Ellington Financial LLC Reports Fourth Quarter 2015 Results.
Net increase in shareholders' equity resulting from operations ("net income") for the fourth quarter was $1.8 million, or $0.05 per basic and diluted share, as compared to net income of $3.9 million, or $0.12 per basic and diluted share, for the quarter ended September 30, 2015.
Book value per share as of December 31, 2015 was $21.80 on a diluted basis, after payment of a quarterly dividend in the fourth quarter of $0.50 per share, as compared to book value per share of $22.22 on a diluted basis as of September 30, 2015.
Our Credit strategy generated gross income of $6.8 million for the quarter ended December 31, 2015.
Our Agency strategy generated gross income of $0.7 million for the quarter ended December 31, 2015.
In accordance with the guidance we provided last quarter, we repurchased approximately 291,000 shares during the quarter, at an average price per share of $17.23 for a total cost of approximately $5.0 million.
Our Board of Directors declared a dividend of $0.50 per share for the fourth quarter of 2015, equating to an annualized dividend yield of 12.2% based on the February 12, 2016 closing price of $16.35; dividends are paid quarterly in arrears.
Fourth Quarter 2015 Results
"In the fourth quarter, EFC generated net income of $1.8 million, or $0.05 per share, including the full impact of mark-to-market adjustments," said Laurence Penn, Chief Executive Officer and President. "We have been warning for some time of the potential for significant shocks in the high-yield corporate credit markets, with potential spillover into related markets, such as more recent vintage CLOs. As a result, in the fourth quarter we reduced our leverage by selling both Agency and non-Agency RMBS, we increased our cash holdings, and we maintained our high-yield short position credit hedges. Our intention of course is to re-invest this excess cash and add back leverage with respect to these and our other targeted assets as we see more attractive entry points, which we expect to see over the coming months. Meanwhile, over the course of the quarter we continued to increase our investments in consumer loans and small balance commercial loans, and just as importantly we increased our projected pipeline of future investments in these areas. The pace of our non-QM loan purchases is accelerating, and we remain optimistic about the opportunities in this growing segment of our portfolio.
"During the fourth quarter, we had excellent contributions from our distressed small balance commercial mortgage loan business as well as our growing consumer loan business, where we have recently added yet another forward flow purchase agreement. These two particular businesses, in addition to providing us a pipeline of investments over which we have greater control and visibility, have the additional benefit of being less exposed to interest rate movements and global macroeconomic events. We remain focused on capitalizing on the wide array of opportunities presented by our broader base of asset classes, and the increasing diversity of our credit portfolio.
"Last quarter, we announced that in the event our shares continued to trade at a significant discount to book value, we planned to repurchase in the open market approximately $5.0 million of our shares per quarter in the coming quarters, and to institute a 10b5-1 plan to maximize the number of trading days available to implement these repurchases. We executed these share repurchases in the fourth quarter according to plan, with a $0.04 accretive effect on our diluted book value per share. Given that our shares our still trading at a significant discount to book value, we expect to continue with this plan."
During the fourth quarter, fixed-income markets continued to be impacted by concerns over the health of the Chinese economy and the decline in commodity prices. In December, for the first time since June 2006, the Federal Reserve raised its target interest rate by 0.25%. While this increase was both modest in size and widely expected, the actual implementation was significant in that it made official the Federal Reserve's view that the U.S. economy was on solid footing, and represented a reversal in course from previous monetary easing policy actions. The increase in the target interest rate put upward pressure on interest rates, especially shorter-term rates, during the fourth quarter. While there was also upward pressure on longer-term interest rates, this upward pressure was somewhat muted by global market concerns and the increase in demand for safe haven securities. The 10-year U.S. Treasury yield ended the fourth quarter at 2.27% as compared to 2.04% at the end of the third quarter, an increase of 23 basis points, and the 2-year U.S. Treasury yield increased 42 basis points, from 0.63% to 1.05% over the course of the quarter. During the fourth quarter, the 2-year swap rate increased 43 basis points while the 10-year swap rate
increased only 18 basis points. The average rate for a fixed rate 30-year conventional mortgage also increased over the course of the fourth quarter, rising to 4.01% as of December 31, 2015 from 3.86% as of September 30, 2015.
