during the quarter. As described above, after a strong start following year-end, the CMBS sector experienced some weakness later in the first quarter in the face of high new issue volume. The Company expects both continued growth and continued volatility in the CMBS market, and this combination should present abundant investment opportunities for the remainder of the year.

In the first quarter the Company also established a small capital allocation to the CLO market, as supply pressures have provided attractive relative value opportunities in certain sectors of that market. As of March 31, 2013, the Company's CLO holdings include both debt and equity tranches. The Company views its investments in this area as opportunistic in nature.

In the Company's Agency RMBS strategy, the Company continues to identify and invest in "specified" Agency pools, which are fixed rate Agency pools with special prepayment characteristics, such as pools comprised of low loan balance mortgages, pools comprised of mortgages backed by investor properties, pools containing mortgages originated through the government-sponsored "Making Homes Affordable" refinancing programs, and pools containing mortgages with various other prepayment characteristics. The Company's specified Agency pools have continued to experience favorable prepayment rates, particularly when compared to their "generic" pool counterparts that underlie TBA Agency pools. The Company continues to hedge risks in its Agency RMBS strategy using a variety of instruments, including TBAs, interest rate swaps, and U.S. Treasuries. Net short positions in TBAs are used to hedge the long specified Agency pool portfolio against both prepayment and interest rate risk, while interest rate swaps and U.S. Treasuries are used to hedge only against interest rate risk. While mortgage rates are slightly higher than the all-time lows they reached in the fourth quarter of 2012, they are still extremely low on a historical basis. As a result, both prepayment risk and interest rate risk remain elevated in the Agency RMBS market. 

For most of the first quarter, "pay-ups" (i.e., price premiums over TBAs) for most specified Agency pools contracted; in most specified pool sectors this was largely the result of technical factors stemming ultimately from Federal Reserve purchasing activity, but in the lowest coupon sectors it also resulted from concerns around extension risk (i.e., dramatically slower prepayments) should interest rates rise. The 10-year U.S. Treasury yield increased to 2.06% in early March from 1.76% at the end of 2012.

The Company's Agency RMBS strategy generated $0.7 million or $0.04 per share in gross income for the quarter, consisting primarily of interest income partially offset by net unrealized losses on specified Agency pools. This represents a decline compared to the fourth quarter of 2012, when this strategy generated $3.2 million or $0.15 per share in gross income. Active trading of both assets and hedges has and continues to be the focus of the Company's Agency RMBS strategy. During the fourth quarter of 2012, many specified pools were trading at all-time highs relative to their TBA counterparts. The Company took advantage of these historically high levels and actively sold many of its specified pools to capture gains, replacing these positions with lower-priced, non-traditional prepayment-protected positions. Going into 2013, the Company also maintained a relatively large portion of its interest rate hedges in the form of TBA mortgages, and as a result was less exposed to the increased volatility in Agency RMBS that ensued. Thus having established a lower risk profile both in its choice of assets and in its choice of hedges, the Company was able to avoid many of the substantial losses in Agency RMBS that were experienced by some other market participants during the quarter, and with the recent contraction in specified pool pay-ups the Company is now able to take advantage of much better entry points.

The Agency RMBS market will continue to revolve greatly around the actions of the Federal Reserve and its ongoing asset purchase programs. Continued improvement in the U.S. economy, particularly in the form of declines in unemployment and the ongoing recovery in the housing market, have only added to speculation that the Federal Reserve will begin to wind down its asset purchase programs - and possibly even begin selling assets - earlier than previously predicted. This speculation notwithstanding, at its March 20, 2013 and May 1, 2013 meetings the Federal Reserve reiterated its intention to stay the course with respect to its economic monetary policy accommodation activities. While the Federal Reserve's eventual exit from quantitative easing could expand the opportunities for the Company in the Agency RMBS market in the long-term, it will no doubt cause a period of significant volatility in the markets. This reinforces the importance of the Company's ability to hedge its risks using a variety of tools, including TBAs, as it navigates the changing market landscape.

One gauge that the Company uses to measure its overall prepayment risk is the Company's net Agency premium as a percentage of its long Agency RMBS holdings. Net Agency premium represents the total premium (excess of market value over outstanding principal balance) on long Agency RMBS holdings less the total premium on net short (TBA) Agency RMBS positions. The lower its net Agency premium, the less the Company believes it is exposed to market-wide increases in Agency RMBS prepayments. As of March 31, 2013, net Agency premium as a percentage of fair value on long Agency RMBS holdings was approximately 3% compared to 2% at December 31, 2013. Excluding its TBA hedging positions, the Company's Agency premium as a percentage of fair value was approximately 7% as of both March 31, 2013 and December 31, 2012.

