Ellington Financial LLC Reports Third Quarter 2012 Results
OLD GREENWICH, Ct ., Nov. 7, 2012 /PRNewswire/ -- Ellington Financial LLC (NYSE: EFC) (the "Company") today reported financial results for the quarter ended September 30, 2012 .
Highlights
- Net increase in shareholders' equity resulting from operations ("net income") for the third quarter was $29.5 million or $1.59 per basic and diluted share. The Company's results were principally driven by a strong contribution from its non-Agency strategy, but also augmented by solid results from its Agency strategy. For the nine months ended September 30, 2012 , net income was $72.4 million and represented an annualized return on equity of 23.5%.
- Book value per share as of September 30, 2012 was $23.88 on a diluted basis after payment of a $0.70 per share second quarter dividend on September 17, 2012 , as compared to book value per share of $23.47 on a diluted basis as of June 30, 2012 .
- The Company's non-Agency MBS strategy generated income of $37.2 million for the quarter ended September 30, 2012 . Performance was driven by yield earned on invested assets, as well as realized and unrealized gains.
- The Company's Agency RMBS strategy also performed well, generating $5.1 million in income during the quarter, and continued to be centered around the Company's ability to identify, invest in and actively trade pools with specific prepayment-protection characteristics.
- During the quarter, the Company completed a public offering of 4.025 million shares of common stock, raising net proceeds of $87.8 million .
- The Company announced a dividend for the third quarter of 2012 of $0.70 per share payable on December 17, 2012 to shareholders of record on November 30, 2012 .
Third Quarter 2012 Results
For the quarter ended September 30, 2012 , the Company recognized net income of $29.5 million , or $1.59 per diluted share. This compares to net income of $10.8 million , or $0.64 per diluted share, for the quarter ended June 30, 2012 . The Company's results reflected positive contributions from both of its current strategies—non-Agency MBS as well as Agency RMBS.
The Company's non-Agency MBS strategy generated income in the amount of $37.2 million for the quarter, or $2.01 per diluted share. In the third quarter, the market for non-Agency MBS rallied significantly. As home prices continue to stabilize (and are even trending higher in many regions), and as mortgage default rates continue to decline, investor demand for non-Agency RMBS has continued to increase. Meanwhile, alternatives for higher yielding investments in those other fixed income sectors where investors typically search for higher yields, such as Agency RMBS and investment grade corporate bonds, have become more limited, thereby further increasing the demand for non-Agency MBS. With interest rates currently at historically low levels, many financial institutions (such as pension funds and insurance companies) are finding that they will be unable to fund their long term liabilities without increasing their allocations to higher-yielding asset classes; we believe that this state of affairs will continue to provide support for the non-Agency MBS sector. In addition, where there had formerly been great concerns that U.S. banks would eventually have to sell much of their non-Agency MBS holdings as Basel III bank capital rules became fully phased in, the release earlier this year of the Simplified Supervisory Formula Approach (SSFA), which changed the method of calculating capital charges for securitization exposures, has reduced the likelihood of future forced selling of non-Agency MBS by banks.
The Company's income during the quarter from its non-Agency MBS strategy consisted primarily of interest income and realized and unrealized gains on long non-Agency MBS. Results for the quarter and nine months benefited directly from the Company's decision, beginning in 2011, to rotate out of higher-priced non-Agency RMBS, and into middle-dollar price non-Agency RMBS that it believed had more upside, and to reduce its credit hedges significantly. However, following the significant non-Agency RMBS rally, the Company has taken advantage of the opportunity to rotate out of certain of its lower-priced 2006/2007 vintage subprime assets that it now believes have become fully valued, and into other non-Agency MBS assets whose prices have lagged in comparison during the recent rally. Given that all non-Agency RMBS assets have rallied substantially, security selection should become an even more important factor in portfolio management, and the Company believes that its analytical approach to security selection will help generate superior returns in this environment. The Company also increased its holdings of CMBS in light of the attractive opportunities in that market.
