Ellington Residential Mortgage REIT Reports Fourth Quarter 2015 Results.
Summary of Financial Results
Net income for the quarter was $1.0 million, or $0.11 per share, as compared to net loss of $(4.8) million, or $(0.53) per share, in the third quarter of 2015.
Core Earnings1 for the quarter was $4.5 million, or $0.49 per share, as compared to $6.3 million, or $0.69 per share, in the third quarter of 2015. Excluding "Catch-up Premium Amortization Adjustments," Core Earnings for the fourth quarter was $5.6 million or $0.61 per share, as compared to $5.4 million or $0.59 per share in the third quarter.
Book value decreased to $15.86 per share as of December 31, 2015 from $16.20 per share as of September 30, 2015, after giving effect to a fourth quarter dividend of $0.45 per share.
Net interest margin was 1.67%, as compared to 2.19% for the third quarter of 2015. Excluding Catch-up Premium Amortization Adjustments, net interest margin was 2.01% for the fourth quarter of 2015 as compared to 1.93% for the third quarter of 2015.
Weighted average prepayment speed for the Agency RMBS portfolio was 7.5% CPR for the quarter, as compared to 7.1% in the third quarter of 2015.
Dividend yield of 16.5% based on February 9, 2016 closing stock price of $10.89.
Debt-to-equity ratio was 8.4:1 as of December 31, 2015, as compared to 8.3:1 as of September 30, 2015. Adjusted for unsettled purchases and sales, the debt-to-equity ratio was 8.1:1 as of December 31, 2015 and September 30, 2015.
Fourth Quarter 2015 Results
"In the fourth quarter, despite a weak Agency RMBS market and a flattening yield curve, EARN generated positive net income of $1.0 million or $0.11 per share. Our hedges partially offset the impact of the decline in asset prices, but their impact was muted somewhat as interest rate swap spreads relative to U.S. Treasury securities became even more negative during the fourth quarter. Excluding the impact of Catch-up Premium Amortization Adjustments, our Core Earnings increased to $0.61 per share in the fourth quarter from $0.59 per share in the third quarter," said Laurence Penn, Chief Executive Officer and President.
"We believe that given recent significant weakness in the credit markets, it may soon be appropriate to increase our allocation to non-Agency RMBS. Meanwhile, we believe that Agency RMBS are currently trading at highly attractive levels, and that our specified pool portfolio is positioned to perform well whether interest rates rise or fall. While 2015 was a difficult year, given the highly liquid nature of our portfolio with only a very modest current allocation to credit-sensitive securities, we believe that we are entering an extremely favorable investment environment for the Company. As always, we expect to continue to actively trade the portfolio to enhance its composition. During the fourth quarter, we turned over 40% of our Agency RMBS portfolio. Notwithstanding the increase in the cost of repo funding as a result of higher short-term interest rates, and the recent developments impacting the ability of certain mortgage REITs to access Federal Home Loan Bank financing for their Agency RMBS, we continue to see ample appetite from lenders to provide repo financing. We have repurchased shares in light of the discount in our stock price relative to our book value, although we are doing so on a measured basis."
As of December 31, 2015, our mortgage-backed securities portfolio consisted of $1.091 billion of fixed rate Agency "specified pools," $38.5 million of Agency RMBS backed by adjustable rate mortgages, or "Agency ARMs," $73.7 million of Agency reverse mortgage pools, $7.8 million of Agency interest only securities, or "Agency IOs," and $31.4 million of non-Agency RMBS. 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. During the quarter, we modestly decreased our holdings of fixed rate pass throughs and we slightly increased our holdings of reverse mortgage pools. Overall, the size of our RMBS portfolio declined to $1.242 billion as of December 31, 2015 from $1.281 billion as of September 30, 2015. In addition, separate and apart from the short TBA portfolio that we hold for hedging purposes, we held $83.7 million in notional amount of long TBA positions for investment purposes at December 31, 2015, as compared to $81.5 million at September 30, 2015. For financial reporting purposes, TBAs are considered derivative instruments.
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
1 Core Earnings is a non-GAAP financial measure. See "Reconciliation of Core Earnings to Net Income (Loss)" below for an explanation regarding the calculation of Core Earnings.
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.
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 $(11.0) million, or $(1.21) per share, on our aggregate Agency RMBS portfolio, while we had total net realized and unrealized gains of $5.1 million, or $0.56 per share, on our interest rate hedging portfolio. Pay-ups on specified pools also declined during the quarter as interest rates rose and prepayments declined, 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 0.73% as of December 31, 2015 from 0.99% 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 40% (as measured by sales and excluding paydowns), and we captured net realized gains of $1.2 million, excluding hedges and U.S. Treasury securities.
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 4.00%, up slightly from 3.97% as of September 30, 2015. 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 continues to include 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.
