Ellington Financial LLC Reports Second Quarter 2018 Results
OLD GREENWICH, Conn.--(BUSINESS WIRE)--Aug 6, 2018--Ellington Financial LLC (NYSE: EFC) today reported financial results for the quarter ended June 30, 2018.
HighlightsNet income 1 of $21.2 million, or $0.69 per basic and diluted share. Book value per share as of June 30, 2018 of $19.57 on a diluted basis, after payment of a quarterly dividend of $0.41 per share, as compared to book value per share of $19.25 on a diluted basis as of March 31, 2018. Credit strategy gross income of $24.9 million for the quarter, or $0.80 per share. Agency strategy gross income of $1.7 million for the quarter, or $0.06 per share. Net investment income of $11.0 million for the quarter, or $0.36 per share; adjusted net investment income 2 of $11.0 million for the quarter, or $0.36 per share. Announced a dividend of $0.41 per share for the second quarter of 2018, equating to an annualized dividend yield of 10.0% based on the August 3, 2018 closing price of $16.34 per share; dividends are paid quarterly in arrears. Repurchased 242,161 common shares during the quarter, or approximately 1% of our outstanding common shares as of the beginning of the quarter, at an average price of $14.98 per share. Debt-to-equity ratio, excluding repo borrowings on U.S. Treasury securities, of 2.77:1 as of June 30, 2018.
Second Quarter 2018 Results
“In the second quarter, Ellington Financial had net income, including the full impact of mark-to-market adjustments, of $21.2 million, or $0.69 per share,” said Laurence Penn, Chief Executive Officer and President. “We were able to build on the strong momentum of the first quarter as we continued to benefit from our larger credit portfolio, which grew another 9% this quarter. As a result, net investment income is also growing nicely, increasing to 36 cents for the quarter. Overall, Ellington Financial generated an economic return of 3.8% in the second quarter, and 8.2% through the first half of the year, or 17.1% annualized.
“The growth and performance of our securitizations continues to be a key driver of our results. This past quarter, we participated in our third Ellington-sponsored corporate CLO, achieving tighter pricing and a longer investment period than our previous issuances, even in the face of a softer overall CLO new issue market. Meanwhile, S&P upgraded three classes of our non-QM securitization; in fact our deal has the highest perfect payer percentage of all non-QM securitizations in its vintage, as reported by Bloomberg.
“Moving into the second half of the year, our primary focus is on executing our business plan, and in particular continuing to grow our credit portfolio, emphasizing high-yielding, short-duration assets, and thereby continuing to grow our net investment income to provide stability of earnings and dividend coverage. If the volatility that we saw earlier this year returns, we believe that we are well positioned to take advantage by adding assets at higher yields and trading out of some of the more liquid parts of the portfolio, while at the same time relying on our hedges and liquidity management to protect and preserve book value.
“In addition, as we’ve discussed previously, we continue to actively evaluate possible changes to our tax status as a publicly traded partnership. Our options include potential conversion to a C-Corp, potential conversion to a REIT, and of course remaining a publicly traded partnership.”
Market OverviewIn June, the Federal Reserve raised the target range for the federal funds rate by 0.25%, to 1.75%–2.00%, its seventh rate increase since December 1, 2015 and its second rate increase so far in 2018. LIBOR rates, which drive many of our financing costs, increased in sympathy, with one-month LIBOR increasing 21 basis points to end the second quarter at 2.09%. In April and July, the Federal Reserve continued to increase 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 $12 billion per month in April and to $16 billion per month in July. The tapering of U.S. Treasury purchases increased to $18 billion per month in April and to $24 billion per month in July. The yield curve flattened for the sixth consecutive quarter: the 2-year U.S. Treasury yield rose 26 basis points to end the second quarter at 2.53%, while the 10-year U.S. Treasury yield rose 12 basis points to 2.86%. The spread between the 2-year and 10-year tightened to just 33 basis points, as compared to 47 basis points at the end of the first quarter. Mortgage rates increased in the second quarter, with the Freddie Mac survey 30-year mortgage rate rising 11 basis points to end the quarter at 4.55%. Overall Agency RMBS prepayment rates continued to be muted during the quarter. The Mortgage Bankers Association’s Refinance Index, which measures refinancing application volumes, fell 11.9% quarter over quarter, dropping intra-quarter to its lowest seasonally-adjusted level in more than 17 years.
The second quarter of 2018 saw the extreme equity volatility of the first quarter subside, but interest rate choppiness and yield curve flattening continue. During the first part of the quarter, interest rates continued their recent upward trend, with the 10-year U.S. Treasury yield rising 37 basis points to an almost seven-year high of 3.11% on May 17 th. Over the next two weeks, this trend reversed, as investors reacted to a possible trade war and political uncertainty in Italy; by May 29 th, the 10-year U.S. Treasury had rallied nearly back to where it started the quarter. The flight to quality was short-lived, however, and the 10-year U.S. Treasury yield finished the quarter 12 basis points higher overall. The yield curve has lately been the flattest it has been since 2007, when it actually inverted during the early part of the year.
