mREIT EARN Uses Data to Manage Interest Rate Risk

REIT magazine: March/April 2019

Ellington Residential Mortgage REIT (NYSE: EARN) is an Old Greenwich, Connecticut-based mREIT, which invests primarily in agency residential mortgage-backed securities (RMBS). The company prides itself on using its data and analytics to manage interest rate risk, rather than attempting to take a direction on where rates are heading. 

JR Herlihy, EARN’s COO, explains, “We don’t have a crystal ball on interest rates, and we’re not in the business of trying to predict them. Our business is seeking to capitalize on a data advantage, when we can use the power of our analytics and prepayment models to invest.”

 According to Douglas Harter, a Credit Suisse analyst who follows the company, “EARN’s exposure to interest rates is at the lower end of the agency-focused mREITs, but higher than more diversified mREITs.”

Maximizing Its Investment Dollar

EARN, co-sponsored by a Blackstone Group fund and Ellington Management Group, was formed in 2012, before going public in 2013. RMBS pools guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae form its mainstay, and it engages in hedging strategies, using interest rate swaps, and to-be-announced (TBA) mortgages to offset its interest rate risk. 

Laurence Penn, EARN’s president and CEO, notes, “We can borrow money basically close to Treasury rates. We can get the higher yields that Fannie Mae, Freddie Mac, and Ginnie Mae securities provide, and we can use leverage to buy securities equal to several multiples of the capital that we have to invest.”

Mark Tecotzky, EARN’s Co-CIO, sees the agency mortgage market as offering favorable investor opportunity today. “Agency mortgages are, on a historical basis, relatively high-yielding versus Treasuries. Prepayments are currently well-contained and fairly easy to manage. And the supply-demand technicals for agency mortgages relative to Treasuries are very good,” Tecotzky notes. 

Smaller Size Has Pros and Cons

With lingering market turbulence and ramifications of the government shutdown, the Fed has been more dovish of late. “The outlook is perhaps a little more sanguine for rates to stay in a range. That could change, because there are a lot of tail risks out there. Being smaller means that we can be flexible in terms of trading and pursuing relative value,” Herlihy says.

The REIT is currently trading at a discount to its book value. Despite the discount, “the above-average dividend yield and the highly regarded portfolio management provided by Ellington Management Group—as evidenced by the company’s historically strong book value performance, especially in periods of high volatility—could make the shares attractive and appropriate for select long-term, income-oriented investors,” says JMP Securities analyst Mikhail Goberman. JMP currently has a market perform rating on the stock.

Another factor that could impact EARN is any potential change to housing policy, including leadership changes at the Federal Housing Finance Agency and the Federal Housing Administration. Tecotzky believes that any change would have more of a positive impact, noting that “most of the potential policy changes have to do with bringing in more outside capital and reducing the amount of credit risk that resides in the GSEs. Generally, most of the proposed changes would be favorable for agency mortgages.”  

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