Our Credit strategy generated gross income of $6.8 million for the fourth quarter, or $0.20 per share. This strategy includes non-Agency RMBS; CMBS; performing, sub-performing, and non-performing residential and commercial mortgage loans; consumer loans; CLOs; investments in mortgage-related entities; distressed corporate debt and equity; interest rate hedges; credit hedges (including relative value trades involving credit hedging instruments); and our equities trading strategy. Income from our Credit strategy was primarily driven by interest income and other income, net interest rate hedges, and net credit hedges and other activities, partially offset by net realized and unrealized losses on investments, interest expense, and other investment related expenses. During the fourth quarter, we turned over approximately 13% of our Credit bond portfolio, as measured by sales, excluding paydowns. Active portfolio trading is a key component of our strategy, and we trade our bond portfolio not only for the generation of total return, but also to enhance the composition of our portfolio. As of December 31, 2015, our total long Credit portfolio declined slightly to $600.5 million, as compared to $618.4 million as of September 30, 2015. Over the course of the fourth quarter, we net sold non-Agency RMBS, as we believed certain positions within those portfolios had become fully valued and as we anticipated more favorable future entry points. The decline in our non-Agency RMBS portfolio was partially offset by an increase in our investments in consumer loans, small balance commercial and non-QM residential mortgage loans, as well as an increase in our cash holdings. Our RMBS, CMBS, consumer and commercial mortgage loans, interest rate hedges, and credit hedges (including relative value trades involving credit hedging instruments), all contributed positively to our results for the quarter, while our distressed debt and equity investments and our equities trading strategy served as a drag on our results. We implement our equities trading strategy through the use of total return swaps, and their contribution to our results is included in our summary operating results under the caption "Net credit hedges and other activities."
Yield spreads on non-Agency RMBS were generally not immune to the broader fourth quarter market widening, although as in the third quarter this sector was somewhat less impacted than other credit sectors. A stable housing market continues to support the non-Agency RMBS sector, while on the technical side the sector continues to be supported by the absence of a robust new issue market (in contrast with the CMBS sector, where new issue supply has been heavy). Over the course of the year, we steadily sold down our legacy non-Agency RMBS, primarily in order to redeploy the net proceeds to our other targeted Credit assets, and more recently in order to increase our cash holdings. While our non-Agency RMBS portfolio currently represents a much smaller portion of our total Credit portfolio than it ever has, it continues to be a core segment of our overall portfolio. We intend to continue to opportunistically increase and decrease the size of this portfolio as market conditions vary. As of December 31, 2015, our investments in U.S. non-Agency RMBS totaled $217.8 million as compared to $266.0 million as of September 30, 2015, and as compared to $530.3 million as of December 31, 2014.
Our credit hedges are primarily in the form of short positions on credit default swaps, or "CDS," on high-yield corporate bond indices, as well as tranches and options on these indices, and we opportunistically overlay these positions with certain relative value long/short positions involving the same or similar instruments. Toward the end of 2015, prices on high-yield corporate CDS indices increased, leading to net losses on our credit hedges. However, our relative value long/short overlay positions generated net gains, more than offsetting these losses. We had net gains on our interest rate hedges, as interest rates increased over the course of the fourth quarter. Our interest rate hedges are principally in the form of interest rate swaps and, to a lesser extent, Eurodollar and U.S. Treasury futures. Our foreign currency hedges offset the impact of foreign currency related transaction and translation losses from our holdings denominated in euros and British pounds. We believe that the credit markets remain vulnerable to potential additional yield spread widening, and so we intend to continue to hedge our portfolio using CDS indices and other credit hedging instruments. We believe that our publicly traded partnership structure affords us valuable flexibility, especially with respect to our ability to reduce exposures nimbly through hedging both credit and interest rate risks. At the same time, we believe that any additional substantial yield spread widening will lead to attractive opportunities for us, especially given the many diverse sectors in which we are active.
During the fourth quarter, volatile conditions in global financial markets and heavy CMBS new issuance continued to put substantial widening pressure on CMBS yield spreads. For the year ended December 31, 2015, CMBS new issuance totaled $61.5 billion, an 8% increase year over year. Despite the difficult market conditions, net of hedges, our CMBS strategy generated positive income for the quarter; this was largely the result of our active trading of the portfolio, which resulted in net realized gains even while CMBS market prices generally trended downward through the quarter. The credit curve steepened, meaning lower rated securities generally experienced greater widening than higher rated securities, as liquidity premiums increased and investor appetite for risk diminished. As of December 31, 2015, our CMBS bond portfolio was comprised entirely of new issue "B-pieces" that we purchased at original issuance. B-pieces are the most subordinated (and therefore the highest yielding and riskiest) CMBS tranches. By purchasing new issue B-pieces, we believe that we are often able to effectively "manufacture" our risk more efficiently than what is generally available in the secondary market, and to better target
the collateral profiles and structures we prefer. As new issue B-piece yields generally tightened during 2015, we reduced our acquisition pace and we took advantage of several favorable selling opportunities. As we reduced our CMBS holdings during the fourth quarter, we realized meaningful gains net of hedges. As of December 31, 2015, our investment in U.S. CMBS was $26.3 million, as compared to $32.2 million as of September 30, 2015.
