Ellington Financial LLC Reports Second Quarter 2012 Results

OLD GREENWICH, Conn., Aug. 6, 2012 /PRNewswire/ -- Ellington Financial LLC (NYSE: EFC) (the "Company") today reported financial results for the quarter ended June 30, 2012.

Highlights

  • Net increase in shareholders' equity resulting from operations ("net income") for the second quarter was $10.8 million or $0.64 per basic and diluted share. The Company's results were driven by positive contributions from both its non-Agency and Agency MBS strategies. For the six months ended June 30, 2012, net income was $42.8 million and represented an annualized return on equity of 22.0%.
  • Book value per share as of June 30, 2012 was $23.47 on a diluted basis after payment of a $0.70 per share first quarter dividend on June 15, 2012, as compared to book value per share of $23.53 on a diluted basis as of March 31, 2012.
  • The Company's non-Agency MBS strategy generated income of $12.9 million for the quarter ended June 30, 2012. Performance was driven by yield earned on invested assets, as well as realized and unrealized gains, which more than offset realized and unrealized losses on credit hedges and interest rate hedges.
  • The Company's Agency RMBS strategy also continued to perform well, generating $3.1 million in income during the quarter, again driven by the Company's strategy to identify, invest in and actively trade pools with specific prepayment-protection characteristics.
  • The Company announced a dividend for the second quarter of 2012 of $0.70 per share payable on September 17, 2012 to shareholders of record on August 31, 2012.

Second Quarter 2012 Results

For the quarter ended June 30, 2012, the Company recognized net income of $10.8 million, or $0.64 per diluted share. This compares to net income of $32.1 million, or $1.90 per diluted share, for the quarter ended March 31, 2012. The Company's reported results reflected positive contributions from both of its current strategies—non-Agency MBS as well as Agency RMBS.

The Company's non-Agency strategy generated income in the amount of $12.9 million for the quarter, or $0.77 per diluted share. While the U.S. stock market generally declined during the quarter in the face of Europe's fiscal problems and a slowing U.S. economy, appetite for non-Agency RMBS remained robust, as U.S. Treasury yields declined sharply and investors sought higher yielding assets. The fundamentals underlying non-Agency RMBS improved, with mortgage delinquencies generally declining and home prices generally stabilizing (and even increasing in many regions). In spite of the uncertain macroeconomic climate, the Company's portfolio performed well as its holdings of high yielding assets generated strong interest income as well as realized and unrealized gains. Realized gains resulted primarily from the sale of certain higher-priced seasoned subprime RMBS, which the Company felt were less likely to appreciate further as compared to certain lower-priced RMBS. The Company also slightly increased its holdings of CMBS in light of the attractive opportunities in that market. The Company's non-Agency MBS strategy results were negatively impacted by losses related to interest rate hedging, as the five year swap rate declined 31 basis points to 0.97% as of June 30, 2012, its lowest quarterly close ever.  

While the non-Agency MBS strategy continues to be the primary driver of the Company's earnings, the Company once again benefited from the strong performance of its Agency RMBS strategy, which generated $3.1 million in income for the quarter. Income in this strategy was mainly driven by the yield on invested Agency RMBS assets above the cost of the TBA short positions, which the Company uses to hedge the Agency RMBS portfolio against prepayment and interest rate risk. Over the course of the last several quarters, the Company has employed a strategy whereby it identifies and invests in pools with prepayment-protection characteristics (known as "prepayment-protected" pools), such as those comprised of low loan balance mortgages, those containing mortgages not eligible for one of the government-sponsored refinancing programs, and those containing mortgages with other prepayment-protection characteristics. The Company's prepayment-protected pools have experienced favorable prepayment rates recently, and in particular have prepaid much more slowly than their generic pool counterparts. However, Agency pool prices are currently at all time highs, and mortgage rates are at all time lows, so prepayment risk for all Agency pools remains at extremely elevated levels. Thus while the Company has benefited from the recent increase in the value of the specific Agency pools that it owns, the Company continues to believe in the importance of continuing to hedge its Agency pools with short TBA positions. In fact, the Company actually benefitted from the increases in overall prepayments during the quarter, as the increases were largely due to the effects of HARP 2.0, which caused much larger prepayment increases on generic pools and relatively smaller increases on prepayment-protected pools. The effects of higher generic pool prepayment rates are most directly felt by the Company in the form of the costs to roll its TBA short positions from month to month: with higher prepayments come lower TBA roll costs, and therefore higher income on the Company's Agency RMBS portfolio. Finally, as with its non-Agency results, the Company's Agency RMBS results were also negatively impacted by losses related to its other interest rate hedging instruments, namely interest rate swaps, in light of the decline in interest rates during the quarter.

