Investment firm sees opportunities in reverse mortgage stake despite market challenges

Ellington Financial described in Q2 earnings that market challenges have hit its reverse mortgage investment, but reasons for optimism exist

Mortgage investment firm Ellington Financial LLC (NYSE: EFC) released its Q2 2022 earnings results, offering details about the performance of top 10 reverse mortgage lender Longbridge Financial and some of its continuing perspectives on the health of the reverse mortgage business.

“Ellington Financial had an economic loss of 6% for the quarter,” said Ellington CEO Larry Penn on an earnings call announcing the Q2 results. “This was mainly the result of losses on our unsecuritized non-QM loans and agency RMBS, where we were hurt by rapidly rising interest rates and widening yield spreads. We also sustained significant mark-to-market losses on our investments in loan originators where unrealized losses totaled $26.5 million or $0.44 per share during the quarter.”

Reverse mortgage market conditions

As it pertains to the firm’s stake in Longbridge, that company has not been immune to the larger economic trends and industry pressure, he said, which tracks with challenges other lenders have described recently.

“In the reverse mortgage market, we have seen HECM yield spreads grind wider throughout the year, and that has weighed heavily on profitability at Longbridge,” Penn explained. “Longbridge had a significant net loss for the second quarter driven by a further reduction in the value of its MSR portfolio and losses on its pipeline of committed loans.”

However, there are positive signs for the lender, he said.

“On the bright side, securitization spreads are showing signs of stabilizing and Longbridge continues to add market share,” he said. “As we saw during the economic turmoil of 2020, demand for reverse mortgages can surge in a challenging economic environment because reverse mortgages provide liquidity to borrowers without the requirement to make monthly principal and interest payments.”

Longbridge’s growth, future reverse prospects

Penn’s observations about growing market share conform to monthly origination data as of late. In reports compiling lender origination data published monthly by Reverse Market Insight (RMI), Longbridge has seen more pronounced volume growth over the past couple of months when compared to other lenders in the space, particularly in the top 10 originator rankings.

In June, Longbridge’s volume rebounded from a May slump by rising 54.6% to 484 loans, and in July the rising trend continued with another jump of 30.6% to 632 loans. Based on July data, Longbridge was the only top 10 originator to see a volume increase for that month.

While current conditions remain challenging particularly on the forward side, Penn relates optimism about the performance of Ellington’s more specialized loan product investments including reverse mortgages, he said.

“The vast majority of our originator stakes are in more specialized sectors, reverse mortgages, non-QM mortgages, specialty, consumer finance, residential transition loans, and commercial mortgage bridge loans,” he said. “In these particular markets, we project stronger growth and more durable profit margins over the long term.”

The company also disclosed its proprietary stakes in loan origination businesses as of June 30th. The combined value of its originator stakes sits at $112 million, with 53% of that figure being in reverse mortgage loan origination according to company CFO J.R. Herlihy.

When asked about the performance of the top 10 lenders for the month of July including Longbridge’s growth, RMI President John Lunde told RMD that technical changes at the lenders themselves likely account for some fluctuations, but the next few months will be telling in terms of how well the major lenders are weathering the change in refi-focused business.

In that same vein, reverse mortgage companies would be well-suited to shift their primary focus to generating new customers if they haven’t already, he said. Industry volume is slowing, and the acquisition of new customers can help to alleviate the pressure that comes from reduced origination volume, he explained.

Recent history

In February, Ellington announced that it would acquire the Mahwah, N.J.-based Longbridge in a deal valued at approximately $75 million for a 49.6% interest, effectively putting the lender under the complete ownership of the investment firm upon the deal’s closing. While initial estimates offered that the deal may close in Q2 2022, the earnings presentation made no mention of an impending closure of the deal.

The deal had been discussed in general terms between teams at Ellington and Longbridge before, but more formal conversations about an acquisition only came into clearer view closer to the announcement of the actual deal, according to an interview in February with Longbridge CEO Chris Mayer. In terms of any changes that could have been made internally, Mayer explains that Longbridge will maintain its existing structure.

When asked about the reasoning for beginning the process of acquiring Longbridge, Penn described a track record in its investment that performed favorably to the standards of the company.

“Longbridge is in a non-commoditized industry with significant barriers to entry and attractive margins, and it has been a star performer for Ellington Financial over the past few years, generating some pretty incredible returns for us, even during the depths of COVID, by the way,” Penn said in February. “Because reverse mortgage loans provide liquidity to borrowers without the requirement of monthly principal and interest payments, borrower demand for the product actually surged amidst the economic turmoil brought on by COVID.”

In late-day trading as of 3:45 p.m. EST on Monday, Ellington’s stock price had grown 1.5% from market open to $15.86.

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