Ellington Residential Mortgage REIT (NYSE:EARN) is a name that I have argued that you need to know about. It has ebbed and flowed with the tides of the mREIT sector. Although I was caught somewhat by surprised by some dividend cuts, the cash flows and core earnings seemed to be covering the payouts. That said, I see the dividends as secure, and overall, EARN has been a winner. The stock now seems to have some momentum once again so the purpose of this article is to check back in on the performance of the name. Many of the companies that have reported their fourth quarters have showed a turnaround for the quarter following dismal first half 2016 reports. EARN's Q4 report followed the trend mostly but there were some important negatives, and so I would like to review the key metrics that I look for in an mREIT (table 1).
Table 1. Key Metrics of Ellington Residential Mortgage REIT
Most Recent Data*
Q4 2016 book value and % change from Q3 2016
Net interest rate spread in Q4 2016
Q4 Net income per share
Q4 Core income per share
52-week share price range
Source: Ellington Residential Mortgage REIT's Q4 Results
*as of 12/31/16
The company saw a quarter-over-over decline, but the company made money on a GAAP basis. It reported a net gain of $2 million or $0.22 compared to a gain of $6.6 million or $0.73 per common share last quarter. However, a better measure of the ability of the company to pay its dividend is its core earnings. Core earnings, excluding catch-up premiums, were $4.3 million or $0.47, versus $4.4 million or $0.48 in Q3. This dip breaks a trend the company had seen of increasing core earnings. What's the most important thing to note here is that the dividend of $0.40 was indeed covered by core income. Given all of the results in 2016, I really am still surprised by the dividend cut. Be that as it may, the company has consistently seen year-to-date core earnings per share more than cover the dividends paid since I have been covering it.
Funds from operations
As many of you know, I believe it also can be helpful to examine a company's funds from operations. That said, EARN's most recent available funds from operations show that although the funds from operations have declined slightly quarter over quarter, it has had very stable numbers here. Further, funds from operations have been relatively stable year to year. The most recent data show funds from operations coming in at a positive $8.7 million, easily covering the $3.7 million in dividends paid.
Book value continues to be the strongest predictor of an mREIT's share price. When examining an mREIT, we need to know what we are paying relative to what the company's assets are roughly worth. Book value has been falling over the last few quarters, just like most names in the sector. At the end of Q3 2015, book value was $16.20. To end Q4 2015, it was $15.86. At the end of Q1 2016 it was $15.39, falling $0.47 or 3%. That hurt. It stabilized in Q2 2016, and then rose 2% in Q3 2016 to $15.70. Then, here in Q4 2016, it fell once again, back to $15.53. Looking at things as a whole, book value is trending lower versus 2015, but has held firm around $15.50 all year. At the very least it seems that there has been in a reversal of the bleeding the name has experienced in book value and as such the stock has been closing its discount-to-book. We have come a long way from when the name was a sub-$10 stock and I pounded the table for you to buy.
Net interest rate spread
The reason earnings were pressured is that there was some negative impacts in the key metrics. The net interest rate spread is a good measure for earnings potential. EARN saw its average asset yield on its investment portfolio come in at 2.95%, rising heavily from Q3 which saw 2.31%. EARN's average cost of funds during the quarter came in at 1.06%. Since the yields rose more than that cost of funds, the company saw its net interest rate spread widen significantly. The average net interest rate spread was 1.89%, versus 1.30%. However, if we back out adjustments that exclude the catch-up premium amortization, the spread actually narrowed. It came in at 1.69% versus 1.77% last year.
Constant prepayment rate
The constant prepayment rate has become my most watched indicator. It is critical. It had been rising for many mREITs over the last year, and I had been on record that I expected prepayments to subside for most mREITs in Q3 and into Q4 2016. As predicted we saw the constant prepayment rate rise for the company, even though its prepayments are well below sector average. The weighted average prepayment rate was 7.1% for the first quarter, then 10.1% in Q2. In Q3 it spiked to 12.7%. For Q4, on the agency specified portfolio, it rocketed to 15.6%. Prepayments are now above sector average. This is the absolute highest prepayment rate I have seen for the company since I started covering it.
Despite what was essentially a mostly negative report versus Q3, the stock is rising. I still consider EARN a superior mREIT over many others on a comparative basis. The yield markets are simply performing well, and this includes mREITs. It had a few bad quarters with the sector. Given the fact that the dividend is being easily covered, I still like the name. It is a conservative mREIT and its key metrics are superior to many in the sector. I still have a hold rating.
Note from the author: Christopher F. Davis has been a leading contributor with Seeking Alpha since early 2012. If you like his material and want to see more, scroll to the top of the article and hit "follow." He also writes a lot of "breaking" articles, which are time sensitive, actionable investing ideas. If you would like to be among the first to be updated, be sure to check the box for "Real-time alerts on this author" under "Follow."
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.