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 June 30, 2012, net Agency premium as a percentage of fair value on long Agency RMBS holdings represents less than 3%. Excluding its TBA hedging positions, the Company's Agency premium as a percentage of fair value is approximately 7%.

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 June 30, 2012, net-asset-value-based total return was 2.7%. For the six months ended June 30, 2012, net asset-value-based total return was 11.6%. Net-asset-value-based total return from inception of the Company (August 17, 2007) through June 30, 2012 was 77.4%.

"As we enter the second half of 2012, we are pleased to report our second quarter and first half financial results for the Company," said Laurence Penn, Chief Executive Officer and President of the Company. "Our annualized return on equity for the first half of the year was 22.0% and was driven by strong results from both our non-Agency and Agency MBS strategies. Our results for the second quarter moderated as compared to our outstanding first quarter results, but we believe that our portfolio is well positioned for continued strong performance. Recent economic data suggests improvements in some of the negative trends that have been prevalent in the U.S. housing market for the last few years. Delinquencies are down, and in many regions home prices have risen recently. We believe that our non-Agency MBS portfolio is well positioned for potential upside as these trends continue. Within our Agency RMBS portfolio, our strategy to identify and invest in assets with prepayment-protection characteristics has served us well. Our ability to use TBAs to hedge against prepayment risk has become even more important as these pools have continued to run up in price. While only utilizing a small amount of our capital, this strategy has produced outsized returns for us over the last several quarters. Overall, we are quite optimistic about the near to medium term outlook for the Company. We believe that the MBS asset class continues to offer – by far and away – the most attractive opportunities in the fixed income market today, especially given the significant drop in yields on U.S. Treasuries."

The following table summarizes the Company's operating results for the quarters ended June 30, 2012 and March 31, 2012 and for the six month period ended June 30, 2012:


























 Quarter 


 % of Average  


 Quarter 


 % of Average  


 Six Month 


 % of Average  


 Ended 

Per

 Shareholders' 


 Ended 

Per

 Shareholders' 


 Period Ended 

Per

 Shareholders' 


6/30/2012

Share

 Equity 


3/31/2012

Share

 Equity 


6/30/2012

Share

 Equity 

(In thousands, except per share amounts)












Non-Agency MBS and Commercial mortgage loans:












  Interest income

$     9,491

$  0.56

2.40%


$     9,565

$  0.57

2.50%


$       19,056

$  1.13

4.90%

  Net realized gain

813

0.05

0.21%


6,545

0.39

1.71%


7,358

0.44

1.89%

  Net change in net unrealized gain

7,210

0.43

1.82%


19,430

1.15

5.07%


26,640

1.58

6.85%

  Net interest rate hedges

(2,726)

(0.16)

-0.69%


138

0.01

0.03%


(2,588)

(0.15)

-0.67%

  Net credit hedges

(603)

(0.04)

-0.15%


(5,825)

(0.35)

-1.52%


(6,428)

(0.39)

-1.65%

  Interest expense

(1,253)

(0.07)

-0.32%


(1,179)

(0.07)

-0.31%


(2,432)

(0.14)

-0.63%

Total non-Agency MBS and Commercial mortgage loans profit

12,932

0.77

3.27%


28,674

1.70

7.48%


41,606

2.47

10.69%













Agency RMBS:












  Interest income

6,538

0.39

1.65%


6,082

0.36

1.59%


12,620

0.75

3.25%

  Net realized gain

5,163

0.31

1.30%


6,815

0.40

1.78%


11,978

0.71

3.08%

  Net change in net unrealized gain (loss)

3,878

0.23

0.98%


(3,925)

(0.23)

-1.02%


(47)

-

-0.01%

  Net interest rate hedges

(11,841)

(0.71)

-2.99%


(2,066)

(0.12)

-0.54%


(13,907)

(0.83)