As of each of December 31, 2015 and September 30, 2015, our portfolio of small balance commercial loans included 25 loans and two real estate owned, or "REO," properties with an aggregate value of $74.8 million and $62.4 million, respectively. Although the number of assets we held quarter over quarter did not change, during the quarter, we resolved certain assets and acquired others. Assets acquired were on average larger in size than those disposed. The number and aggregate value of loans held, as well as the income generated by our loans, may fluctuate significantly from period to period, especially as loans are resolved or sold. Our distressed small balance commercial loan portfolio performed well during the fourth quarter.
During the fourth quarter, European MBS/ABS and CLOs were marked by a general ongoing lack of activity and liquidity. When the European Central Bank, or "ECB," did not loosen monetary policy to the extent that the market participants expected in the fourth quarter, inactivity in these sectors continued, as sellers did not wish to realize losses and buyers sought better pricing. While asset prices generally declined during the fourth quarter, our European CMBS and CLO portfolios benefited from the fact that some of our holdings were called at par, generating net gains. During the fourth quarter we did not acquire any new packages of non-performing Spanish consumer, residential, or commercial mortgage loans; nevertheless we continue to believe that the Spanish and Portuguese non-performing loan markets will present additional attractive opportunities, and we are actively pursuing opportunities in these areas. Overall, net of hedges, including currency hedges, our European non-dollar denominated portfolio generated positive income for the fourth quarter. As of December 31, 2015, our investments in European non-dollar denominated assets totaled $72.5 million, as compared to $77.8 million as of September 30, 2015. As of December 31, 2015 our total holdings of European non-dollar denominated assets included $37.2 million in RMBS, $7.8 million in CMBS, $24.4 million in CLOs, $2.9 million in ABS, and $0.2 million in distressed corporate debt. As of September 30, 2015 our total holdings of European non-dollar denominated assets included $38.0 million in RMBS, $10.3 million in CMBS, $26.3 million in CLOs, $3.0 million in ABS, and $0.3 million in distressed corporate debt. These assets include securities denominated in British pounds as well as in euros.
During the fourth quarter, the effect of market volatility on U.S. CLOs continued to weigh heavily on more recently issued CLOs. While prices of legacy CLOs also declined during the quarter--albeit to a much lesser extent--we believe that their risk/reward profile has greatly improved as the underlying securitizations have continued to de-leverage. Meanwhile, more recently issued CLOs continued to be adversely impacted by aggressive selling by large banks in advance of quarter end, as they contended with the balance sheet limitations imposed by the "Volker Rule." Within our U.S. CLO portfolio, we have focused on the legacy sector, where we have found opportunities in both mezzanine and equity tranches. We have previously avoided more recently issued CLOs since we believed that they did not provide attractive risk-adjusted returns, particularly given that the underlying loans were generally originated with relaxed underwriting standards, or "covenant light" features. While we believe that more recently issued CLOs may fall much further in price, we also believe that this could present a promising buying opportunity over the near to medium term. During the fourth quarter, our total U.S. CLO portfolio declined to $21.6 million as of December 31, 2015, from $30.5 million as of September 30, 2015, partly because certain of our CLO equity positions were optionally redeemed. Since we owned these CLO equity positions at a discount to net asset value, they benefited from the optional redemptions. Inclusive of credit hedges, our U.S. CLO portfolio generated a small net loss for the fourth quarter.
