Ellington Residential Mortgage REIT Reports First Quarter 2018 Results
OLD GREENWICH, Conn.--(BUSINESS WIRE)--May 3, 2018--Ellington Residential Mortgage REIT (NYSE: EARN) today reported financial results for the quarter ended March 31, 2018.
HighlightsNet loss of $(4.0) million, or $(0.30) per share. Core Earnings 1 of $4.3 million, or $0.32 per share, and Adjusted Core Earnings 1 of $4.4 million, or $0.34 per share. Book value of $13.90 per share as of March 31, 2018, after giving effect to a first quarter dividend of $0.37 per share. Net interest margin of 1.06%, and adjusted net interest margin 2 of 1.09%. Weighted average constant prepayment rate for the fixed-rate Agency specified pool portfolio of 8.0%. Dividend yield of 13.1% based on May 2, 2018 closing stock price of $11.30. Debt-to-equity ratio of 8.9:1 as of March 31, 2018; adjusted for unsettled purchases and sales, the debt-to-equity ratio was 8.6:1. Net mortgage assets-to-equity ratio of 7.8:1 3 as of March 31, 2018. Repurchased 512,367 shares during the quarter, or approximately 3.8% of our outstanding shares as of the beginning of the quarter, at an average price of $11.21 per share.
First Quarter 2018 Results
“In the first quarter, Ellington Residential had a net loss of $(0.30) per share and Adjusted Core Earnings of $0.34 per share,” said Laurence Penn, Chief Executive Officer and President. “In sharp contrast to 2017, the first few months of 2018 saw a spike in market volatility, rising interest rates, and a significant selloff in Agency RMBS. Despite these headwinds, EARN’s book value was stable, as the gains on our interest rate hedges, along with net carry from the portfolio, offset most of the declines in our asset prices over the quarter. Share repurchases were also a boost to book value, and altogether EARN’s economic return for the quarter was a modestly negative (1.2)%, which we believe is a strong result for the quarter relative to the Agency REIT peer group.
“The sudden return of volatility in the first months of the year, along with underperformance of the Agency mortgage sector relative to U.S. Treasuries, enabled us to cover some of our short TBA positions at attractive prices, while adding net Agency RMBS exposure at higher asset yields. At quarter end, our net mortgage assets-to-equity ratio increased to 7.8:1 from 5.7:1 in the prior quarter.
“Also during the first quarter, with our share price trading at a significant discount to book value, we repurchased shares aggressively. We bought back 3.8% of our shares outstanding, which was accretive to book value by $0.13 per share. We continue to consider share repurchases as the market presents us with attractive opportunities, while balancing the accretive effect of such repurchases against the attractiveness of new investments, together with the effects on our expense ratios and on the liquidity of our shares.
“Going forward, we will continue to seek to capitalize on pricing dislocations that occur as the Federal Reserve’s footprint in the market diminishes. As we demonstrated again this quarter, our diligent hedging and liquidity management protect book value while also providing the flexibility to dial up and down our Agency RMBS exposure dynamically in response to market opportunities.”
Market OverviewIn March, the Federal Reserve raised the target range for the federal funds rate by 0.25%, to 1.50%–1.75%, its sixth rate increase since December 1, 2015. In January, and then again in April, the Federal Reserve increased the amount of the tapering of its reinvestments, in line with the schedule it had laid out in September 2017. The tapering of Agency RMBS purchases increased to $8 billion per month in January, and to $12 billion per month in April. Despite steepening over the first two months of the year, the yield curve finished the quarter flatter than where it started, for the fifth consecutive quarter. The 2-year U.S. Treasury yield rose 38 basis points to end the quarter at 2.27%, while the 10-year U.S. Treasury yield increased 33 basis points to 2.74%; the spread between the 2-year and 10-year tightened to just 47 basis points, as compared to 52 basis points at year-end. One-month LIBOR increased 32 basis points to end the first quarter at 1.88%, while three-month LIBOR increased 62 basis points to 2.31%. Both of these levels were the highest in over nine years. Mortgage rates increased in the first quarter, with the Freddie Mac survey 30-year mortgage rate rising 45 basis points to end the quarter at 4.44%. Overall Agency RMBS prepayment rates continued to be muted during the quarter. The Mortgage Bankers Association’s Refinance Index, which measures refinancing application volumes, was unchanged quarter over quarter.
