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Ellington Financial Corp.'s Strategy Outperforms, Yet The Stock Trades At A Huge Discount To Peers

Mar. 09, 2018 4:54 PM ETEllington Financial Inc. (EFC)8 Comments
MicroValue profile picture


  • Although structured as a master limited partnership (MLP), Ellington Financial Corp. (EFC) is essentially a diversified mortgage REIT (mREIT) that has lagged its mREIT peers due to its conservative hedging.
  • The hedging is finally paying off as Ellington's book value has grown nicely in the first two months of the year while peers expect losses.
  • What's more, EFC is aggressively buying back stock at deep discounts in a huge win for shareholders.
  • With volatility on the rise and EFC's strategy working, EFC deserves to trade in line with its peers, not at a big discount.

Before we start, let's make one thing clear: Ellington Financial Corp. (NYSE:EFC) is a master limited partnership (MLP), so if you don't want to deal with filing an annoying K-1 tax form or only have IRA money, EFC is probably not for you. I don't like filing K-1s either, but I'm willing to put up with extra hassle for an attractive return opportunity, which I think EFC currently offers. (As a side note, many believe that MLPs are tax disadvantaged now relative to REITs, but this Forbes article seems to state otherwise: 2018 Tax Guide To MLPs.)

Although technically an MLP, EFC invests like a mortgage REIT (mREIT). As shown in the figure below, EFC is primarily invested in mortgage-related investments such as RMBS, CMBS, and residential loans, even as it has diversified its portfolio with CLOs, consumer loans, and ABS:


Source: Q4 Earnings Presentation

With credit spreads tight and interest rates on the rise, one can reasonably ask why invest in an mREIT-type investment, especially one that owns exotic risky stuff such as collateralized loan obligations (CLOs) and asset-backed securities (ABS)? I thought the same thing myself, but I found EFC too compelling to ignore for the following reasons:

  • EFC is trading at 22%+ discount to diluted NAV and aggressively buying back stock, allowing investors to benefit from a 22%+ risk-free arbitrage.
  • EFC has a strong long-term performance record of consistently growing book value per share. Notably, this includes navigating the last financial crisis in which many credit-related mREITs went bankrupt.
  • EFC has a conservative philosophy with substantial credit and interest rates hedges to preserve book value through difficult market conditions.
  • The buyback and hedges have been working. EFC has been growing book value in 2018, while its hybrid mREIT peers have had flat-to-declining book values.
  • EFC offers an

This article was written by

MicroValue profile picture
I am a conservative investor focused on value stocks, exchange-traded debt, and closed-end mutual funds. I worked for 14 years for a fund that invested primarily in closed-end mutual funds, BDCs, and mortgage REITs. I also have 20 years of experience investing in smallcap and microcap stocks. I am a CFA charterholder and teach at Westminster College.

Analyst’s Disclosure: I am/we are long EFC. 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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (8)

tadsuhm profile picture
Disagree with DVL above. Mgmt is very smart and experienced. Look up there resumes. EFC hasn’t performed well because they have been conservative with hedges not because they don’t know what they are doing. Most mreits & bdc’s just go long and pray. These guys operate more like a hedge fund and like hedge funds they have underperformed because we’ve been in a bull market and they haven’t gone all-in long.
PennyPlanSupporter profile picture
There is "underperformance" and then there is "terrible performance much worse than a random toss of a dart at a page of equity and debt listings".
MicroValue profile picture
You have to differentiate portfolio performance from stock performance. Management directly controls the performance of the investment portfolio. Management does not directly control stock price performance, which can deteriorate significantly if the manager's investment approach goes out of style.

This is which happened in the case of EFC, which is now trading at a 20%+ discount. EFC has gone out of favor as its hedged approach has been underperforming. It has been underearning its dividend, while its less-hedged peers have been earning double-digit ROEs in the recent stock and bond bull markets. Note that EFC has been earning positive portfolio returns, just not enough to cover the high dividends.

Now, however, we are finally starting to see the benefits of EFC's hedged strategy. For instance, AGNC just announced a large drop in its February NAV, while EFC is up nicely for the year.

Also, EFC is finally taking aggressive action to buy back stock at deep discounts. If they continue to do so, this should support the price to prevent further discount widening. Even better, these share repurchases are very accretive to NAV.

This may be cold comfort to those who bought earlier and see the stock trading at 20%+ discount, but for those buying now I feel EFC's discount offers an attractive entry point. And there is always the possibility the discount will narrow as the company's hedged approach may come back into style.
MicroValue profile picture
One clarification. They did have a horrible 2016, with a negative book value return due to losses on corporate credit hedges, but other than that yearly book value returns have been solid if not spectacular.
PennyPlanSupporter profile picture
Terrible management and a history of dividend cuts
Hampton108 profile picture
Have owned EFC since it paid .77 cents per quarter dividend...and though I won’t see the entire return of my investment, the dividends have taken the sting out of my losses. At today’s price and lower is a good entry point. Don’t foresee another dividend cut for awhile...

Long: EFC
MicroValue profile picture
Yes unfortunately investor returns can be much worse than book value returns when a company goes from a premium or modest discount to a deep discount. That is why I mostly avoid companies at premiums, but then I miss out on some great businesses such as NRZ or MAIN, so there is no perfect solution.
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