We remain active in non-performing and sub-performing U.S. residential mortgage loans, or "residential NPLs." Year over year, the sales volume of widely distributed offerings of residential NPLs increased roughly 20% to approximately $25.4 billion, with a significant portion of the volume coming from the U.S. Department of Housing and Urban Development, or "HUD," the Government Sponsored Enterprises, or "GSEs," and large banks. While sales volume from HUD has decreased, sales volume from the GSEs, each now a "program seller," has more than offset the impact of diminished HUD activity. The market for large residential NPL pools remains highly concentrated, with the great majority having traded to only a handful of large players who typically securitize the NPLs that they purchase; these buyers include several REITs, private equity firms, and large investment management firms. During the fourth quarter, we were net sellers of residential NPLs and REO, and, as a result, our portfolio decreased in size. Our residential NPL portfolio generated a modest income during the fourth quarter, and our strategy continues to focus on smaller, less-competitive, mixed legacy pools sourced from motivated sellers. As of December 31, 2015, we held $17.0 million in residential NPLs and related foreclosure property as compared to $21.2 million as of September 30, 2015.
During the fourth quarter, under flow agreements with multiple originators, we continued to add to our consumer loan portfolio, which includes unsecured loans as well as auto loans. Our U.S. consumer loan and ABS portfolio performed well in the fourth quarter, although our credit hedges in this portfolio partially offset gross income earned. We expect the contribution from our consumer loan portfolio to increase as the portfolio continues to ramp up in volume. In the fourth quarter we renewed an
existing flow agreement for unsecured consumer loans for an additional one-year term, and we continue to actively evaluate other consumer loan originators with whom we may enter into flow arrangements. We are financing most of our consumer loan portfolio with a large investment bank. As of December 31, 2015, our investments in U.S. consumer loans and ABS totaled $112.5 million, as compared to $74.7 million as of September 30, 2015.
The distressed debt market experienced a very weak fourth quarter, resulting in the worst annual performance of distressed debt securities since 2008 and, prior to that, 1989. This weakness was not just confined to the oil and gas space. Rather, broad declines were experienced across sectors including metals, mining, retail and telecom. By the way of illustration, for the year ended December 31, 2015 the distressed sector of the Credit Suisse High Yield Index was down 43.45%, while the distressed sector of the Credit Suisse Leveraged Loan Index was down 41.01%. Given the weak backdrop, we have continued to focus on senior secured leverage loans, and we have opportunistically entered into short positions on energy related companies where we deemed it prudent. We have also kept our portfolio relatively small. Given the historic declines in distressed debt in 2015, we believe there could be attractive opportunities in this sector in the medium term. However, we remain cautious on the market at this time, and we intend to make purchases opportunistically as attractive entry points arise. During the fourth quarter, our distressed corporate debt portfolio, including credit hedges, generated a meaningful net loss. As of December 31, 2015, our net long holdings of distressed corporate debt, including related equity and the underlying value of loans acquired through total return swap contracts, totaled $55.7 million, as compared to $60.9 million as of September 30, 2015.
During the fourth quarter, the pace of our non-QM loan purchases continued to accelerate, and we are hopeful that our investments in non-QM loans will grow meaningfully over the medium to longer term. As of December 31, 2015, our non-QM mortgage loans totaled $9.2 million as compared to $3.5 million as of September 30, 2015. We also had outstanding commitments to purchase non-QM mortgage loans in the amount of $7.7 million as of December 31, 2015, as compared to $4.8 million as of September 30, 2015. In January 2016, we began financing our non-QM loans under a facility with a large investment bank. During the fourth quarter, we invested in a fourth mortgage originator; our investment is principally in the form of secured debt. We expect to continue to explore making investments in other mortgage originators where we see opportunities to enhance longer term enterprise values and/or to establish strategic relationships, including where we could gain access to desirable assets, such as through flow agreements.
Our Agency strategy generated gross income of $0.7 million, or $0.02 per share, during the fourth quarter of 2015. Interest rates increased and Agency RMBS yield spreads widened during the fourth quarter, resulting in net realized and unrealized losses, which were partially offset by income from our interest rate hedges and other activities.
Consistent with past quarters, as of December 31, 2015, our Agency RMBS were principally comprised of "specified pools." Specified pools are fixed rate Agency pools with special 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 characteristics. Our Agency strategy also includes RMBS which are backed by ARMs or Hybrid ARMs, and reverse mortgages; and CMOs, including IOs, POs and IIOs. Our Agency strategy also includes interest rate hedges for our Agency RMBS, as well as certain relative value trading positions in interest rate-related and TBA-related instruments.