For the quarter ended September 30, 2012 , interest income was positively impacted by the Company's upward adjustment of its future housing price assumptions, which are used in the determination of the yields at which the Company accrues interest income on its investments. While this adjustment in assumptions increased the effective yields at which the Company accrued interest income on many of its investments during the quarter, total net income was not affected since all of the Company's investments are marked to market through net income. On a more detailed level, to the extent that an increase in book yields causes an incremental increase in interest income during a reporting period for any investment, the amortized cost of such investment at the end of such reporting period is incrementally increased by the same amount, which, as a result of the mark-to-market process, leads to an exactly offsetting incremental decrease in the change in net unrealized gain (loss) on such investment.
The Company's Agency RMBS strategy had its third consecutive strong quarter, generating $5.1 million in income consisting primarily of interest income and realized and unrealized gains on long Agency RMBS. Total interest income and realized and unrealized gains for long Agency RMBS for the quarter ended September 30, 2012 was $12.2 million . Opportunistic trading of assets within this portfolio has and continues to be a key contributor of returns in this strategy. Income was partially offset by hedging costs of $6.6 million , including net short positions in TBAs, interest rate swaps and U.S. Treasuries. TBAs are used to hedge the long Agency RMBS portfolio against prepayment and interest rate risk, while interest rate swaps and U.S. Treasuries are used to hedge against 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 (which we refer to 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 continued to experience favorable prepayment rates, and in particular, have prepaid much more slowly than their generic pool counterparts. However, current prepayment risk in the market remains elevated. The Fed's announcement on September 13, 2012 of its intent to purchase $40 billion of Agency RMBS a month for an indefinite period drove Agency MBS prices to all-time highs. This move by the Fed is directly intended to lower mortgage rates and spur refinancing activity, and reinforces the importance of the Company's strategy to invest in prepayment-protected pools and to maintain short positions, through the TBA market, in generic pools that are most vulnerable to increased prepayments. While the Fed's action has contributed to a decline in yields on purchased Agency RMBS, the effect of higher generic pool prepayment rates are reflected in lowered costs to roll the Company's TBA short positions. At the time of the Fed announcement, the majority of the Company's long portfolio was invested in higher coupon prepayment-protected pools. These pools, which exhibit materially slower prepayment speeds than their generic pool counterparts, continue to earn high positive carry compared to the cost of their associated TBA hedge.
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 September 30, 2012 , net Agency premium as a percentage of fair value on long Agency RMBS holdings was approximately 3%. Excluding its TBA hedging positions, the Company's Agency premium as a percentage of fair value is approximately 8%.
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 September 30, 2012 , net-asset-value-based total return was 4.25%. For the nine months ended September 30, 2012 , net asset-value-based total return was 16.31%. Net-asset-value-based total return from inception of the Company ( August 17, 2007 ) through September 30, 2012 was 84.92%.
"We are very pleased to report our third quarter and nine month financial results for the Company," said Laurence Penn , Chief Executive Officer and President of the Company. "The third quarter was gratifying for two reasons. First and most importantly, our results for the quarter were quite strong and were driven by significant contributions from both of our core strategies: non-Agency MBS and Agency RMBS. Our non-annualized return on equity was 6.6% for the quarter and 17.6% for the nine months ended September 30, 2012 . Our non-Agency MBS results, while clearly benefitting from the overall rally that occurred in the sector, also validated our previous decision to rotate the portfolio into lower-priced securities that we thought had become undervalued. Re-assessing the non-Agency RMBS market following this rally, we have taken the opportunity to partially rotate out of certain of those same sectors that we had previously rotated into. The performance of our Agency RMBS strategy demonstrates that we have continued to succeed in identifying pools with undervalued prepayment-protection characteristics. Now that the Federal Reserve has embarked on a third round of quantitative easing, our ability to execute this strategy has become even more important, as is our ability to hedge the portfolio against prepayment risk with TBAs. Our Agency strategy continues to deliver outsized returns for us, particularly in relation to the relatively small amount of our capital that it utilizes."
"We were also extremely pleased to have successfully completed our first share offering following our October 2010 initial public offering. With this offering, which resulted in net proceeds to the Company of $87.8 million , we have increased the liquidity of our shares, increased the size of our company and lowered our expense ratio."
The following table summarizes the Company's operating results for the quarters ended September 30, 2012 and June 30, 2012 and for the nine month period ended September 30 , 2012: Click here To View