-3.58%

  Interest expense

(660)

(0.04)

-0.17%


(572)

(0.03)

-0.15%


(1,232)

(0.07)

-0.32%

Total Agency RMBS profit

3,078

0.18

0.77%


6,334

0.38

1.66%


9,412

0.56

2.42%













Total non-Agency and Agency MBS and Commercial mortgage loans profit

16,010

0.95

4.04%


35,008

2.08

9.14%


51,018

3.03

13.11%













Other interest expense, net

(11)

-

0.00%


(12)

-

0.00%


(23)

-

-0.01%

Other expenses (excluding incentive fee)

(2,919)

(0.17)

-0.74%


(2,941)

(0.18)

-0.77%


(5,860)

(0.35)

-1.51%

Net increase in shareholders' equity












resulting from operations (before incentive fee)

13,080

0.78

3.30%


32,055

1.90

8.37%


45,135

2.68

11.59%













Incentive fee

(2,312)

(0.14)

-0.58%


-

-

0.00%


(2,312)

(0.14)

-0.59%

Net increase in shareholders' equity












resulting from operations

$   10,768

$  0.64

2.72%


$   32,055

$  1.90

8.37%


$       42,823

$  2.54

11.00%













Weighted average shares & LTIP units outstanding

16,838




16,838




16,838



Average shareholders' equity(1)

$ 396,118




$ 383,038




$     388,623



(1) Average shareholders' equity is calculated using month end values.







Portfolio

The following tables summarize the Company's portfolio holdings as of June 30, 2012 and March 31, 2012:

Bond Portfolio


















June 30, 2012


March 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)

$     683,528

$     384,082

$   56.19

$     385,927

$   56.46


$     716,516

$     407,197

$   56.83

$     416,520

$   58.13

Non-Agency CMBS and Commercial Mortgage Loans

43,345

33,055

76.26

34,934

80.59


22,004

16,671

75.76

18,274

83.05


Total Non-Agency MBS and Commercial Mortgage Loans

726,873

417,137

57.39

420,861

57.90


738,520

423,868

57.39

434,794

58.87

Agency RMBS: (3)














Floating

21,458

22,710

105.84

22,126

103.11


22,741

24,065

105.82

23,509

103.38



Fixed

579,363

622,967

107.53

612,769

105.77


708,867

753,353

106.28

747,803

105.49


Total Agency RMBS

600,821

645,677

107.47

634,895

105.67


731,608

777,418

106.26

771,312

105.43

Total Non-Agency and Agency MBS and Commercial Mortgage Loans

$  1,327,694

$  1,062,814

$   80.05

$  1,055,756

$   79.52


$  1,470,128

$  1,201,286

$   81.71

$  1,206,106

$   82.04















Agency Interest Only RMBS

 n/a 

$         4,667

 n/a 

$         7,110

 n/a 


 n/a 

$         6,016

 n/a 

$         7,663

 n/a 

Non-Agency Interest Only RMBS and Other

 n/a 

$            977

 n/a 

$         1,049

 n/a 


 n/a 

$         1,033

 n/a 

$         1,102

 n/a 















TBAs:














Long

$       54,550

$       57,739

$ 105.85

$       57,577

$ 105.55


$       16,500

$       17,249

$ 104.54

$       17,291

$ 104.79



Short

(427,900)

(458,028)

107.04

(457,115)

106.83


(534,680)

(566,366)

105.93

(566,348)

105.92


Net Short TBAs

$   (373,350)

$    (400,289)

$ 107.22

$    (399,538)

$ 107.01


$   (518,180)

$    (549,117)

$ 105.97

$    (549,057)

$ 105.96















U.S. Treasury Securities:














Long

$         5,000

$         5,045

$ 100.90

$         5,049

$ 100.97


$               -

$               -

$         -

$               -

$         -



Short

(36,000)

(36,496)

101.38

(36,015)

100.04


(13,000)

(13,486)

103.74

(13,099)

100.76


Net Short U.S. Treasury Securities

$     (31,000)

$      (31,451)

$ 101.45

$      (30,966)

$   99.89


$     (13,000)

$      (13,486)

$ 103.74

$      (13,099)

$ 100.76















Repurchase Agreements

$       36,748

$       36,748

$ 100.00

$       36,748

$ 100.00


$       13,650

$       13,650

$ 100.00

$       13,650

$ 100.00















Total Net Investments


$     673,466


$     670,159




$     659,382


$     666,365







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

(2) Excludes Interest Only and similar securities.