During the fourth quarter, yield spreads on Agency RMBS continued to widen relative to interest rate swaps. In addition, the 10-year interest rate swap spread to U.S. Treasury securities became even more negative during the fourth quarter than it had been in the third quarter, when this spread had become negative for the first time since 2010. These swap spread movements exacerbated the widening in yield spreads between Agency RMBS and interest rate swaps, and negatively impacted our results for the quarter. Specifically, for the quarter ended December 31, 2015, we had total net realized and unrealized losses of $(11.1) million, or $(0.32) per share, on our aggregate Agency RMBS portfolio, while we had total net realized and unrealized gains of $5.2 million, or $0.15 per share, on our interest rate hedges and other activities. Pay-ups on specified pools also declined during the quarter as interest rates rose, and as the dealer community became increasingly reluctant to hold inventory into the end of the year. Over the course of the quarter, pay-ups on our specified pools decreased to 0.64% as of December 31, 2015 from 0.91% as of September 30, 2015. Pay-ups are price premiums for specified pools relative to their TBA counterparts.
During the fourth quarter, we continued to use short positions in TBAs to hedge interest rate risk, and these positions generated net gains. However, TBAs generally outperformed specified pools during the quarter, and as a result, the net gains from our short TBAs were outweighed by the net unrealized losses on our specified pools. We actively traded our Agency RMBS portfolio during the fourth quarter in order to take advantage of volatility and to harvest modest gains. Our portfolio turnover for the quarter was 43% (as measured by sales and excluding paydowns), and we captured net realized gains of $1.6 million, excluding hedges.
As of December 31, 2015, our long Agency RMBS portfolio declined to $962.6 million from $1.2 billion as of September 30, 2015. Over the course of the fourth quarter we net sold assets so as to increase our cash positions and be generally more defensively positioned. Our outstanding borrowings declined as a result of these sales, and thus our leverage declined as well. As we see more attractive entry points over the coming months, especially with respect to our other targeted assets, our intention is to re-invest this excess cash and add back leverage.
During the fourth quarter, we continued to focus our Agency RMBS purchasing activity primarily on specified pools, especially those with higher coupons. As of December 31, 2015, the weighted average coupon on our fixed rate specified pools was 4.06%. During the fourth quarter, yield spreads on reverse mortgage pools continued to widen, both in sympathy with the broader RMBS markets and as a result of recent increases in reverse mortgage pool prepayment speeds. In response to this yield spread widening, we added to our reverse mortgage pool holdings. Our Agency RMBS portfolio also includes a small allocation to Agency ARMs and Agency IOs. We believe that there remains a heightened risk of substantial interest rate and prepayment volatility in the near term, thus reinforcing the importance of our ability to hedge our Agency RMBS portfolio using a variety of tools, including TBAs.
Our net Agency premium as a percentage of our long Agency RMBS holdings is one metric that we use to measure our overall prepayment risk. 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 related net short (TBA) Agency RMBS positions. The net short TBA position related to our long Agency RMBS had a notional value of $392.9 million and a fair value of $420.0 million as of December 31, 2015, and a notional value of $638.3 million and a fair value of $684.4 million as of September 30, 2015. The lower our net Agency premium, the less we believe that we are exposed to market-wide increases in Agency RMBS prepayments. As of December 31, 2015 and September 30, 2015, our net Agency premium as a percentage of fair value on long Agency RMBS holdings was approximately 3.4% and 3.3%, respectively. Excluding TBA positions used to hedge our long Agency RMBS portfolio, our Agency premium as a percentage of fair value was approximately 6.3% and 7.2% as of December 31, 2015 and September 30, 2015, respectively. These percentages may fluctuate from period to period based on market factors, including interest rates and mortgage rates, as well as, with respect to the net percentages, the degree to which we hedge prepayment risk with short TBAs. We believe that our focus on purchasing pools with specific prepayment characteristics provides a measure of protection against prepayments.
We prepare our financial statements in accordance with ASC 946, Financial Services--Investment Companies. As a result, our investments are carried at fair value and all valuation changes are recorded in the Consolidated Statement of Operations.
We also measure our performance based on our diluted net-asset-value-based total return, which measures the change in our diluted book value per share and assumes the reinvestment of dividends at diluted book value per share and the conversion of all convertible units into common shares at their issuance dates. Diluted net-asset-value-based total return was 0.40% and 5.20% for the quarter and year ended December 31, 2015, respectively. Based on our diluted net-asset-value-based total return of 162.06% from our inception (August 17, 2007) through December 31, 2015, our annualized inception-to-date diluted net-asset-value-based total return was 12.19% as of December 31, 2015.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Article Type:||Financial report|
|Date:||Feb 23, 2016|
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