The beginning of 2018 started much like 2017 finished, with equities reaching new highs in January. However, toward the end of January, the relative stability of 2017 suddenly reversed course. Equities sold off violently, driven in part by concerns over inflation and rising interest rates. The Dow Jones Industrial Average moved more than 2% in four of the first six trading sessions of February, as compared to no such days during 2017. By February 8 th, just nine trading days after reaching its all-time high, the S&P 500 Index entered correction territory. At the same time, long-term interest rates rose steadily and finally broke out of their 2017 ranges, with the 10-year U.S. Treasury yield reaching 2.95% on February 21 st, marking the highest daily close in more than four years and 91 basis points higher than the 2017 lows reached just last September. The Chicago Board Options Exchange Volatility Index, known as the VIX, jumped 282% between January 1 st and February 5 th, with a 20-point surge occurring on February 5 th, its largest one-day movement on record. On February 9 th, the Merrill Lynch Option Volatility Estimate Index, or MOVE Index, closed 54% above its year-end level, reaching its highest level since April 2017.
In March, equity volatility remained elevated amidst new concerns of an international trade war, while long-term interest rates leveled off and the yield curve flattened. Despite all of the volatility, the S&P 500 Index finished the quarter down only 1.2%.
During the quarter, yield spreads across many credit products widened in sympathy with the interest rate and equity market volatility. Corporate credit spreads tightened slightly during January but then widened dramatically. The Markit North America High Yield Index widened 63 basis points during the quarter—and in March reached its highest level since December 2016—while the Bloomberg Barclays U.S. Corporate Investment Grade Index registered a negative return of (79) basis points for the first quarter. Meanwhile, LIBOR continued its rapid rise, with 3-month LIBOR climbing 62 basis points from the end of last year. This increase in LIBOR boosted coupons in floating rate debt instruments and benefited the structured credit sector, including CLOs, leveraged loans, and legacy Non-Agency RMBS.
Agency RMBS prices came under substantial pressure during the first quarter, with interest rates materially higher and many coupons experiencing significant duration extension. These price movements were further compounded by a significant widening in Agency RMBS yield spreads, caused primarily by increased interest rate volatility and the technical drag created by the escalation of the Federal Reserve’s tapering program. As measured by the Bloomberg Barclays U.S. MBS Agency Fixed Rate Index, Agency RMBS generated a negative return of (1.19%) for the quarter, underperforming (on a duration-adjusted basis) the Bloomberg Barclays U.S. Treasury Index by 39 basis points.
As of March 31, 2018, our mortgage-backed securities portfolio consisted of $1.505 billion of fixed-rate Agency “specified pools,” $23.4 million of Agency RMBS backed by adjustable rate mortgages, or “Agency ARMs,” $75.4 million of Agency reverse mortgage pools, $14.5 million of Agency interest only securities, or “Agency IOs,” and $12.4 million of non-Agency RMBS. Specified pools are fixed-rate Agency pools consisting of mortgages with special characteristics, such as mortgages with low loan balances, mortgages backed by investor properties, mortgages originated through the government-sponsored “Making Homes Affordable” refinancing programs, and mortgages with various other characteristics.
Our overall RMBS portfolio decreased by 3.3% to $1.631 billion as of March 31, 2018, as compared to $1.686 billion as of December 31, 2017. Although our portfolio was slightly smaller by quarter end, our equity base was also smaller, with the result that our overall debt-to-equity ratio, adjusted for unsettled purchases and sales, increased to 8.6:1 as of March 31, 2018, up from 8.2:1 as of December 31, 2017. Our debt-to-equity ratio may fluctuate period over period based on portfolio management decisions, market conditions, and the timing of security purchase and sale transactions.
We capitalized on the widening in Agency RMBS yield spreads by covering a portion of the short TBA positions that we use for hedging purposes, as well as by increasing our long TBA portfolio held for investment purposes. These portfolio maneuvers increased our net mortgage assets-to-equity ratio to 7.8:1 as of March 31, 2018, from 5.7:1 as of December 31, 2017. As of March 31, 2018, we had short TBAs of $386.2 million, as compared to $713.4 million as of December 31, 2017. Also as of March 31, 2018, we had $142.9 million of long TBAs held for investment purposes, as compared to $117.4 million as of December 31, 2017. TBAs are forward-settling Agency RMBS where the mortgage pass-through certificates to be delivered are “To-Be-Announced.”
With Agency RMBS prices dropping during the quarter, our portfolio had significant unrealized losses. While this was partially offset by significant gains on our interest rate swaps and TBA short positions, strong TBA dollar rolls and muted prepayments caused TBAs to outperform specified pools, which in turn dampened our results. Even though we covered a portion of our TBA short positions during the quarter, short positions in TBAs continued to represent a significant portion of our interest rate hedging portfolio. Average pay-ups on our specified pools decreased to 0.59% as of March 31, 2018, as compared to 0.68% as of December 31, 2017. Pay-ups are price premiums for specified pools relative to their TBA counterparts.
Our non-Agency RMBS performed well during the quarter, driven by strong net interest income and net realized and unrealized gains. Fundamentals underlying non-Agency RMBS continue to remain strong, led by a stable housing market. During the quarter we net sold assets at gains. Our total investment in non-Agency RMBS decreased to $12.4 million as of March 31, 2018, as compared to $18.0 million as of December 31, 2017. To the extent that more attractive entry points develop in non-Agency RMBS, we may increase our capital allocation to this sector.