We expect to continue to target specified pools that, taking into account their particular composition and based on our prepayment projections: (1) should generate attractive yields relative to other Agency RMBS and U.S. Treasury securities, (2) should have less prepayment sensitivity to government policy shocks, and/or (3) should create opportunities for trading gains once the market recognizes their value, which for newer pools may come only after several months, when actual prepayment experience can be observed. We believe that our research team, proprietary prepayment models, and extensive databases remain essential tools in our implementation of this strategy.
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 positions. The lower our net Agency premium, the less we believe we are exposed to market-wide increases in Agency RMBS prepayments. As of December 31, 2015, our net Agency premium as a percentage of fair value on long Agency RMBS holdings was approximately 4.1% as compared to 4.8%, as of September 30, 2015. Excluding TBA positions used to hedge our long Agency RMBS portfolio, our Agency premium as a percentage of fair value was approximately 6.2% and 7.0% 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.
In the aftermath of the significant fourth quarter yield spread widening, and with prepayments remaining relatively muted despite continued low levels of mortgage rates, we believe that Agency RMBS currently offer very attractive net interest margins and overall relative value.
Yield spreads on non-Agency RMBS were generally not immune to the fourth quarter broad 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. During the quarter, our non-Agency RMBS generated a positive return and in light of more attractive opportunities in the market, we slightly increased our portfolio. As of December 31, 2015, our investment in non-Agency RMBS was $31.4 million as compared to $28.9 million as of September 30, 2015.
For the quarter ended December 31, 2015, the weighted average yield of our portfolio of Agency and non-Agency RMBS was 2.84%, while our average cost of funds including interest rate swaps and U.S. Treasuries was 1.17%, resulting in a net interest margin for the quarter of 1.67%. In comparison, for the quarter ended September 30, 2015, the annualized weighted average yield of our Agency and non-Agency RMBS was 3.40%, while the average cost of funds including interest rate swaps and U.S. Treasuries was 1.21%, resulting in a net interest margin of 2.19%. Our interest income is subject to fluctuations based on adjustments to premium amortization as a result of changes in prepayments of our Agency RMBS (accompanied by a corresponding offsetting adjustment to realized and unrealized gains and losses). We refer to this adjustment as a "Catch-up Premium Amortization Adjustment." The amount of this adjustment can vary significantly from quarter to quarter. During the fourth quarter, we had a negative Catch-up Premium Amortization Adjustment in the amount of $1.1 million, which decreased our net interest income. Excluding the Catch-up Premium Amortization Adjustment, our weighted average yield on our portfolio was 3.18% and our net interest margin was 2.01%. During the quarter ended September 30, 2015, the Catch-up Premium Amortization Adjustment increased interest income by approximately $0.9 million. Excluding this Catch-up Premium Amortization Adjustment, the weighted average yield on our portfolio for the quarter ended September 30, 2015 would have been 3.14% and our net interest margin would have been 1.93%.
While on a quarter-over-quarter basis our annualized cost of funds decreased to 1.17% from 1.21%, our cost of repo funding increased and our cost of hedging with interest rate swaps and short positions in U.S. Treasury securities decreased. As mentioned above, market participants had widely anticipated that the Federal Reserve would raise its target interest rate at the December meeting, which, in fact, did occur. This put upward pressure on repo funding costs. Leading up to year end, we shortened the average term of our repo borrowings, but following year end we have generally sought to lengthen the term of our repo borrowings. In light of the FHFA's decision to proceed with its ban of captive insurance company memberships in the Federal Home Loan Bank System, or "FHLB," the need for current member companies to find alternative financing could put additional upward pressure on repo rates for Agency RMBS over the next several months. However, we believe the impact of this development should be mitigated by the abundance of Agency RMBS repo lenders currently active in the market. Over the course of the fourth quarter, our interest rate swaps decreased in notional size as well as in weighted average years remaining to maturity, thereby leading to a decline in this component of our cost of funds. This was generally consistent with the fact that we held a slightly smaller portfolio of Agency RMBS in the fourth quarter as compared to that of the third quarter.
After giving effect to a fourth quarter dividend of $0.45 per share, our book value per share was $15.86 as of December 31, 2015, a 2.1% decrease from our book value per share as of September 30, 2015 of $16.20. Our economic return on book value for the fourth quarter was 0.7%. Economic return on book value is computed by adding back dividends to ending book value per share, and comparing that amount to book value per share as of the beginning of the quarter.
For the quarter ended December 31, 2015, Core Earnings was $4.5 million, or $0.49 per share, and for the quarter ended September 30, 2015, Core Earnings was $6.3 million, or $0.69 per share. Core Earnings is a non-GAAP financial measure. The decrease in our Core Earnings quarter over quarter was primarily related to a decrease in our net interest income, which was principally related to a Catch-up Premium Amortization Adjustment related to an increase in prepayments in our Agency pools. See "Reconciliation of Core Earnings to Net Income (Loss)" below for an explanation regarding the calculation of Core Earnings, and Core Earnings excluding Catch-up Premium Amortization Adjustments.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Article Type:||Financial report|
|Date:||Feb 18, 2016|
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