Mergers on Wall Street have a way of creating substantial volatility. 

Usually, the company that makes the acquisition immediately loses a few points, while the company that is acquired skyrockets because of the price premium it receives on the deal. Investors who own the acquiring company hope that the merger will create substantial earnings and revenue that will propel the stock higher down the road.

Take a look at one mortgage real estate investment trust (mREIT) that recently purchased two other mREITs over the past two months and whether it appears that investors should be optimistic about the purchases.

Ellington Financial takes some risks other mREITs won’t touch, but only if it feels the return adequately compensates for that risk. For example, loans are often made to underserved niche market segments that cannot procure loans elsewhere. Ellington Financial uses a risk-management infrastructure system to assess the risks involved in any deals it makes and charges higher interest rates to compensate for potential losses.

Ellington Financial has done well over the first half of 2023, with a total return of 16.95%. It has a market cap of $919.645 million.

Under the terms of the agreement, Ellington Financial will pay $4.77 per Arlington common stock share. This was a 73% premium to the closing price on May 26 for Arlington Asset Investment and a 15% discount to Arlington’s diluted tangible book value per share as of March 31.

Arlington Asset Investment has a poor record over the past five years. Its quarterly earnings per share (EPS), which ranged between $0.44 and $0.59 in 2018, have declined into the single digits. Its total return over the past five years is negative 38.33%. It also suspended its dividend at the end of 2019 and has not paid one since.

Arlington Asset Investment’s total return of 56.95% in the first half of 2023 is far better, but most of that was the direct result of the merger announcement. Bethe announcement, Arlington Asset had a first half 2023 total return of negative 6.78% in the first half of 2023. 

Then on July 3, Ellington Financial announced it will acquire Great Ajax Corp. (NYSE:AJX) for $7.33 per share, a 19.5% premium to the $6.13 closing price of Great Ajax on June 30. At the close of the transaction, each Great Ajax common share will convert to 0.5308 shares of Ellington Financial stock.

“We are extremely excited about the opportunity to add a significant portfolio of strategic assets, including over $1 billion of highly creditworthy first-lien residential RPL (reperforming loans) and NPL (nonperforming loans) investments at attractive prices, which complement our existing investment portfolio nicely and align with our expertise and existing management platform,” Ellington Financial CEO Laurence Penn said of the purchase.

Ellington Financial makes it clear that its philosophy is to assess risk before making any transaction, and there are risks to these acquisitions. On May 5, Great Ajax cut its quarterly dividend from $0.25 to $0.20, following its poor earnings report the previous day. Non-generally accepted accounting practices (GAAP) earnings per share of negative $0.09 missed analyst estimates by $0.14, and revenue of $0.54 million was $6.3 million below the estimates.

Since the beginning of 2022, Great Ajax has had a negative total return of 35.83%, but in 2023, the shares have performed a bit better with a 1% total return.

Analysts have been bullish on Ellington Financial recently. On May 16, Keefe, Bruyette & Woods Inc. upgraded Ellington Financial from Market Perform to Outperform and announced a price target of $13.75. On May 26, JMP Securities reiterated a Market Outperform rating on Ellington Financial and maintained a $13.50 price target.

Long-term Ellington Financial investors will hope that these two acquisitions bear fruit in the years to come, but for now it looks like Ellington Financial has taken on two new and somewhat large risks in its overall portfolio.

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