Earnings and Net Interest Margin
We had a net loss of $(4.0) million, or $(0.30) per share, for the quarter ended March 31, 2018, as compared to net income of $0.8 million, or $0.06 per share, for the quarter ended December 31, 2017. The loss for the quarter was primarily driven by unrealized losses on our Agency RMBS investments, which were only partially offset by net gains from our interest rate hedges and net interest income from our investments. For the quarter ended March 31, 2018, Core Earnings was $4.3 million, or $0.32 per share, as compared to $4.9 million, or $0.37 per share, for the quarter ended December 31, 2017. Adjusted Core Earnings for the quarter ended March 31, 2018 was $4.4 million, or $0.34 per share, as compared to $5.3 million, or $0.40 per share, for the quarter ended December 31, 2017. Lower per-share Core Earnings and Adjusted Core Earnings in the current quarter reflected a significant quarter-over-quarter decline in our adjusted net interest margin, which in turn was largely the result of a significant quarter-over-quarter increase in repo borrowing rates. Core Earnings and Adjusted Core Earnings are non-GAAP financial measures. See “Reconciliation of Core Earnings to Net Income (Loss)” below for an explanation regarding the calculation of Core Earnings, Adjusted Core Earnings, and the Catch-up Premium Amortization Adjustment.
For the quarter ended March 31, 2018, the weighted average yield of our portfolio of Agency and non-Agency RMBS was 2.99%, while our average cost of funds, including interest rate swaps and U.S. Treasury securities, was 1.93%, resulting in a net interest margin for the quarter of 1.06%. By comparison, for the quarter ended December 31, 2017, the weighted average yield of our Agency and non-Agency RMBS was 2.95%, while our average cost of funds, including interest rate swaps and U.S. Treasury securities, was 1.63%, resulting in a net interest margin of 1.32%. Excluding the impact of the Catch-up Premium Amortization Adjustment, the weighted average yield of our portfolio decreased to 3.02% for the first quarter as compared to 3.04% for the fourth quarter, and our adjusted net interest margin was 1.09% and 1.41%, respectively.
On a quarter-over-quarter basis, our cost of funds, including the cost of repo, interest rate swaps, and short positions in U.S. Treasury securities, increased to 1.93% from 1.63%. This quarter-over-quarter increase resulted mainly from an increase in our repo borrowing rates, which increased as LIBOR rose. Our average repo borrowing rate increased 23 basis points quarter over quarter to 1.63%, and the cost related to our short positions in U.S. Treasury securities increased by 11 basis points from the prior quarter. These increases were partially offset by lower costs related to our interest rate swaps, which decreased 3 basis points from the prior quarter.
For the quarter ended March 31, 2018, we had total net realized and unrealized losses of $(29.7) million, or $(2.24) per share, on our aggregate Agency RMBS portfolio. Prices on our Agency RMBS portfolio dropped, leading to significant unrealized losses for the quarter. Our Agency RMBS portfolio turnover was 15% for the quarter, which was slightly higher than the prior quarter. In addition, we had total net realized and unrealized gains of $0.5 million, or $0.04 per share, on our non-Agency RMBS portfolio as underlying fundamentals remained strong.
During the quarter we continued to hedge interest rate risk, primarily through the use of interest rate swaps, and short positions in TBAs, U.S. Treasury securities, and futures. For the quarter, we had total net realized and unrealized gains of $20.6 million, or $1.56 per share, on our interest rate hedging portfolio. In our hedging portfolio, the relative proportion (based on 10-year equivalents 4 ) of short positions in TBAs decreased quarter over quarter relative to our other interest rate hedges, as we increased our exposure to Agency RMBS to take advantage of the widening in Agency RMBS yield spreads. The relative makeup of our interest rate hedging portfolio can change materially from quarter to quarter.
After giving effect to a first quarter dividend of $0.37 per share, our book value per share decreased to $13.90 as of March 31, 2018, from $14.45 as of December 31, 2017, and we had an economic return of (1.2)% for the quarter. Economic return is computed by adding back dividends declared to ending book value per share, and comparing that amount to book value per share as of the beginning of the quarter.
4 “10-year equivalents” for a group of positions represent the amount of 10-year U.S. Treasury securities that would experience a similar change in market value under a standard parallel move in interest rates.
The following table summarizes our portfolio of securities as of March 31, 2018 and December 31, 2017:
Our weighted average holdings of RMBS based on amortized cost was $1.728 billion and $1.740 billion for the three month periods ended March 31, 2018 and December 31, 2017, respectively.
Financial Derivatives Portfolio
The following table summarizes fair value of our financial derivatives as of March 31, 2018 and December 31, 2017:
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