Ellington takes stake in Great Ajax after merger cancellation

Ellington Financial and Great Ajax, a pair of real estate investment trusts, have mutually decided to terminate their merger agreement announced in July, citing a lack of progress made towards completing the deal.

But Ellington isn't walking away empty handed from the canceled deal, which was announced in a joint press release. It is paying a break-up fee of $16 million, of which $5 million is cash.

The remaining $11 million is being used to purchase 1.666 million shares of Great Ajax at $6.60 per share.

That means Ellington now owns 6.1% of Great Ajax stock. Another 273,983 shares are owned by an affiliate of Ellington's external manager.

However, the underlying reason for the shift might be evident in how both companies' stock price has moved since the agreement was signed, a Keefe, Bruyette & Woods report said.

"We believe the termination was likely driven by a combination of underperformance of Great Ajax assets and outperformance of Great Ajax versus Ellington shares since the merger announcement," Bose George, an analyst at KBW, wrote.

"Since the all-stock transaction was announced in July, Ellington's shares are down 11% while Great Ajax' shares are up 9%."

Specifically, Great Ajax' portfolio of fixed-rate loans could have duration risk as a result of the increase in mortgage rates over the past few weeks, said BTIG analyst Eric Hagen in his weekly roundup. On Monday morning, the yield on the 10-year Treasury poked slightly above the 5% ceiling; anecdotal reports indicate some lenders are already pricing 30-year fixed-rate loans at or above 8%.

"We liked the merger for Ellington, and think it may have only received partial credit for the deal in its valuation since initially announced in July, yet we don't see a lot of downside from it breaking apart," Hagen declared. "We think an $11 million investment in Great Ajax could still be attractive at these valuations, but isn't big enough to move the needle at Ellington."

But for Great Ajax, the termination is more material, because it is likely to hold down the stock price, especially now that concentration risk exists with Ellington as a major shareholder.

Great Ajax shares are getting harder hit as a result of the deal's cancellation. The agreement priced the stock at $7.33 per share.

On June 30, before the deal was announced, Great Ajax closed at $6.13 per share, before increasing on July 3 to $6.95.

By Sept. 20, the stock had retreated to $6.37. The merger termination was announced after the markets closed that day.

The following Monday, Great Ajax opened at $5.27 per share and by 11 a.m., it was down to $4.25 per share.

Ellington, on the other, closed at $13.80 per share on June 30, and fell to $13.54 on July 3. The stock did rally a few weeks later but that was short-lived and by Oct. 4, touched a 52-week low at $11.77.

Its Oct. 20 close was $12.23 per share, down $0.59 from the Oct. 16 close of $12.82. By 11 a.m. on Oct. 23, it was at $12.15 per share.

"Ellington remains a securitization joint venture partner of Great Ajax and the companies will continue to work together on mortgage loan opportunities," George noted.

Through an affiliate, Great Ajax owns mortgage servicer Gregory Funding. That tie was part of Ellington's rationale for the merger in the first place.

In May, looking to boost its servicing portfolio, Ellington agreed to merge with Arlington Asset Investment. That $154 million transaction is apparently still in progress; a request for a status update from Ellington has not yet been returned.