Performance was mixed for the quarter across the various credit-sensitive sectors. Investment grade and high yield corporate credit spreads tightened during April but then widened in May and June, and finished the quarter approximately flat. Meanwhile, CMBS credit spreads generally tightened during the quarter (with especially strong demand for higher-yielding, non-investment grade CMBS securities), and the legacy non-Agency RMBS market continued to be well supported. The continued increase in LIBOR boosted coupons of floating-rate debt instruments, benefiting CLOs, leveraged loans, and other structured credit products.
Despite higher rates and the continued increase of Fed tapering, Agency RMBS spreads generally held firm over the quarter, continuing to benefit from a muted prepayment environment. As measured by the Bloomberg Barclays U.S. MBS Agency Fixed Rate Index, Agency RMBS generated a total return of 24 basis points for the quarter, and an excess return (on a duration-adjusted basis) over the Bloomberg Barclays U.S. Treasury Index of 15 basis points.
As of June 30, 2018, our total long Credit portfolio (excluding corporate relative value trading positions, hedges, and other derivatives) was $1.224 billion, which was an increase of approximately 7% from $1.146 billion as of March 31, 2018. Our total long Credit portfolio was $1.123 billion 3 as of June 30, 2018, which was an increase of approximately 9% from $1.032 billion 3 as of March 31, 2018. During the second quarter, our Credit strategy generated total gross income of $24.9 million, or $0.80 per share.
The growth of our Credit portfolio primarily came from net purchases in the following target strategies: consumer loans and ABS, residential mortgage loans and REO, European RMBS, and retained tranches in CLO securitizations. Our corporate debt and equity portfolio decreased in size during the quarter. We also sold a portion of our more liquid, lower-risk assets, such as certain U.S. non-Agency RMBS and CLO note investments, and rotated that capital into our higher-yielding strategies.
At the end of the second quarter, we held $150.2 million of unsecuritized non-QM mortgages, and we are optimistic that later this year we will be able to complete our second non-QM securitization. In our CLO securitization strategy, we participated in our third Ellington-sponsored CLO, which priced in June and closed in July. In addition, the liquidity of certain of our retained tranches from our prior CLO securitizations benefited from a ruling by the United States Court of Appeals for the District of Columbia Circuit, which ruled that U.S. risk retention rules do not apply to managers of open-market CLOs.
Our Credit portfolio performed very well during the quarter and continued to be the primary driver of our earnings. During the second quarter, our Credit strategy generated gross investment income of $12.1 million and net realized and change in net unrealized gains of $11.2 million. We benefited from strong performance in several of our loan-related strategies, including consumer loans, small balance commercial mortgage loans, European non-performing loans, and non-QM loans. Among our securities strategies, U.S. and European CLOs, U.S. CMBS, corporate credit relative value, and European RMBS all contributed strong results.
In the second quarter, our credit hedges modestly reduced profitability. The interest rate hedges in our Credit strategy, which currently consist primarily of interest rate swaps, had no material impact on our results. We had net losses on foreign currency-related transactions and translation, but these were more than offset by net gains on our foreign currency hedges.
In our corporate credit relative value strategy as of June 30, 2018, the market value of our long corporate bonds was $65.2 million, the aggregate market value of our short corporate bonds was $(50.2) million, and the aggregate notional amount of our credit default swaps where we were long protection and short protection was $81.8 million and $(122.4) million, respectively. As mentioned above, this strategy performed well in the second quarter. As of March 31, 2018 in this strategy, the market value of our long corporate bonds was $74.2 million, the aggregate market value of our short corporate bonds was $(46.4) million, and the aggregate notional amount of our credit default swaps where we were long protection and short protection was $122.8 million and $(162.4) million, respectively.
As of June 30, 2018, our long Agency RMBS portfolio increased approximately 2% to $948.5 million, from $928.2 million as of March 31, 2018. During the second quarter, our Agency strategy generated gross income of $1.7 million, or $0.06 per share. Agency RMBS prices declined again during the quarter, which led to net realized and unrealized losses on our portfolio of $(5.7) million. However, these losses were more than offset by net interest income from the Agency portfolio of $3.9 million and gains on our interest rate hedges and other activities of $3.4 million. Our results were also dampened by the outperformance of TBAs relative to specified pools during the quarter, driven by strong TBA dollar rolls and muted prepayments. We continued to concentrate our long investments in specified pools and hold net short positions in TBAs as a significant component of our interest rate hedging strategy.
Average pay-ups on our specified pools were unchanged at 0.61% as of June 30, 2018 as compared to March 31, 2018. Pay-ups are price premiums for specified pools relative to their TBA counterparts. As of June 30, 2018, the weighted average coupon on our fixed-rate specified pools was 4.1%.
During the quarter we continued to hedge interest rate risk in our Agency strategy, primarily through the use of short positions in TBAs, and to a lesser extent interest rate swaps and short positions in U.S. Treasury securities and futures. For the quarter, we had total net gains of $3.4 million from our interest rate hedges and other activities, as interest rates increased. In our hedging portfolio, the relative proportion (based on 10-year equivalents 4 ) of short positions in TBAs decreased slightly quarter over quarter relative to interest rate swaps.
Portfolio turnover for our Agency strategy was approximately 9.4% for the quarter (as measured by sales and excluding paydowns), and we had net realized losses of $(1.5) million, excluding interest rate hedges.
The following table summarizes our operating results for the quarters ended June 30, 2018 and March 31, 2018 and the six-month period ended June 30, 2018:
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