(3) 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








June 30, 2012


March 31, 2012


Notional Value

Fair Value


Notional Value

Fair Value

(In thousands)






  Net Long Mortgage Related:(1)






     CDS on RMBS and CMBS Indices

$        51,448

$      (17,646)


$        19,800

$      (11,508)

   Total Net Long Mortgage Related Derivatives

51,448

(17,646)


19,800

(11,508)







  Net Short Mortgage Related:(2) (3)






     CDS on RMBS and CMBS Indices

(94,468)

30,020


(86,819)

36,195

     CDS on Individual RMBS

(46,828)

38,759


(57,875)

48,746

   Total Net Short Mortgage Related Derivatives

(141,296)

68,779


(144,694)

84,941

Net Mortgage Related Derivatives

(89,848)

51,133


(124,894)

73,433







   Short CDS on Corporate Bond Indices

(58,250)

316


(78,250)

(364)

   Short Total Return Swaps on Corporate Equities (4)

(22,304)

(253)


(22,446)

(249)







Interest Rate Derivatives:






     Net Interest Rate Swaps(2)

(248,100)

(5,518)


(205,700)

(6,010)

     Eurodollar Futures (5)

(105,000)

(54)


(126,000)

(52)

   Total Net Interest Rate Derivatives

(353,100)

(5,572)


(331,700)

(6,062)







Total Net Derivatives

$    (523,502)

$        45,624


$    (557,290)

$        66,758


(1) Long mortgage-related derivatives represent transactions where the Company sold credit protection to a counterparty.

(2) In the table above, CDS transactions involving the same underlying security but with different counterparties are shown on a net basis. Additionally, long and short interest rate swaps are shown net. The accompanying financial statements separate derivative transactions as either assets or liabilities. As of June 30, 2012, derivative assets and derivative liabilities were $74.3 million and $28.7 million, respectively, for a net fair value of $45.6 million, as reflected in "Total Net Derivatives" above. As of March 31, 2012, derivative assets and derivative liabilities were $94.1 million and $27.3 million, respectively, for a net fair value of $66.8 million, as reflected in "Total Net Derivatives" above.

(3) Short mortgage-related derivatives represent transactions where the Company purchased credit protection from a counterparty.

(4) Notional value represents number of underlying shares or par value times the closing price of the underlying security.

(5) Every $1 million in notional value represents one contract.

The Company's short positions in RMBS and CMBS indices remained concentrated in MBS vintage years 2006 and 2007 and short total return swaps on corporate equities are principally short equity positions in certain publicly traded, commercial property REITs.

The following table summarizes, as of June 30, 2012, the estimated effects on the value of our portfolio, both overall and by category, of hypothetical, immediate 50 basis point downward and upward parallel shifts in interest rates.






Estimated Change in Value(1)

(In thousands)

50 Basis Point Decline in Interest Rates


50 Basis Point Increase in Interest Rates

Agency ARM Pools

$                   34


$                 (70)

Agency Fixed Pools and IOs

8,182


(10,985)

TBAs

(4,580)


6,867

Non-Agency RMBS, CMBS and Commercial Mortgage Loans

6,095


(6,294)

Interest Rate Swaps

(6,156)


5,930

U.S. Treasury Securities

(438)


435

Eurodollar Futures

(130)


130

Mortgage-Related Derivatives

(686)


426

Repurchase Agreements and Reverse Repurchase Agreements

(317)


371


$              2,004


$            (3,190)


(1) Based on the market environment as of June 30, 2012. The preceding analysis does not include sensitivities to changes in interest rates for our derivatives on corporate securities (whether debt or equity-related), or other categories of instruments for which we believe that the effect of a change in interest rates is not material to the value of the overall portfolio and/or cannot be accurately estimated. Results are based on forward-looking models, which are inherently imperfect, and incorporate various simplifying assumptions. Therefore, the table above is for illustrative purposes only and actual changes in interest rates would likely cause changes in the actual value of our portfolio that would differ from those presented above and such differences might be significant and adverse.