The Company prepares its financial statements in accordance with ASC 946, Financial Services—Investment Companies. As a result, investments are carried at fair value and all valuation changes are recorded in the Consolidated Statement of Operations.

The Company also measures its performance through net-asset-value-based total return. Net-asset-value-based total return measures the change in the Company's book value per share and assumes the reinvestment of dividends at book value per share. For the quarter ended March 31, 2013, net-asset-value-based total return was 7.87%. Net-asset-value-based total return from inception of the Company (August 17, 2007) through March 31, 2013 was 109.51%.

"Ellington Financial has started off the year on a very strong note," said Laurence Penn, Chief Executive Officer and President of the Company." The Company generated a non-annualized return on shareholders' equity of 7.8%, with our non-Agency RMBS strategy being the primary driver of the quarter's results. For the past five quarters, almost all sectors of the non-Agency RMBS market have rallied. For the remainder of the year, however, skillful security selection will represent a much more important driver of returns, and our extensive research capabilities and analytical tools should serve us extremely well in the current environment. In the near term, we remain generally constructive on the non-Agency RMBS market, and so we have continued to replace some of our mortgage-related hedges with other hedges that we believe will protect us better in the event of an economic downturn. Within our Agency RMBS strategy, our decision to reduce risk going into the quarter was vindicated, as we sidestepped the losses suffered by some of our peers. With the recent weakening in the specified pool market, we have increased our long Agency RMBS portfolio by approximately 11% quarter-over-quarter, and we remain optimistic that the Agency RMBS market will continue to provide a wealth of opportunities. In the medium and longer term, the mortgage market continues to evolve and the role of government in the mortgage market continues to be re-evaluated. Thanks to both our flexible structure and the breadth of our range of targeted asset classes, we will continue to adapt to changing conditions and opportunities. Our ability to nimbly rotate in and out of securities and sectors as market conditions change remains a hallmark of our portfolio management style."

The following table summarizes the Company's operating results for the quarters ended March 31, 2013 and December 31, 2012: 



Quarter Ended

March 31, 2013


Per

Share


% of Average

Equity


Quarter Ended

December 31, 2012


Per

Share


% of Average

Equity

(In thousands, except per share amounts)













Non-Agency MBS, Other ABS, and Commercial

mortgage loans:













Interest income


$

12,118



$

0.58



2.32

%


$

12,013



$

0.58



2.38

%

Net realized gain


14,153



0.67



2.71

%


7,573



0.36



1.50

%

Change in net unrealized gain (loss)


27,384



1.30



5.24

%


19,132



0.92



3.79

%

Net interest rate hedges(1)


348



0.02



0.07

%


(66)





(0.01)

%

Net credit hedges and other derivatives


(7,079)



(0.34)



(1.36)

%


(4,717)



(0.23)



(0.93)

%

Interest expense


(1,175)



(0.06)



(0.23)

%


(1,416)



(0.07)



(0.28)

%

Total non-Agency MBS, Other ABS, and Commercial

mortgage loans profit


45,749



2.17



8.75

%


32,519



1.56



6.45

%

Agency RMBS:













Interest income


6,262



0.30



1.20

%


4,557



0.22



0.90

%

Net realized gain (loss)


(1,135)



(0.05)



(0.22)

%


2,192



0.11



0.43

%

Change in net unrealized gain (loss)


(4,425)



(0.21)



(0.85)

%


(3,537)



(0.17)



(0.70)

%

Net interest rate hedges(1)


811



0.04



0.16

%


484



0.02



0.10

%

Interest expense


(779)



(0.04)



(0.15)

%


(533)



(0.03)



(0.11)

%

Total Agency RMBS profit


734



0.04



0.14

%


3,163



0.15



0.62

%

Total non-Agency and Agency MBS, Other ABS, and

Commercial mortgage loans profit


46,483



2.21



8.89

%


35,682



1.71



7.07

%

Other interest income (expense), net


(67)





(0.01)

%


45





0.01

%

Other expenses (excluding incentive fee)


(3,615)



(0.17)



(0.69)

%


(3,599)



(0.17)



(0.71)

%

Net increase in equity resulting from operations (before

incentive fee)


42,801



2.04



8.19

%


32,128



1.54



6.37

%

Incentive fee


(2,055)



(0.10)



(0.39)

%


(7,342)



(0.35)



(1.45)

%

Net increase in equity resulting from operations


$

40,746



$

1.94



7.80

%


$

24,786



$

1.19



4.92

%

Less: Net increase in equity resulting from operations

attributable to non-controlling interest


411












Net increase in shareholders' equity resulting from operations(5)


$

40,335



$

1.94



7.80

%


$

24,786



$

1.19



4.92

%

Weighted average shares and convertible units(2)

outstanding


20,997







20,899






Average equity (includes non-controlling interest)(3)


$

522,200







$

504,639






Weighted average shares and LTIP units outstanding(4)


20,785







20,899






Average shareholders' equity (excludes non-controlling

interest)(3)


$

517,426







$

504,639








(1)

Includes TBAs and U.S. Treasuries, if applicable.