Borrowed Funds and Liquidity(1)

By Collateral Type



As of June 30, 2012


For the Quarter Ended
June 30, 2012


As of March 31, 2012


For the Quarter Ended
March 31, 2012

Collateral for Borrowing


Outstanding Borrowings


Average Borrowings for the Quarter Ended

Average Cost of Funds


Outstanding Borrowings


Average Borrowings for the Quarter Ended

Average Cost of Funds

(In thousands)











Non-Agency RMBS, CMBS and Other


$          238,469


$                 227,071

2.18%


$             224,280


$                 231,496

2.02%

Agency RMBS


644,853


716,492

0.37%


697,126


657,354

0.35%

  Total


$          883,322


$                 943,563

0.80%


$             921,406


$                 888,850

0.78%












Leverage Ratio (2)




2.24:1





2.33:1





(1) Borrowed amounts exclude $1.4 million and $1.5 million in securitized debt, as of June 30, 2012 and March 31, 2012, respectively, representing long term financing for the related asset.

(2) The leverage ratio does not account for liabilities other than debt financings. The Company's debt financings consist solely of reverse repurchase agreements ("reverse repos") and a securitized debt financing in the amount of $1.4 million and $1.5 million as of June 30, 2012 and March 31, 2012, respectively.



 

By Remaining Maturity (1)(2)

(In thousands)









As of  June 30, 2012


As of  March 31, 2012

Remaining Maturity (3)


Outstanding Borrowings

% of Borrowings


Outstanding Borrowings

% of Borrowings








30 Days or Less


$             479,624

54.3%


$             520,213

56.5%

31-60 Days


144,577

16.4%


156,280

17.0%

61-90 Days


187,244

21.2%


99,058

10.7%

91-120 Days


-

0.0%


87,336

9.5%

121-150 Days


-

0.0%


-

0.0%

151-180 Days


71,877

8.1%


58,519

6.3%

181-360 Days


-

0.0%


-

0.0%



$             883,322

100.0%


$             921,406

100.0%


(1) Borrowed amounts exclude $1.4 million and $1.5 million in securitized debt as of June 30, 2012 and March 31, 2012, respectively, representing long term financing for the related asset.

(2) Reverse repos involving underlying investments that the Company had sold prior to the applicable period end for settlement following the applicable period end, are shown using their original maturity dates even though such reverse repos may be expected to be terminated early upon settlement of the sale of the underlying investment. Not included are any reverse repos that the Company may have entered into prior to the applicable period end for which delivery of the borrowed funds is not scheduled until after the applicable period end.

(3) Remaining maturity for a reverse repo is based on the contractual maturity date in effect as of the applicable period end. Some reverse repos have floating interest rates, which may reset before maturity.

The vast majority of the Company's borrowed funds are in the form of reverse repos. Aside from borrowings under reverse repos, as of June 30, 2012 and March 31, 2012, the Company also had securitized debt outstanding in the amount of $1.4 million and $1.5 million, respectively. The weighted average remaining term on the Company's reverse repos as of June 30, 2012 and March 31, 2012 were 45 and 43 days, respectively. The Company's borrowings outstanding under reverse repos were with a total of 11 counterparties as of June 30, 2012 and as of March 31, 2012. As of June 30, 2012, the Company had liquid assets in the form of cash in the amount of $48.1 million. In addition, at June 30, 2012, the Company held investments in unencumbered Agency pools on a settlement date basis in the amount of $99.0 million.

Hedging Summary

The following table summarizes the components of the Company's hedging results for the quarter ended June 30, 2012 and March 31, 2012:

(In thousands)

Quarter Ended June 30, 2012


Quarter Ended March 31, 2012

Hedges:

 Net Interest Expense 

Realized Gain (Loss)

Unrealized Gain (Loss)

Total


 Net Interest Expense 

Realized Gain (Loss)

Unrealized Gain (Loss)

Total

Interest Rate Swaps

$         (688)

$      (4,607)

$           289

$      (5,006)


$         (931)

$        (8,931)

$        10,576

$            714

Eurodollar Futures

-

(9)

(2)

(11)


-

(8)

(63)

(71)

Net TBA's Held Short

-

(8,696)

(691)

(9,387)


-

(4,681)

2,567

(2,114)

Net U.S. Treasuries Held Short

(52)

(14)

(97)

(163)