(2)

Convertible units include LTIP units and Operating Partnership units attributable to the non-controlling interest.

(3)

Average equity and average shareholders' equity is calculated using month end values.

(4)

Excludes Operating Partnership units attributable to the non-controlling interest.

(5)

Per share information calculated using weighted average shares and LTIP units outstanding. Percentage of average equity calculated using average shareholders' equity, which excludes the non-controlling interest.

 

Portfolio

The following tables summarize the Company's portfolio holdings as of March 31, 2013 and December 31, 2012:

Bond Portfolio



March 31, 2013


December 31, 2012

(In thousands)


Current

Principal


Fair Value


Average

Price(1)


Cost


Average

Cost(1)


Current

Principal


Fair Value


Average

Price(1)


Cost


Average

Cost(1)

Non-Agency RMBS(2)


$

761,019



$

553,640



$

72.75



$

488,279



$

64.16



$

818,878



$

524,881



$

64.10



$

482,824



$

58.96


Non-Agency CMBS

and Commercial

mortgage loans


17,196



15,491



90.09



15,294



88.94



41,667



28,873



69.29



32,078



76.99


Other ABS(3)


5,713



5,529



96.78



5,609



98.18












Total Non-Agency

MBS, Other ABS,

and Commercial

mortgage loans


783,928



574,660



73.31



509,182



64.95



860,545



553,754



64.35



514,902



59.83


Agency RMBS: (4)





















Floating


13,720



14,512



105.77



14,071



102.56



16,219



17,169



105.86



16,612



102.42


Fixed


772,494



830,266



107.48



824,821



106.77



696,123



750,454



107.80



740,463



106.37


Total Agency

RMBS


786,214



844,778



107.45



838,892



106.70



712,342



767,623



107.76



757,075



106.28


Total Non-Agency

and Agency MBS,

Other ABS, and

Commercial mortgage

loans


$

1,570,142



$

1,419,438



$

90.40



$

1,348,074



$

85.86



$

1,572,887



$

1,321,377



$

84.01



$

1,271,977



$

80.87


Agency Interest Only

RMBS


n/a      


$

16,228



n/a      


$

18,636



n/a      


n/a      


$

6,644



n/a      


$

9,289



n/a      

Non-Agency Interest

Only and Principal

Only RMBS and

Other


n/a      


$

10,289



n/a      


$

9,423



n/a      


n/a      


$

3,485



n/a      


$

3,308



n/a      

TBAs:





















Long


$

86,920



$

89,969



$

103.51



$

89,655



$

103.15



$

41,150



$

43,610



$

105.98



$

43,579



$

105.90


Short


(572,782)



(607,285)



106.02



(606,162)



105.83



(568,880)



(608,720)



107.00



(607,967)



106.87


Net Short TBAs


$

(485,862)



$

(517,316)



$

106.47



$

(516,507)



$

106.31



$

(527,730)



$

(565,110)



$

107.08



$

(564,388)



$

106.95


Short U.S. Treasury

Securities


$

(41,700)



$

(42,471)



$

101.85



$

(41,939)



$

100.57



$

(13,000)



$

(13,581)



$

104.47



$

(13,081)



$

100.62


Repurchase

Agreements


$

42,614



$

42,614



$

100.00



$

42,614



$

100.00



$

13,650



$

13,650



$

100.00



$

13,650



$

100.00


Total Net Investments




$

928,782





$

860,301







$

766,465





$

720,755






(1)

Represents the dollar amount, per $100 of current principal of the price or cost for the security.

(2)

Excludes Interest Only, Principal Only, and similar securities.

(3)

Excludes equity tranches and similar securities.

(4)

Excludes Interest Only securities and TBAs.

 

Non-Agency RMBS and CMBS are generally securitized in senior/subordinated structures, or in excess spread/over-collateralization structures. Disregarding TBAs, Agency RMBS consist primarily of whole-pool pass through certificates.

The Company actively invests in the TBA market. TBAs are forward-settling Agency RMBS where the mortgage pass-through certificates to be delivered are "To-Be Announced." Given that the Company uses TBAs primarily to hedge risks associated with its long Agency RMBS (and to a lesser extent long non-Agency MBS), the Company generally carries a net short TBA position.

Derivatives Portfolio



March 31, 2013


December 31, 2012



Notional

Value


Fair

Value


Notional

Value


Fair